In most bankruptcy cases, once a decision has been made to conduct a going-concern sale of the debtor’s business under Section 363 of the Bankruptcy Code, the emphasis is on maximizing the value of the business assets in order to return the largest distribution to the creditors. Indeed, the majority of recently filed Chapter 11 cases have resulted in going-concern sales. Experienced insolvency professionals have mastered the sale process and achieved extraordinary results, often under difficult circumstances. One common characteristic of all successful sales is the provision of adequate information about the assets and the operation of the debtor’s business in order to encourage prospective bidders to make the highest and best offers. By contrast, a lack of adequate information leads to uncertainty, undervaluation, and generally a poor sale. The corollary principle to adequate disclosure of information is that the winning bidder gets what it pays for – exclusive ownership of the assets and business it bought. All others who had an opportunity to review confidential information must refrain from using it to their competitive advantage. This article describes the techniques often used to reconcile these two disparate goals: the need to provide adequate information for potential purchasers and the need to protect the winning bidder from other potential purchasers' misuse of the confidential portions of that information.
Bankruptcy Court Role
The process commences with the debtor or trustee presenting the bankruptcy court with a motion to authorize a sale of the business assets of the debtor. The motion will describe the assets to be sold and the type of sale. A separate exhibit of the terms and conditions of sale indicating the place and time of the sale; the conditions for submission of qualified bids; and contact information for additional information, due diligence access, and inspection of the property will frequently be attached. Parties in interest may object at this stage if they feel the sale terms are improvident, e.g., the sale is being conducted before all prospective bidders can complete due diligence. Prior to the presentation of the sale motion, or often at the same hearing, the debtor will present a motion to retain a financial advisor and investment banker who is responsible for the conduct of the sale. Such motions will also disclose and ask the court to approve any special compensation agreements for the financial advisor or investment banker.
Typically the order authorizing a 363 sale will approve the terms and conditions, fix a date for objections, a date for the sale, and a date for the court to approve the sale by entry of a specific order. If all goes well, the parties won’t return to the court until after the bidding has concluded, the winning bidder identified, and the order specifically approving the sale to the winning bidder is submitted. Occasionally, a dispute over the timing or other term of the sale brings the parties to court in advance of the sale. Most often, the issues are the timing of the sale or the rights of secured lenders to credit bid at the sale.
The Initial Sale Process
Preliminarily, the Chapter 11 debtor will likely engage the services of a qualified investment banker or a financial advisor who will have some familiarity with the business and can determine the appropriate time period for identifying the universe of potential bidders, the marketing period, and methodology of sale (e.g., public auction) to obtain the highest and best offers. In most cases, solicitation of interest is made via a teaser advertisement inviting further inquiry. The teaser will be sent, unsolicited, to those who engage in a similar line of business and to all others who may have expressed an interest in making an offer. Before the sale process began, this universe of prospective buyers will necessarily include existing competitors of the debtor and those seeking entry into the same markets.
The Virtual Data Room
While the solicitation of interested buyers is underway, the financial advisor will be creating and populating an online virtual data room for the prospective bidders’ due diligence. In a typical Chapter 11 bankruptcy case, a lot of information about a debtor’s assets and liabilities is already available to everyone who has access to the bankruptcy courts' Pacer system. This public information includes schedules of the debtor’s assets and liabilities and monthly operating reports.
By contrast, the virtual data room will include not only the publicly available information, but also a great deal of confidential information about the debtor. Access to the virtual data room is strictly controlled and password protected. Typically, the information in the data room includes:
- A comprehensive description of the business, its products and services, and its locations.
- A current schedule of all tangible assets such as machinery, equipment, office furniture, and fixtures.
- An analysis of inventory categorized by raw material, work in process, and finished product.
- An analysis of all existing receivables, with an aging report.
- Three years of historical financial information, often with additional analyses such as profitability of products or product lines and schedules of material contracts and critical suppliers.
- A list of key customers and amount of annualized business volumes with each.
- Copies of all collective bargaining agreements and all benefit and retirement plans.
- A list of employees by location with salary and benefits, including medical and retirement.
- Copies of key employment contracts, including covenants not to compete.
- A recent search of filed UCC financing statements, tax liens, judgments, and filings in the U.S. Patent and Trademark Office.
- A schedule of all lawsuits pending and threatened.
- Copies of all insurance policies including property/casualty and workers' comp.
- All registered patents, copyrights, trademarks, trade names, and pending applications.
- A list of trade secrets.
- A model form purchase and sale agreement and a proposed sale order.
