March 13, 2017 - Are quick asset sales to resolve bankruptcy a good or bad thing? The issue of whether Section 363 of the bankruptcy code, the section that permits quick asset sales, is in need of reform was first raised by the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11 (the “Commission”). In its 2014 report the Commission pointed to the increased use of 363 sales and the increasingly fast pace at which they have been completed, and concluded (based on anecdotal evidence) that these two factors lead to systemic undervaluation of companies to the detriment of junior creditors. The LSTA, in its response to the Commission, argued (based on extensive analysis) that the Commission’s conclusions were based on perception rather than data and cautioned against imposing a solution in search of a problem.
In an article published last week in Law360, Konstantin Danilov took a fresh look at the issue. His answer: Neither the increased use of 363 sales nor the faster pace of bankruptcy appears to be out of the ordinary when studied from a broader market context. In fact, 363 sales represent one of the more efficient ways to resolve a Chapter 11 bankruptcy proceeding while valuation indicators appear to show similarly favorable signs. Indeed, a look at various valuation measures indicates that more 363 sales have occurred during periods when companies are relatively overvalued rather than when they are undervalued. After all, directors of insolvent firms now focus on maximizing value for all stakeholders – not just equity-holders. As such, they are more likely to pursue value-maximizing sales in lieu of protracted court proceedings meant to increase the option value of out-of-the-money stakeholders.
Danilov notes that the faster pace of 363 sales is in line with broader market trends. In fact, all Chapter 11 cases have been faster since passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), so it only makes sense that 363 sales would proceed more quickly as well. Given that the 363 sale marketing process often begins prior to the debtor’s Chapter 11 filing, what is seen as a “quick sale” may more likely be the result of a lengthy advance marketing process.
Danilov also demonstrates that while historical M&A premiums can vary dramatically, they typically were very high during periods when 363 sales were most prevalent. This suggests that the bidders in 363 sales would not have been able to acquire companies or assets at below-market levels. Finally, he analyzes market value multiples, including price-to-book value and price-to-earnings for companies comprising the S&P 500 Index. On balance, he finds that more 363 sales were conducted during periods when market multiples, and hence valuations, were above average.
Danilov concludes that his findings should serve as a caution against rushing in to fix a bankruptcy process that may not be broken.