Stalking Horse Bidder in Section 363 Sales: Benefactor or Predator?

Debtors and creditors committees in Chapter 11 cases often regard a “stalking horse” bidder as a benefactor of most or all stakeholders, for it enhances the market for the sale of the debtor's assets as a going concern in a section 363 sale. Outside of U.S. bankruptcy usage, and for the vast majority of its life, the term “stalking horse” has referred to an artifice for predators. In some circumstances, a stalking horse bidder in a section 363 sale can more closely resemble the term's original meaning.

The Stalking Horse Bidder As Benefactor

The stalking horse bidder as benefactor is conceived of as walking ' or trotting briskly, where necessary to preserve value ' through several stages, as follows: 1) debtor and stalking horse agree on the assets to be sold, their price, the timing of the sale, the amount of the large deposit the stalking horse and other bidders must pay, and the stalking horse's binding commitment to close if no higher qualified bid is made within the relevant period; 2) bankruptcy court approval of bidding procedures (including financial incentives for the stalking horse, like break-up fees and bid protections); 3) the court pronouncement of clear rules for the rest for the sales process; 4) notice of the proposed sale is given to potential bidders (who are often actively solicited by an investment banker employed by the debtor's estate); 5) qualified bids are received by the debtor based upon the stalking horse agreement as a template as to non-price terms (facilitating apples-to-apples comparisons of bids) with bidders relying on due diligence compiled by the stalking horse; 6) an auction is conducted; and 7) a sale is closed, with the bidder that made the highest and best qualified bid paying cash and taking the assets free and clear of liens and encumbrances.

Thus, a benefactor stalking horse helps create a market and abets a vigorous and efficient sales process, which is particularly meaningful where the underlying business assets are nearing complete failure, i.e., they are a “melting ice cube.” If the stalking horse's bid prevails, it pays and takes the assets as a going concern. If another bidder prevails, the stalking horse may receive, in addition to return of its deposit, a substantial break-up fee for its expenses in creating the market and making its due diligence available to other qualified bidders. The stalking horse as benefactor spurs a transparent and very public process, by which participation is expanded and possibly even optimized, value is maximized, and everyone (who is in the money) wins. The stalking horse is deservedly rewarded for its pains even if it does not prevail in the auction.

However, whoever coined the term for section 363 sales diverged from historical meanings of “stalking horse.” From the Oxford Universal English Dictionary (Oxford Univ. Press, 1937) [aka The Shorter Oxford English Dictionary]:

Stalking Horse 1519 [fr. Stalking vbl. sb.] 1. A horse trained to allow a fowler to conceal himself behind it or under its coverings in order to get within easy range of the game without alarming it. Hence, a portable screen made in the figure of a horse, similarly used. 2. Fig. A person whose participation in a production is made use of to prevent its real design from being suspected 1612. B. An underhand means for making an attack or attaining some sinister object; usu., a pretext put forward for this purpose 1579.

1.Giovanni d'Undine ' is thought to have been the inventor of the s., which poachers now use 1706. 2.b. He uses his folly like a s. SHAKS.

The Stalking Horse Bidder As Predator

This “stalking horse” assists a party's predation by deception of birds or listeners. The Shakespeare passage referred to is from Act V, scene 4 of Measure for Measure, wherein Touchstone ' who with his companion Aubrey is described as “very strange beasts which in all tongues are called fools” ' confounds his listeners with his discourse on, among other things, the Retort Courteous, the Quip Modest, the Reply Churlish, the Reproof Valiant, the Countercheque Quarrelsome, the Lie with Circumstance, and the Lie Direct. Whereupon the Duke Senior concludes, “He uses his folly like a stalking-horse and under the presentation of that he shoots his wit.”

The older meaning appears to pose a point of connection with the contemporary bankruptcy notion, in that the stalking horse bidder, like the hunter's stalking horse, does try to entice other bidders without alarming them, that is, by doing important contractual and due diligence work for them, drawing them hither. But the point of connection is illusory because the goal is predation by deception, with appearances managed by the creator of the stalking horse.

In the section 363 context, the predatory stalking horse would be deployed pretextually in order to obtain a sinister or at least unannounced object. There are circumstances in which the stalking horse bidder can dictate the terms of its agreement with the debtor, and craft provisions that facilitate either its safe exit at will from the sale process or its power to compel the faltering debtor to alter the terms of the original deal to the bidder's advantage. The melting ice cube debtor may be liquefying so rapidly that it has nowhere else to turn (perhaps from waiting too long to file for bankruptcy protection, or from some sudden mishap), or only a few potential purchasers have any use for the assets, or only a few potential purchasers have the managerial capability or institutional breadth to absorb the debtor as a going concern.

