December 12, 2018
Authored by: Khaled Tarazi
You’re an investor kicking the tires on a company in bankruptcy. If you agree to be the “stalking horse” bidder, you’ll expend significant time and money vetting the opportunity (including attorneys’ fees, quality of earnings analysis, valuation and appraisal work, and site visits), only to possibly end up in a bidding war with others wanting a free ride on your due diligence.
To lure you in, the debtor offers you $250,000 in “Bid Protections” (total breakup fee and expense reimbursement) if you don’t win at auction. Not only that, you’ll get a credit toward your cash bid at the auction in the amount of the Bid Protections. This makes sense, you think, because the economic value of a competing bid is deflated by the $250,000 in Bid Protections that must be paid to you if the competitor is ultimately successful. So to compare the economic value of the bids on an apples-to-apples basis, your bid should include a continuing credit in the amount of the Bid Protections.
You love the upside of this company, so you take the leap and sign the Asset Purchase Agreement (“APA”) hoping no competing offers come in and there will be no auction. Unfortunately, a competing bid does come in, and you’re off to the races.
At the auction, your bid is currently at $4.5 million. The competitor now enters a bid of $5 million, resulting in a net economic value to the bankruptcy estate of $4.75 million – that is, a $5 million dollar bid by a competitor is only worth a net $4.75 million to the estate, because $250,000 of the $5 million must be paid to you if the competitor wins the auction.
Bidding turns to you, and you enter a $5.1 million bid. The competitor bows out. Following the auction, your attorney sends debtor’s counsel a draft sale order setting forth that your final cash sale price is $4.85 million (the $5.1 million bid reduced by the Bid Protections credit). Debtor’s counsel asserts that you did receive the credit at the auction, that your $5.1 million bid was not qualified by any language referring to the Bid Protections, and threatens to blow up the sale prior to the hearing if you do not agree to pay the full $5.1 million in cash. How could this have been avoided?
How to Get the Bid Credit you Deserve
For “stalking horse” bidders, the purchase of a bankruptcy debtor’s assets comes with certain risks, including uncompensated due diligence. To provide incentive to prospective stalking horse bidders, courts will often approve Bid Protections, which are commonly memorialized in the APA between the stalking horse and the debtor and included in the bid procedures order (the “Procedures Order”). Also commonly included in the Procedures Order is a bid credit for the stalking horse for the amount of its Bid Protections, which created the issue in our scenario above.
To avoid any ambiguity as to the cash portion of your bid, be sure to do the following:
1. Be sure the language in the APA is clear that the Bid Protections credit, if there is an auction, will be netted out of the purchase price. The following (or similar) language is recommended:
On the Closing Date, in consideration for the conveyance of the Assets, Buyer shall deliver the following consideration to Seller (the “Purchase Price”): payment of an amount (the “Closing Cash Payment”) in cash equal to $X less (A) the Cash Deposit, and (B) if there is an auction resulting in a final cash purchase price greater than that contemplated herein, an amount equal to the Bid Protections.
(of course, be sure that “Bid Protections” is accurately defined in the APA).
2. Include language in the APA and Procedures Order that provides for a credit toward the cash purchase price for the amount of the Bid Protections, as described above, such as: “At the auction, Buyer shall receive a continuing cash ‘credit’ toward any bid in an amount equal to the Bid Protections.”
- It is important to note that the credit is continuing. That is, every single bid of a competitor, no matter how many rounds of bidding, is always subject to (or deflated by, to use the terminology above) your Bid Protections. No matter how high the bidding goes, a successful competing bid will result in the payment to you of the Bid Protections. Parties will sometimes argue that the “credit” only applies to the first overbid – this is wrong.
3. Most critically, when announcing your bid at the auction, be crystal clear as to the net effect of the Bid Protections credit. For example, for our scenario above, instead of simply entering a $5.1 million bid, use the following: “The Stalking Horse hereby submits a bid of $5.1 million, comprised of $4.85 million in cash, plus the Stalking Horse’s $250,000 cash credit for the Bid Protections pursuant to the APA and Procedures Order.”
From a bankruptcy sale perspective, the entire process is always about maximizing value. If stalking horse bidders are not actually given the full benefit of making a market by having the Bid Protections increment taken away from them after the auction, they will be less likely to take the risk and step up. Clarity on how this issue should be addressed would be helpful for all market participants, but more importantly, clarity regarding the components of your bid – spoken clearly as part of every incremental bid – will ensure you get the Bid Protection credit you deserve at auction.