Sale of Assets during Bankruptcy
When a company is facing bankruptcy, it tries to free up as much capital as possible. This freed up capital is used to finance the operations of the firm. One way to free up the capital is to sell fixed assets of the firm. During the bankruptcy process, it is possible for a company to decide to shut down a particular department or a product line. As a result, fixed assets related to that department may no longer be in use. Therefore, it is possible to sell these assets and raise some much needed extra cash.
However, the problem is that when the company starts to sell these assets, there is an objection from the creditor community. The creditor community starts believing that the company is trying to stealthily sell its assets, and then later in the event of a liquidation sale, there will not be enough money to cover the creditors. This feeling can be avoided by clearly communicating with the creditors in question. If the creditors understand the business rationale behind selling the assets, they are less likely to object to it.
There are several ways in which assets can be sold during bankruptcy proceedings. Some of the mechanisms have been listed down in the article below.
Removal of Lien
Companies that go into bankruptcy court tend to have a lien on all their assets. This lien is a legal barrier that prevents the realization of the full value of the asset. For instance, if the market value of an asset is $2000, and there is a lien of $1000 on the assets, then the assets cannot be sold, and proceeds cannot be realized. In such cases, there is a dispute between the creditor and the debtor.
As a result of this dispute, the asset often gets foreclosed and sold at a much lower price as compared to its market value. In such cases, the United States court has allowed the company to sell the asset, assuming that there are no liens against the same. The company is allowed to sell its assets. However, the creditor has the first claim on the proceeds. Therefore, if the company is able to sell the asset for $1500, then they can give the $1000 back to the creditor and still have $500 to infuse into the business. This is an important strategy that helps unlock value from the fixed assets of the company.
Credit bidding is another important tool that is used by the bankruptcy courts and the debtors to maximize the value of the assets being sold. Credit bidding is a mechanism under which debt can be used as currency. Instead of paying cash to acquire an asset, creditors can acquire an asset in lieu of debt.
For instance, if a creditor has a $1000 debt in a company, they can use that to bid for assets. If a creditor purchases as an asset worth $1000 with its debt, the company does not receive any money, but it no longer has to pay back the debt. For the creditor, this option might be valuable since they may stand to recover more dues by acquiring the asset. If they do not acquire the asset, they may lose a lot of money in the form of haircuts.
In the event of bankruptcy, the sale of every asset takes place via bidding. This is because the courts are involved, and they do not want one creditor to get an unfair advantage over another creditor of the same standing. However, there is a problem when it comes to auction sales. No company is willing to make the first bid. This is because when they make the first bid, they have to spend money and time to do due diligence. Later, when the diligence has been done, other companies tend to outbid them by small amounts. The company that does the due diligence is called a stalking horse in bankruptcy court parlance. Often this bid is used by the debtor company to set the floor price at an auction.
There are certain mechanisms that have been put into place to ensure that the bidding process is fair to everyone, including the stalking horse.
- The expenses incurred by the stalking horse in order to complete the due diligence, as well as a small compensation has to be paid back to them by the debtor company in case they select a higher bid being made by a different company. This is done to ensure that companies are not hesitant to make the first bid.
- In many cases, court agreements prevent the debtor firm to actively seek more bids from other participants when they are dealing with one bidder. If another bidder were to approach the debtor without solicitation, they would still be allowed to consider those bids
- Lastly, the auction rules are set in a way that marginally higher bids are not used to undercut the initial bid. If the company wants to overbid, it has to do so by a significant amount. Also, the increments in bid prices have to be higher.
Depending upon the type of assets being sold, the court may allow one or several of the provisions mentioned above. The bottom line is that it is possible to raise funds using fixed assets that a firm already has.
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