Filing for bankruptcy can have negative connotations, but a Chapter 11 reorganization is also a phenomenal and beneficial tool to keep a business alive and pay creditors. It can also be a way for another company to obtain valuable assets from the financially distressed company, free and clear of liens, debts and encumbrances.
Purchasing Assets from a Company in Bankruptcy
Consider for example the recent bankruptcy of A123 Systems. This company is located in Livonia, Michigan and develops and manufactures lithium ion batteries and energy storage units. A123 employed over 2400 people worldwide. In 2012, however, A123 filed for Chapter 11 bankruptcy protection. But on October 16, 2012, A123 Systems entered into an asset purchase agreement (“APA”) with one of its former competitors, Johnson Controls Inc., and agreed to $72.5 million in debtor-in-possession financing to support continued operations during the transition.
Pursuant to the APA, Johnson Controls plans to acquire A123’s automotive business assets, which includes automotive technology, products, customer contracts, facilities in Michigan and China, its equity interest in Shanghai Advanced Traction Battery Systems Co., and a joint venture with Shanghai Automotive. The A123 APA also includes provisions allowing Johnson Controls to license back to A123 certain technology for its grid, commercial, and government businesses.
Challenges and Obstacles for Purchasing Assets out of Bankruptcy
Navigating an acquisition of assets from a Chapter 11 bankruptcy can be complicated. For starters, Johnson Controls assumed the role of a “stalking horse,” which in bankruptcy context is the initial company that is chosen by the bankrupt company to bid on its assets. But assuming the role of a stalking horse is not without risks.
It is critical for prospective buyers like Johnson Control to negotiate protections that include a break-up fee, also known as a termination fee. Break-up fees may be a percentage of the purchase price or a set amount. Such fees are intended to encourage potential buyers to bid on a bankrupt company’s assets by allowing such a buyer to recoup its investment in terms costs incurred, such as professional fees, due diligence efforts and other resources utilized for the process, should the bid fail.
Further disadvantages for prospective buyers of bankruptcy asset include the failure of the Bankruptcy Court to approve the sale, a competitor may challenge the stalking horse and outbid it, or other creditors may raise objections.
Katherine Shinn focuses on working with companies to avoid or to respond to bankruptcy legal issues. Prior to this, Ms. Shinn managed her family-owned Metro Detroit business. For more information about Ms. Shinn or her law firm, see www.shinnlegal.com.
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