363 Sales as a Health Care M&A Tool, Part 1 – Overview
This two-part blog series discusses why buyers looking to make strategic purchases in the health care industry might want to take advantage of the Bankruptcy Code Section 363 sale process (363 Sale) and the pros and cons of buying assets out of bankruptcy through a 363 Sale.
Beginning in March, COVID-19 upended equity markets and forced health care businesses to take on more debt. Even with extensive stimulus programs, many businesses (including health care businesses) will not survive the sustained COVID-19 economic environment and will be forced to consider, and file for, bankruptcy.
As some states slowly reopen and others close back down parts of their economies in response to a resurgence of COVID-19 infections, health care businesses continue to adjust. Although health care may be well positioned to weather the storm as an industry, certain sectors, including ambulatory surgery, vision, dermatology, dental, and other physician practices will bear the brunt of stay-at-home orders and patients delaying non-emergency care. While the onset of COVID-19 has delayed or derailed many transactions, strategic buyers should consider all of the different transaction tools available them to help maximize value and successfully get to closing. For knowledgeable investors and strategic buyers, now is the time to position yourself to acquire valuable health care assets at steep discounts.
For those unfamiliar with 363 Sales, a 363 Sale couples a flexible and fast process with ample liability protection for willing buyers. The primary benefit of a 363 Sale is that a buyer can acquire the debtor’s assets free and clear of virtually all liens, claims, and encumbrances burdening the assets and the debtor. When a target is experiencing severe financial distress, the benefit of acquiring assets “free and clear of all liens” is extraordinarily valuable.
Buying Assets Free and Clear of All Liens
What does “free and clear of all liens” mean for buyers? It means the assets transfer to a buyer free and clear in many cases even if:
- The seller is insolvent;
- A secured lender to the seller has a lien on the assets;
- The seller or the assets are subject to suits or litigation;
- The seller cannot pay its employees, creditors, or any other party;
- A minority investor or equity holder opposes the sale; or
- The sale is opposed by creditors of the seller.
The “free and clear” benefit of a 363 Sale is conferred on the buyer by the express statutory terms of the Bankruptcy Code, and is embodied in the order entered by a federal Bankruptcy Court approving the sale. Since Bankruptcy Courts have nationwide jurisdiction, a 363 Sale order binds all of the debtor’s creditors and equity holders, wherever they are located and whether or not they approved or objected to the 363 Sale.
Using 363 Sales to Override Anti-Assignment Clauses
Another unique benefit of buying assets through the bankruptcy process is the power granted to debtors by Section 365 of the Bankruptcy Code, a companion provision to Section 363. Section 365 effectively overrides contract anti-assignment clauses and renders them unenforceable as a matter of federal law, including contract terms naming bankruptcy as an event of default that can lead to termination. Consequently, debtors can invoke Section 365 to assign most contracts or leases that a buyer may wish to purchase, including contracts with ironclad anti-assignment language, provided that certain conditions are satisfied.
The primary condition to the assignment of a contract or lease through a 363 Sale is a debtor’s ability to retain the agreement pursuant to the requirement under Section 365 that any defaults must be first be cured. In the case of a lease, for example, a debtor must first cure, or pay, any outstanding rental payments before the lease can be assigned to a buyer. Whether the debtor/seller or the buyer must satisfy the cure costs is a matter for the sale negotiations and should be set forth in the purchase agreement.
In any 363 Sale, a buyer should couple its use of Section 363 with Section 365 to acquire: (i) assets free and clear of all liens; and (ii) key business contracts that may not otherwise be easily assignable in a traditional asset transaction.
A Fresh Start for Buyers
Once an order approving the 363 Sale becomes a final, non-appealable order, neither the debtor's creditors nor any other party can void the sale or assert any of their rights or claims against the assets or the buyer.
By using Section 365, a buyer will have acquired the assigned contracts and purchased assets free and clear of all liens and liabilities and will have a fresh start to operate and revitalize the business.
363 Sale Process
The 363 Sale process often starts when a buyer identifies and approaches a target with an expression of interest. If the target debtor reciprocates the interest, a limited and accelerated due diligence process begins. Often, the debtor’s management team is focused exclusively on keeping the business open, and the potential buyer may not be able to complete its typical comprehensive legal and financial diligence process. However, given the cleansing power of a 363 Sale, the typical issues a buyer would seek to identify in due diligence may not apply. Instead, buyers will want to confirm the identity and value of the assets and contracts to be included in the 363 Sale.
A standard 363 Sale can take fewer than 75 days from signing the purchase agreement to the court issuing the 363 Sale Order, allowing the parties to close. If a buyer has completed its accelerated diligence process, the debtor has agreed to pursue bankruptcy, and the buyer has decided to act as the stalking horse, then a standard 363 Sale includes the following steps: (i) negotiation and execution of an purchase agreement; (ii) filing the executed purchase agreement and motion for a sale order with the court; (iii) final notice and marketing of the 363 Sale, including an auction if necessary; and (iv) the issuance of the sale order and closing.
For a more extensive overview of the Section 363 process, including thoughts for a buyer determining whether to act as the stalking horse bidder, please see this post written by our colleagues.
In part 2 of this blog series, we will discuss the pros and cons for potential health care buyers and sellers in a 363 Sale transaction. If you are considering a 363 Sale or have questions, please reach out to your trusted Mintz advisors.