Section 363

Section 363 sale asset purchase agreements can be sprawling and complex affairs. A stalking horse ' as predator or benefactor ' is wise to condition its obligation to close upon, among other things: 1) the debtor supplying adequate due diligence; 2) the debtor preserving customer and supplier relationships; 3) the debtor maintaining valuable rights under executory contracts and unexpired leases that the bidder seeks to have assumed by the debtor and assigned to the purchaser; 4) the validity and assignability of such rights especially under intellectual property licenses; 5) the amounts of cash required to cure defaults under executory contracts that are to be assumed and assigned; 6) the debtor complying with regulatory regimes; 7) the debtor disclosing and mitigating litigation or environmental risks; 8) the debtor preserving valuable inputs from non-debtor affiliates (such as power sources and distribution facilities); and 9) the continued participation of certain personnel considered essential to the going concern value of the assets.

The careful crafting of conditions to close, albeit sometimes essential in narrowing the risks to the stalking horse, may create levers for predatory demands that the debtor agree to purchase price reductions or changes to the asset mix or the addition of non-debtor guarantees ' all under the threat of the stalking horse's withdrawal of its bid, to be succeeded by its insistence on return of its deposit. By way of threat, the predatory stalking horse summons the specter of a non-going concern liquidation of the debtor, to be accompanied by interesting and horridly expensive litigation between the debtor's cash-poor estate and the stalking horse.

Conclusion

Thus, a predatory stalking horse bidder can paint itself as the frustrated benefactor, while in truth it overreaches as part of a strategy in pursuit of its sinister objective (such as a fire sale purchase price, or even the destruction of a competitor). But might the stalking horse's self-portrayal be reasonably true? Might whether a stalking horse is benefactor or predator be mainly a matter of perspective? The negotiation parlors for going-concern bankruptcy sales of highly distressed businesses are obviously not for the birds, the gullible, or the insouciant.

Christopher M. Cahill, of Lowis & Gellen LLP in Chicago, guides stakeholders through bankruptcy cases, out-of-court workouts, and assignments for the benefit of creditors. Mr. Cahill is an executive editor of Commercial Bankruptcy Litigation (Jonathan P. Friedland, Elizabeth Vandesteeg & Christopher M. Cahill eds., 2d ed. 2015), published by Thomson Reuters. He also hosts Accredited Investor Markets Radio, a weekly interview and commentary program and podcast for investors, on accreditedinvestormarkets.com. He can be reached at [email protected].

Debtors and creditors committees in Chapter 11 cases often regard a “stalking horse” bidder as a benefactor of most or all stakeholders, for it enhances the market for the sale of the debtor's assets as a going concern in a section 363 sale. Outside of U.S. bankruptcy usage, and for the vast majority of its life, the term “stalking horse” has referred to an artifice for predators. In some circumstances, a stalking horse bidder in a section 363 sale can more closely resemble the term's original meaning.

The Stalking Horse Bidder As Benefactor

The stalking horse bidder as benefactor is conceived of as walking ' or trotting briskly, where necessary to preserve value ' through several stages, as follows: 1) debtor and stalking horse agree on the assets to be sold, their price, the timing of the sale, the amount of the large deposit the stalking horse and other bidders must pay, and the stalking horse's binding commitment to close if no higher qualified bid is made within the relevant period; 2) bankruptcy court approval of bidding procedures (including financial incentives for the stalking horse, like break-up fees and bid protections); 3) the court pronouncement of clear rules for the rest for the sales process; 4) notice of the proposed sale is given to potential bidders (who are often actively solicited by an investment banker employed by the debtor's estate); 5) qualified bids are received by the debtor based upon the stalking horse agreement as a template as to non-price terms (facilitating apples-to-apples comparisons of bids) with bidders relying on due diligence compiled by the stalking horse; 6) an auction is conducted; and 7) a sale is closed, with the bidder that made the highest and best qualified bid paying cash and taking the assets free and clear of liens and encumbrances.

Thus, a benefactor stalking horse helps create a market and abets a vigorous and efficient sales process, which is particularly meaningful where the underlying business assets are nearing complete failure, i.e., they are a “melting ice cube.” If the stalking horse's bid prevails, it pays and takes the assets as a going concern. If another bidder prevails, the stalking horse may receive, in addition to return of its deposit, a substantial break-up fee for its expenses in creating the market and making its due diligence available to other qualified bidders. The stalking horse as benefactor spurs a transparent and very public process, by which participation is expanded and possibly even optimized, value is maximized, and everyone (who is in the money) wins. The stalking horse is deservedly rewarded for its pains even if it does not prevail in the auction.

