For skilled buyers of distressed assets, the past several years were a boom time. Factors as diverse as an economic downturn, corporate fraud and terrorist attacks compelled a number of companies to restructure. Fundamentally sound businesses became available at excellent prices to buyers who could manage the challenges of acquiring in such a situation. Now that economic conditions have improved, one might think that these skills are no longer so important. But troubled sellers never really disappear from the landscape, and the ability to deal with them always remains an important part of a dealmaker's repertoire.

In some cases, a distressed seller has found itself in a downward spiral for reasons unrelated to the actual operations and prospects of the businesses it is offering. In other cases, the business being sold may have flaws that can easily be addressed, such as oppressive debt or legacy costs, or accounting irregularities that have misstated the value of the business. The challenge for buyers interested in these businesses is determining which ones are sound, what their intrinsic values are and how to best unlock those values.

Acquisitions of assets from distressed sellers can take place either inside or outside the bankruptcy context, with varying risks and results. In most cases, the risks are greatest before the seller has decided to file for bankruptcy; at that point, fiduciary duties are unclear and competing constituencies pull management in different directions. Under these chaotic circumstances, a potential buyer may find it very difficult to negotiate a deal that satisfies everyone who matters. Even if a deal can be struck, the buyer will face the risks of fraudulent-conveyance challenges. And if the seller subsequently files for bankruptcy, it may reject the purchase agreement before closing, or extract an enhanced deal by threatening to do so.

In contrast, buying assets after a bankruptcy filing can be a more orderly and less risky process. Asset sales by debtors in a Chapter 11 proceeding take one of two forms: sales outside the ordinary course of business (under Section 363 of the Bankruptcy Code) or sales pursuant to a debtor's reorganization plan. Section 363 transactions, which permit the sale of assets outside the plan confirmation process, are conducted through a bankruptcy-court approved auction, with the goal of attaining the "highest and best" bid for the assets being sold. Although Section 363 sales are often completed faster than plan sales, they have the disadvantage (for buyers) of guaranteeing a competitive bidding process, which may negate any advantage gained by an early bidder. Plan sales typically take more time than Section 363 sales because they require completion of the relatively lengthy plan confirmation process. Plan sales are usually best suited to circumstances where the debtor's entire business is being sold or the desired transaction is in essence a reorganization of the debtor, with new equity holders and, in some cases, new lenders.

Acquiring assets in a chapter 11 proceeding offers a number of benefits for buyers. Most important, the buyer gets these assets free of all liens. A Section 363 sale will also give the buyer maximum flexibility as to which assets it will acquire and which liabilities it will assume. The bankruptcy process itself imposes order on an otherwise chaotic situation and will help a buyer manage the multiple decision makers. Bankruptcy-court approval of the sale will bar fraudulent transfer claims and provide certainty as to the enforceability of the transaction documents. Other benefits include an expedited waiting period under the Hart-Scott-Rodino Antitrust Improvements Act, a limited exemption from the registration requirements of the Securities Act of 1933, and the inapplicability of state laws, such as bulk transfer, transfer tax and shareholder approval requirements.

Regardless of economic conditions, there will always be troubled companies seeking to shed assets in order to stay alive. These circumstances present unique opportunities for buyers who are prepared to act on them. - John K. Kane

John Kane is a partner in the New York office of the international law firm Jones Day, practicing primarily in the area of mergers and acquisitions and focusing on private transactions and acquisitions or restructurings involving distressed targets or sellers.

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