Stalking Horse Bidders: What Bid Protections Can You Expect in a Section 363 Sale?

Conducting an asset sale through a bankruptcy auction — a Section 363 sale — is an effective and common M&A tool for a distressed company.

In anticipation of a 363 sale, a Chapter 11 debtor typically tries before its Chapter 11 filing to negotiate a binding “stalking horse bid” for its assets. The stalking horse bid ensures that the debtor will have a purchaser willing to pay an acceptable price and serves as a starting point against which other potential purchasers must initially bid. If the debtor receives overbids, it will hold an auction. The stalking horse bidder can participate in the auction but may not win if another bidder is willing to pay more.

In exchange for its bid serving as a floor, the stalking horse bidder traditionally receives bid protections. If the debtor does not sell to the stalking horse bidder, these protections usually include a breakup fee of 1-3% of the stalking horse bid’s purchase price and reimbursement of reasonable and documented expenses. The debtor must get bankruptcy court approval of proposed bid protections. The debtor usually seeks this approval when it seeks approval of the bid and auction procedures for the 363 sale.

Two ongoing cases in the Bankruptcy Court in the District of Delaware, Ideanomics and First Mode, provide examples of objections to the approval of bid protections and potential outcomes for the stalking horse bidder.¹

In Ideanomics, the stalking horse bidder served as the debtors’ pre- and post-bankruptcy secured lender and had ties to the board. Sales to insiders are subject to heightened scrutiny. As with many insider sales, the debtors sought court approval of reimbursement of the stalking horse bidder’s expenses (up to $500,000) but did not seek approval of a breakup fee.

In First Mode, the stalking horse bidder is not an insider, and the debtors sought court approval of a 3% breakup fee and reimbursement of expenses (up to $550,000).

In each case, the debtors sought superpriority status under the Bankruptcy Code for bid protection claims of the stalking horse. Superpriority status entitles claims to payment ahead of other costs of administering a debtor’s estate (i.e., administrative expense claims).

In both Ideanomics and First Mode, the US Trustee (UST) objected to the proposed bid protections, arguing that they did not benefit the debtors’ respective estates. In Ideanomics, the UST argued the expense reimbursement did not benefit the estates because, due to the stalking horse bidder’s status as the debtors’ pre- and post- bankruptcy secured lender, it needed a successful auction to monetize its collateral and consequently would make a bid even without bid protections. In First Mode, the UST argued that the breakup fee might not benefit the debtors’ estates because it could be earned in circumstances other than a sale to an alternative purchaser, such as withdrawal of the sale motion or conversion or dismissal of the Chapter 11 cases. The UST also argued in both cases that the court should not approve superpriority status for bid protection claims because superpriority status for a bid protection claim allegedly has no basis in the Bankruptcy Code.

In Ideanomics, the court rejected the UST’s argument that the expense reimbursement claims are not “actual and necessary costs to preserve the estate” but held that expense reimbursement claims would be entitled only to administrative priority instead of superpriority. In denying superpriority status, the court explained that the main trade-off of being a secured lender and a purchaser in a Section 363 sale is that the secured lender must provide for the payment of all costs to administer the debtor’s Chapter 11 estate. The Ideanomics lender/stalking horse’s requirement that its bid protection claims be paid before administrative claims suggested to the court that the lender/stalking horse might fear administrative insolvency, which would give credence to dismissing the bankruptcy cases and not proceeding with the Section 363 sale. The Ideanomics stalking horse accepted the court’s ruling, and the sale process with the stalking horse bidder is moving forward.

In FirstMode, the debtors, stalking horse bidder, and UST consensually resolved the UST’s objection, and the bankruptcy court approved the modified bid protections. As with the litigated outcome in Ideanomics, the parties in FirstMode agreed that bid protection claims would have administrative priority instead of superpriority.

These cases demonstrate that bankruptcy courts value stalking horse bids and recognize the appropriateness of customary bid protections, even when a stalking horse bidder is also a prepetition lender or has insider connections to a debtor. However, the court’s ruling on superpriority status in Ideanomics leaves uncertain the ability of stalking horse bidders to obtain superpriority status for bid protection claims.

 

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^[1] See In re Ideanomics, Inc. et al., Case No. 24-12728-CTG; In re First Mode Holdings Inc., et al., Case No. 24-12794-KBO. 

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.