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Caveat Emptor: Bottom Fishing With No Regrets

The pros and cons of waiting for the seller to declare bankruptcy.
Fortnightly Magazine - March 15 2003
  1. process to solicit additional offers and ensure that creditors are protected. Time is of the essence here. How the court conducts this overbidding process will depend on several factors, such as: (a) the scope of prior marketing efforts; (b) whether the debtor's operations are deteriorating; (c) whether the debtor is running out of the cash necessary to continue operations and preserve going-concern value pending a sale; (d) whether other potential bidders that have been contacted are willing to sign confidentiality agreements and invest the time and money necessary to commence due diligence; and (e) the size and complexity of the business.
    If the seller cannot meet payroll or other key expenditures to get to the point where it can close a sale as an ongoing business, the bargaining leverage of the seller and its creditors will be substantially reduced. The new potential buyer may be the only source of a bridge loan to meet payroll pending a closing. Perhaps most importantly, the shorter the time available to other potential bidders, the less likely they will be able to complete their due diligence in time to submit a competing bid.
    By waiting until the last minute, which often happens while the seller is trying to negotiate the best possible deal with the initial bidder, the seller may reduce the chances of creating a competitive bidding process.
  2. Buyer Protections. In most jurisdictions, a buyer that guarantees an opening minimum bid for a Chapter 11 auction can obtain reasonable protections to compensate it for the time and money it has spent in completing due diligence and negotiating its agreement with the debtor.
    In typical cases, courts will assure the stalking horse bidder that if it is outbid, it will be reimbursed for its out-of-pocket costs, within reason, and will receive a breakup fee. Such fees are usually in the range of 2 to 4 percent of the total purchase price.

These sorts of provisions may chill the willingness of other bidders to submit an overbid by increasing the initial minimum overbid to cover these costs. Moreover, such provisions always reduce the benefit of any overbid for creditors, because the stalking horse bidder must first be paid from any higher bid.

Some courts also will approve: (a) a "matching right" that allows the stalking horse bidder to prevail merely by equaling a competing bid; and (b) the right to "bid" the breakup fee and costs, so that it can "match" by bidding the amount a competitor bids, minus the amount it would receive if it is outbid. Virtually all courts will approve reasonable restrictions on competing bids, like a material minimum overbid relative to the size of the transaction.

Competing bids must usually be completely noncontingent. This gives the stalking horse bidder, which often has completed due diligence before the sale motion is even filed, a distinct advantage in large complex transactions. Other bidders are, quite literally, running to catch up so they can learn enough about the assets and operations to determine a fair price and remove all contingencies.

Some stalking horse bidders also may