BUYING AND SELLING ASSETS FROM AN ENTITY IN CHAPTER 11
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1 BUYING AND SELLING ASSETS FROM AN ENTITY IN CHAPTER 11 Francis P. Dicello, Esq. I. Sources of Financial Information for Troubled Companies A. Nonbankruptcy Sources 1. Lien Judgment Search 2. Reports to Regulatory Agencies B. Bankruptcy Sources 1. Schedules of Assets & Liabilities Contains debtor company's estimate of the fair market value of each of its assets and the amount of debt owed to each creditor (whether fixed, contingent or disputed) as of the bankruptcy petition date. Also lists secured indebtedness and debtor's estimate of value of secured collateral. 2. Statement of Financial Affairs Contains significant information such as the names, addresses, and compensation of all officers and directors the names of all shareholders owning 5% or more of the voting securities and the accountants and attorneys employed by the corporation during the past two years. This document also contains a statement of the gross income for the two full years preceding the bankruptcy petition, a description of pending lawsuits and administrative proceedings, and any set offs, recoupments or foreclosures which have occurred within one year of filing. It also requires the debtor to list all financial institutions, creditors, or other parties to whom a financial statement was issued within the two years immediately preceding the bankruptcy petition. 3. List of Executory Contracts Lists all leases of nonresidential real property as well as supplier contracts and equipment leases. 4. Monthly Profit and Loss and Cash Flow Statements Normally required by local rule or court order within days of the close of each month. Critical issue is whether there is an administrative insolvency. 5. Court Docket a. Financing Orders Debtor-in-Possession or trustee may incur unsecured credit allowable as an administrative expense in the ordinary course of business. Bankruptcy Code Sec. 364(a). Court may also authorize debtor to incur secured debt with priority over administrative debt and/or existing secured debt in limited circumstances. Bankruptcy Code Sec. 364(b), (c), and (d).
2 Cash collateral, such as accounts receivable, may be used in operations only by providing adequate protection to secured lender. Bankruptcy Code Sec. 363(e). Judicial determinations here may include a post filing valuation of collateral, and highlight any difficulties with collection of receivables. b. Claims Register c. Adversary Proceedings (1) Complaints to Recover or Turnover Property (2) Complaints to Determine an Interest in Property (3) Complaints by Secured Creditors to Lift Stay and Permit Foreclosure C. Creditors' Committee Normally 3 7 of the largest unsecured creditors. D. Rule 2004 Examination The examination may cover any matter relevant to the case or to the formulation of a Plan. II. The Players A. The Debtor-in-Possession In the typical Chapter 11 case, management is permitted to remain in possession and control the debtor entity and operates with substantially all of the powers and duties of a trustee (Bankruptcy Code Sec. 1107) unless the court orders the appointment of a trustee for cause. (Sec. 1104). B. The Trustee If appointed, investigates affairs of debtor and possesses all powers of chief executive officer of company. C. The Unsecured Creditors' Committee The committee generally consists of the largest unsecured creditors of the debtor it investigates and monitors affairs of the debtor while operating in Chapter 11 and may, after termination of the exclusive period, file its own plan of reorganization which may include sale of the debtor or significant assets. Bankruptcy Code, Sec and D. The Secured Lenders III. Sales by Entities in Chapter 11 Proceedings A. Sales of Selected Assets Sales of selected assets out of the ordinary course of business may be made after notification containing the terms of the sale and an opportunity for hearing by a creditor or other parties in interest. Bankruptcy Code Section 363(b)(1). B. Free and Clear of Liens Sales of property subject to an interest such as a lien may be sold free and clear of such interest in the property if: (i) applicable nonbankruptcy law permits sale of
3 such property free and clear of such interest (ii) such entity consents (iii) such interest is a lien and the price at which the property is to be sold is greater than the aggregate value of all liens on the property (iv) such interest is in bona fide dispute or (v) such entity could be compelled in a legal or equitable proceeding to accept a money satisfaction of such interest. Bankruptcy Code Section 363(f). C. Appeals from Sale Authorization Orders The reversal or modification on appeal of an order authorizing a sale outside the ordinary course of business, or of an order recognizing the propriety of a sale made in the ordinary course of business does not affect the validity of the sale or lease under such authorization to an entity that purchased or leased in good faith, whether or not the purchasing entity knew of the appeal, unless the authorization and the sale or lease were stayed pending appeal. Bankruptcy Code Sec. 363(m). D. Sales of Substantially All Assets Outside of Plan In limited circumstances, courts have allowed a sale of substantially all the assets of a debtor