The Confidentiality Agreement
As a condition to access the virtual data room, each prospective bidder must sign a confidentiality agreement in the exact form proposed by the debtor’s counsel. Once the confidentiality agreement is signed and returned, a bidder will be assigned a unique access code allowing only that bidder to access the virtual data room.
Most of the confidentiality agreements include the following types of provisions:
- The Receiving Party understands and acknowledges that the Confidential Information has been developed or obtained by Debtor by the investment of significant time, resources, and expenses, and that the Confidential Information is a valuable, special, and unique asset of the Debtor which has provided Debtor with a significant competitive advantage. Therefore, for a period of three years, the Receiving Party agrees to hold in confidence and to not disclose the Confidential Information to any person or entity without the prior written consent of Debtor.
- For a period of three years, Receiving Party agrees not use any Confidential Information for any purpose other than to make an offer to purchase the assets or business of the Debtor.
- For a period of three years, Receiving Party shall not solicit, hire, or retain as a consultant any current employee of the Debtor unless such employee has been terminated by the Debtor for at least 90 days, and such employee is not subject to a nondisclosure agreement.
- Upon the written request of Debtor, the Receiving Party shall return or destroy, without protest, to Debtor, all written materials containing the Confidential Information delivered by Debtor to Receiving Party in connection with this Agreement, including, without limitation, all related notes. Within ten (10) business days of receipt of the request, the Receiving Party shall also deliver to Debtor a written statement signed by a corporate officer, certifying that all such materials have been returned or destroyed.
Depending on the nature of the business, access to confidential information is frequently staged, meaning that each prospective bidder who signs and returns the confidentiality agreement will have access to some confidential information, but only the qualifying bidders (those executing a form purchase and sale agreement, making an earnest money deposit, and demonstrating the financial ability to close the sale) will have access to more sensitive information such as customer purchases, inventory mix, or patent applications. Finally, only the winning bidder will have access to highly-confidential information such as source codes and trade secrets.
The Due Diligence Period
As the sale process unfolds and the deadline for submission of qualifying bids approaches, new due diligence issues often arise. Prospective bidders may wish to conduct confidential interviews of key employees or contact key customers to gauge the likelihood that they will stay with the business once it is sold. In addition, prospective bidders may want to tour the debtor’s plant to observe manufacturing processes, some of which may be highly confidential. These inquiries should also be covered by the confidentiality agreement.
Submission of Bids and the Auction
In some circumstances the debtor may designate a "stalking-horse" bidder, who makes an unconditional first offer that the debtor is prepared to accept absent a higher or better offer. The stalking-horse bidder is entitled to overbid protection and a break-up fee if it is not the winning bidder at the conclusion of the sale. Secured creditors may inquire about the status of the offers and may even be bidders themselves. Some are “loan to own” creditors who buy secured claims just to credit bid those claims at an auction sale.
After the deadline for submission of bids has passed, the debtor, its lenders, any unsecured creditors' committee, and any other official committee will want to evaluate the offers received and decide on the next step in the process, often making a recommendation to the bankruptcy court about which offer is the highest and best. Each of these parties should also execute a confidentiality agreement as a condition of reviewing the bids.
If more than one qualifying bid is received, there will be an auction sale among all qualified bidders, sometimes by sealed bid, but more often by open auction at a specified time and place. At one time, it was common for sales to be conducted in the bankruptcy court before the judge, but that rarely occurs now. Depending on the number of qualified bidders, the auction will be conducted at the office of one of the professionals, or in a large forum such as a hotel. Usually, only qualified bidders and their advisors, the debtor, the secured lender, and committee professionals are permitted to attend the sale. Breakout rooms will be furnished for bidders who want to discuss their topping bids or bidding strategy in confidence. Although questions regarding the sale format and procedures are permitted at the sale, the time for due diligence questions is expired and all bids made at the auction sale are unconditional.
Court Approval and Closing
Once the bidding has concluded, the debtor, the secured lender, and any official committee will meet to determine which bidder has made the highest and best offer. The winning bid will be submitted for court approval. Often, the winning bidder will be allowed additional time to determine which contracts it will designate for the debtor to assume and assign to the purchaser. It is extremely important that all executed confidentiality agreements are assigned to the purchaser so that it has the right to enforce any breach of the agreement. Most confidentiality agreements contain some form of the following assignment and enforcement language:
- The Receiving Party recognizes and acknowledges the competitive and confidential nature of the Confidential Information and that irreparable damage may result to the Debtor or to any purchaser if information contained therein is disclosed to any third party except as permitted. It is further understood and agreed that money damages may not be a sufficient remedy for any breach of this agreement. Accordingly, you agree that the Debtor or any assignee of the Debtor is entitled to an injunction or preliminary injunction without the posting of any bond and without proof of actual damages to prevent breaches or threatened breaches of this agreement and to specific performance of this agreement. Such remedies shall not be deemed to be the exclusive remedies for a breach by you or your Representatives of this agreement, but shall be in addition to all other remedies available at law or equity to you or the Debtor. Furthermore, you agree that you will notify the Debtor if you become aware of any unauthorized disclosure of any Confidential Information by you or any of your Representatives and you will reasonably cooperate in any attempt by any of the Debtor to obtain any remedy or relief relative thereto.