However, whoever coined the term for section 363 sales diverged from historical meanings of “stalking horse.” From the Oxford Universal English Dictionary (Oxford Univ. Press, 1937) [aka The Shorter Oxford English Dictionary]:

Stalking Horse 1519 [fr. Stalking vbl. sb.] 1. A horse trained to allow a fowler to conceal himself behind it or under its coverings in order to get within easy range of the game without alarming it. Hence, a portable screen made in the figure of a horse, similarly used. 2. Fig. A person whose participation in a production is made use of to prevent its real design from being suspected 1612. B. An underhand means for making an attack or attaining some sinister object; usu., a pretext put forward for this purpose 1579.

1.Giovanni d'Undine ' is thought to have been the inventor of the s., which poachers now use 1706. 2.b. He uses his folly like a s. SHAKS.

The Stalking Horse Bidder As Predator

This “stalking horse” assists a party's predation by deception of birds or listeners. The Shakespeare passage referred to is from Act V, scene 4 of Measure for Measure, wherein Touchstone ' who with his companion Aubrey is described as “very strange beasts which in all tongues are called fools” ' confounds his listeners with his discourse on, among other things, the Retort Courteous, the Quip Modest, the Reply Churlish, the Reproof Valiant, the Countercheque Quarrelsome, the Lie with Circumstance, and the Lie Direct. Whereupon the Duke Senior concludes, “He uses his folly like a stalking-horse and under the presentation of that he shoots his wit.”

The older meaning appears to pose a point of connection with the contemporary bankruptcy notion, in that the stalking horse bidder, like the hunter's stalking horse, does try to entice other bidders without alarming them, that is, by doing important contractual and due diligence work for them, drawing them hither. But the point of connection is illusory because the goal is predation by deception, with appearances managed by the creator of the stalking horse.

In the section 363 context, the predatory stalking horse would be deployed pretextually in order to obtain a sinister or at least unannounced object. There are circumstances in which the stalking horse bidder can dictate the terms of its agreement with the debtor, and craft provisions that facilitate either its safe exit at will from the sale process or its power to compel the faltering debtor to alter the terms of the original deal to the bidder's advantage. The melting ice cube debtor may be liquefying so rapidly that it has nowhere else to turn (perhaps from waiting too long to file for bankruptcy protection, or from some sudden mishap), or only a few potential purchasers have any use for the assets, or only a few potential purchasers have the managerial capability or institutional breadth to absorb the debtor as a going concern.

Section 363

Section 363 sale asset purchase agreements can be sprawling and complex affairs. A stalking horse ' as predator or benefactor ' is wise to condition its obligation to close upon, among other things: 1) the debtor supplying adequate due diligence; 2) the debtor preserving customer and supplier relationships; 3) the debtor maintaining valuable rights under executory contracts and unexpired leases that the bidder seeks to have assumed by the debtor and assigned to the purchaser; 4) the validity and assignability of such rights especially under intellectual property licenses; 5) the amounts of cash required to cure defaults under executory contracts that are to be assumed and assigned; 6) the debtor complying with regulatory regimes; 7) the debtor disclosing and mitigating litigation or environmental risks; 8) the debtor preserving valuable inputs from non-debtor affiliates (such as power sources and distribution facilities); and 9) the continued participation of certain personnel considered essential to the going concern value of the assets.

The careful crafting of conditions to close, albeit sometimes essential in narrowing the risks to the stalking horse, may create levers for predatory demands that the debtor agree to purchase price reductions or changes to the asset mix or the addition of non-debtor guarantees ' all under the threat of the stalking horse's withdrawal of its bid, to be succeeded by its insistence on return of its deposit. By way of threat, the predatory stalking horse summons the specter of a non-going concern liquidation of the debtor, to be accompanied by interesting and horridly expensive litigation between the debtor's cash-poor estate and the stalking horse.

Conclusion

Thus, a predatory stalking horse bidder can paint itself as the frustrated benefactor, while in truth it overreaches as part of a strategy in pursuit of its sinister objective (such as a fire sale purchase price, or even the destruction of a competitor). But might the stalking horse's self-portrayal be reasonably true? Might whether a stalking horse is benefactor or predator be mainly a matter of perspective? The negotiation parlors for going-concern bankruptcy sales of highly distressed businesses are obviously not for the birds, the gullible, or the insouciant.

Christopher M. Cahill, of Lowis & Gellen LLP in Chicago, guides stakeholders through bankruptcy cases, out-of-court workouts, and assignments for the benefit of creditors. Mr. Cahill is an executive editor of Commercial Bankruptcy Litigation (Jonathan P. Friedland, Elizabeth Vandesteeg & Christopher M. Cahill eds., 2d ed. 2015), published by Thomson Reuters. He also hosts Accredited Investor Markets Radio, a weekly interview and commentary program and podcast for investors, on accreditedinvestormarkets.com. He can be reached at [email protected].