outside a plan when there is a sound business reason which is distinct from appeasement of creditors, and which justifies the departure from the plan confirmation process. See In re the Lionel Corporation, 722 F.2d 1063 (1983). IV. ACQUISITION UNDER A PLAN A. Standards for Confirmation of a Plan In negotiating a purchase of the assets of the debtor under a plan, it is important to understand the minimum requirements the debtor will need to confirm a plan. These are summarized in Sections 1123 and 1129 of the Bankruptcy Code and include the payment of all administrative debt (debt incurred since the filing), and priority claims (such as certain taxes, employee wages and benefits, customer deposits and similar items). In addition, secured creditors are entitled to receive a stream of payments equal to the present value of their claims. There must also be one class of impaired creditors who accept the plan. This acceptance must be by two-thirds in amount and half in number of those who actually vote in that class. Bankruptcy Code Sec The court must also find that the plan is feasible and will not be followed by another reorganization. B. Rejection of Plan by Impaired Class Generally a class of claims is impaired if the legal, equitable or contractual right of creditors therein is impaired. Bankruptcy Code Section If an impaired class of interests or creditors rejects the plan, it may still be confirmed if the court finds that the plan has been proposed in good faith, complies with other provisions of the Bankruptcy Code, does not discriminate unfairly and is fair and equitable to the rejecting class. The court must also find that it is unlikely that the plan will be followed by the need for further reorganization or liquidation. C. Assignments of Executory Contracts 1. Subject to court approval, debtor/trustee may assume or reject executory contracts during reorganization or as part of a plan. If default has occurred (other than default predicated on fact of insolvency, bankruptcy filing or appointment of trustee) debtor/trustee must at time of assumption: a. Cure default or give assurance of timely ability to do so
4 b. Provide compensation for pecuniary loss incurred and c. Provide adequate assurance of future performance. D. Provider Agreement as Executory Contract The majority of courts have determined that a provider agreement under the Medicare scheme is an executory contract within the meaning of Section 365 of the Code. In re University Medical Center, 973 F.2d 1065, 1075 n.3 (3d Cir. 1992) In re Consumer Health Services of America, Inc., 171 B.R. 917, 920 (Bankr. D.Dist. Col. 1994) In re Advanced Professional Home Health Care, Inc., 94 B.R. 95 (E.D.Mich. 1988). Compare Lee v. Schweiker, 739 F.2d 870 (3d Cir. 1984) (distinguishing Medicare scheme from social security scheme for purposes of recouping overpayments of social security benefits on basis that Social Security benefits are statutory entitlements rather than contractual right). E. Assumption of Provider Agreements 1. One line of cases provides that performance by the debtor of an executory contract may amount to an assumption carrying with it the burden of recoupment under the contract. See In re Yonkers Hamilton Sanitarium, Inc., 22 B.R. 427 (Bankr. S.D.N.Y. 1982), aff'd, In re Yonkers Hamilton Sanitarium, Inc. v. Blue Cross/Blue Shield of Greater New York, 34 B.R. 385 (D.C. 1983) In re Advanced Professional Home Health Care, Inc., 94 B.R. 95 (E.D.Mich. 1988). 2. Other courts have required court approval for an assumption of a provider agreement to be valid. Absent such assumption, the contractual right of recoupment does not exist. See In re University Medical Center, 973 F.2d 1065 (3d Cir. 1992) In re Consumer Health Services of America, Inc., 171 B.R. 917 (Bankr. D.Dist. Col. 1994) In re Memorial Hospital of Iowa County, Inc., 82 B.R. 478 (W.D.Wis. 1988). 3. Assumption is not a prerequisite to the exercise of the right of equitable recoupment. An equitable right of recoupment exists independent of any contractual right to recoupment. In re University Medical Center, 973 F.2d 1065 (3d Cir. 1992) In re Consumer Health Services of America, Inc., 171 B.R. 917 (Bankr. D.Dist. Col. 1994). If actions of the intermediary fall within the parameters of equitable recoupment, assumption of provider agreement is not required. 4. Exercise of equitable right of recoupment depends upon whether the respective claims of the parties arise out of the same transaction. Hence, the ability of the intermediary to recoup overpayments depends upon whether the overpayments were part of the same transaction as the transactions giving rise to the debtor's claims for reimbursement for postpetition services. In re Consumer Health Services of America, Inc., 171 B.R. 917 (Bankr. D.Dist. Col. 1994). F. Collective Bargaining Agreements 1. The Bankruptcy Code provides for assumption or rejection of collective bargaining agreement. Rejection may occur only if debtor or trustee: a. Makes proposal to authorized agent which is based on most reliable information and which provides for those necessary modifications in employee benefits and protections necessary to permit reorganization of debtor and assure fairness to all parties. b. Subject to applicable protection orders, provides information to employees necessary to evaluate offers.