- THIS LETTER AGREEMENT IS GOVERNED BY AND SHALL BE CONSTRUED IN ACCORDANCE WITH LAWS OF THE STATE OF DELAWARE WITHOUT GIVING EFFECT TO ANY CHOICE OR CONFLICT OF LAW PROVISION OR RULE (WHETHER OF THE STATE OF DELAWARE OF ANY OTHER JURISDICTION) THAT WOULD CAUSE THE APPLICATION OF THE LAWS OF ANY JURISDICTION OTHER THAN THE STATE OF DELAWARE.
- The Receiving Party: (a) submits itself to any legal action or proceeding relating to this agreement, or for recognition and enforcement of any judgment in respect thereof, to the nonexclusive general jurisdiction of the courts of the State of Delaware; (b) consents that any such action or proceeding may be brought in such courts and waives any objection that it may now or hereafter have to the venue of any such action or proceeding in any such court or any such action or proceeding that was brought in an inconvenient court, and agrees not to plead or claim the same; and (c) agrees that service of process in any such action or proceeding may be affected by mailing a copy by registered or certified mail (or any form of substantially similar mail), postage prepaid, to you.
- THE PARTIES HEREBY IRREVOCABLY AND UNCONDITIONALLY WAIVE TRIAL BY JURY IN ANY LEGAL ACTION OR PROCEEDING RELATING TO THIS LETTER AGREEMENT AND FOR ANY COUNTERCLAIM RELATED THERETO.
- It is understood and agreed that no failure or delay by the Debtor in exercising any right, power, or privilege hereunder shall operate as a waiver thereof, nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any right, power, or privilege hereunder.
- Upon prior written notice to you, the Debtor reserves the right to assign all of its respective rights, powers, and privileges under this letter agreement, including without limitation the right to enforce all of its terms, to any entity which acquires a majority of the outstanding shares or all or substantially all of the assets of the Debtor. You acknowledge and agree that you may not assign or otherwise delegate your obligations or duties under this letter agreement to any other person or entity. Any assignment in violation of this letter agreement shall be null and void ab initio.
After the sale order is entered, the sale is closed, and the sale proceeds are distributed in accordance with the priorities established by the Bankruptcy Code, so far as the debtor’s bankruptcy estate is concerned, the sale is concluded.
When Confidences Are Broken
Given the open nature of the bankruptcy sale process, there are many opportunities to abuse confidences and obtain competitive advantages. Fortunately, there are few reported cases dealing with breaches of the confidentiality obligations, but it’s easy to envision costly and difficult litigation occasioned by breaches. See, e.g., Metal Foundations Acquisition, LLC. v. Reinert, 13-4299 (3rd Cir. 2015). See also Prithvi Catalytic, Inc. v. Microsoft Corporation et al., 2015 WL 1651433 (Bkrtcy. W.D. Pa.).
Sale of Attorney-Client Privilege
A novel question recently addressed by one court is whether attorney-client confidences, including privileged documents, are included in a sale of “substantially all assets.” In SimpleAir, Inc. v. Microsoft Corp., No. 11-CV-416, 2013 WL 457494 (E.D. Tex Aug. 27, 2013), the court held that control of the attorney-client relationship follows ownership and that a sale of substantially all assets does include the right to control the privilege.
Jurisdiction to Enforce Confidentiality Agreements
Finally, a discussion of this subject would not be complete without inquiring into the court in which a case for breach of confidentiality may be brought. Bankruptcy courts, like other federal courts, are courts of limited jurisdiction, and disputes over confidentiality involve two non-debtor parties litigating a matter which has little or no impact on any distribution to creditors. See In re Xonics, 813 F.2d 127 (7th Cir. 1987); In re Pacor, Inc., 743 F.2d 984, 994 (3d Cir. 1984). By comparison, other courts have held that even a court of limited jurisdiction retains the power to enforce its own orders for some period of time.
As a practice tip, some buyers withhold a portion of the sale consideration or provide an earn-out so as long as there are no post-sale closing breaches of any executed confidentiality agreement.