What is a Stalking Horse Bid in a Section 363 Asset Sale?

In a business reorganization bankruptcy, an insolvent company reorganizes the structure of its business operations through a sale of assets and renegotiates the terms of loans and other debts owed. Under § 363 of the bankruptcy code, a debtor may sell all or part of its assets in an auction under the direction and approval of the court and creditor’s committee.

The stalking horse is a potential investor that makes the initial offer on the company’s assets, working with the debtor and creditors committee to structure the timeline and procedures of sale. The company in bankruptcy usually chooses the investor who gets the stalking horse bid. The identity of a potential bidder along with the proposed sale terms is submitted to the court in a motion to sell. That investor gets to make the opening offer on the assets, prior to the formal auction where a pool of potential buyers can bid. The stalking horse’s bid offer serves as the reserve amount which sets the floor and prevents other investors from bidding below their proposed purchase price: in other words, it sets the value of assets at the sale. It helps the company maximize the value of its assets and bring more money into the bankruptcy estate.

Bid Protections

The stalking horse bidder has access to the details of the bankrupt company’s assets and uses this information to set the market terms of the sale by handling the valuation. They perform due diligence by reviewing vendor and customer agreements, reviewing leases with landlords, and determining the scope of liens, contracts, and assets owned. Because the bidder is responsible for valuation and due diligence costs, it puts itself at greater risk than subsequent bidders at auction.

To buffer against this risk, the investor makes a request to the court by motion for bid protections in the event another investor prevails at auction. Bid protections include breakup fees and reimbursement for expenses because the investor assumes the cost of performing due diligence and valuation. There is often a cap set on the amount, but it usually includes reimbursement for a lawyer and court costs, environmental evaluations, forensic accounting, or other appraisal costs depending on the nature of the business in bankruptcy.

Asset purchase agreements

The investor uses the bidding process to their advantage by negotiating the terms of the purchase agreement. The stalking horse bidder structures the terms of the deal, choosing which assets or liabilities it will assume, and uses bid terms to repel other investors.

By liquidating some of the assets of the business being reorganized and pulling it into the estate to pay creditors, the debtor in possession is able to create more cash flow. With new cash flow infused in the business to continue operations, the goal is for the business to return to profitability and remain afloat.

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