5 c. Meets with employee representative and negotiates in good faith in an attempt to reach mutually satisfactory modifications to the agreement. 2. The court may authorize rejection only if: a. The trustee or debtor has made the proposal set forth above b. The authorized representative of the employees has refused to accept the proposal without good cause and c. The balance of the equities clearly favor rejection of the agreement. V. Negotiating the Deal A. Break Up Fees Break up fees are sometimes authorized by bankruptcy courts and allow a payment to a potential buyer, if the seller accepts an alternative offer, or for some other reason does not go through with the sale. In deciding whether to approve break up fee, courts will look to see whether allowing such a provision in a contract will discourage bidding, whether the fee is unreasonable, or whether there is any evidence of self-dealing. See In re Integrated Resources, Inc., 135 B.R. 746 (Bankr. S.D.N.Y. 1992). B. Topping Fees A topping fee is a device which allows the bidder for assets who was overbid in the final approval process to recover a percentage of the amount by which his bid was exceeded. Since topping fees will not usually discourage bids which may lead to a higher recovery for the estate, they are generally acceptable as long as they are reasonable. Courts have allowed topping fees in the 20% range. See In re Crowthers McCall Pattern, Inc., 114 B.R. 877 (Bankr. S.D.N.Y. 1990). C. Lockup or Lockout Option This is a procedure sometimes utilized in which the first bidder will make an offer for all assets of a corporation but will be allowed to purchase a significant asset if the sale to the first bidder is not completed. This, of course, can result in no other bidder having the opportunity to acquire all of the assets of the company, including the significant targeted asset, thereby diminishing the prospects for competitive bids. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). VI. Purchaser Liability A. Depreciation Recapture Medicaid intermediaries reimburse health care providers for the costs of the medical services provided to Medicaid-qualified patients. Among the costs reimbursable is the depreciation of a nursing home's tangible assets. Depreciation is calculated according to a standard accounting method, dividing an asset's purchase price by its estimated useful life and reimbursing the facility for the resulting annual depreciation. Upon the sale of the asset, state statute authorizes the intermediary to recapture the depreciation it paid to the extent that the sale price exceeds the depreciated original cost of the asset (i.e. the original purchase price less all depreciation payments made before the sale). See e.g. Va. Code (Michie 1988).
6 1. 11 U.S.C. 363(f) permits the trustee or debtor inpossession to sell property of the estate (either inthe ordinary course of business or outside of theordinary course of business) free and clear of anyinterest in such property of an entity other thanthe estate, only if-- a. applicable nonbankruptcy law permits sale of such property free and clear of such interest b. such entity consents c. such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property d. such interest is in bona fide dispute or e. such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest. 2. The right to recapture depreciation from the provider falls within the category of any interest that is the subject of Section 363(f) of the Code. See In re WBQ Partnership, 27 BCD 1200 (Bankr. E.D.Va. 1995) In re P.K.R. Convalescent Centers, Inc., 1995 Bankr. LEXIS 1772 (Bankr. E.D.Va. 1995). The right of recapture is said to run with the property, so it is more than a mere claim against the debtor. It is an interest in property. 3. Federal law under 11 U.S.C. 363(f) permittingsales free and clear of liens, claims or interests,preempts state law permitting recapture ofdepreciation from subsequent purchaser ofprovider's property. Id. 4. The bankruptcy court may therefore permanently enjoin the intermediary from attempting to recapture depreciation from the purchaser of the provider's assets. Id. B. Plan Provisions A plan may have provisions requiring releases by parties who accept a distribution under a confirmed plan.
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