As has been well publicized, several retail businesses have recently filed Chapter 11 bankruptcies only to fail to reorganize and be forced to shut down operations and liquidate. Toys R Us is one of the more high-profile failed reorganizations, and Sears, as of the date of this article, is barely escaping liquidation. There are plenty of examples, as this listing shows. When forced to liquidate, a retail debtor company’s real estate portfolio is often the most significant non-operating asset that will be sold to pay creditors. Opportunities for real estate value investors abound, but prospective buyers must be aware of nuances specific to bankruptcy sales in pursuing such potential deals. Below are some highlights of what to expect as you mine for value.

Expedited Timeline

Under most circumstances, the debtor company will remain in control of the sale of its assets, with the sale of the real estate taking place on an expedited timeline to mitigate the administrative costs of the liquidation and maximize recovery for the debtor’s creditors.

Buyers should be aware that they will have to move quickly and make the opportunity a top priority. The entire process, from receiving an initial executive summary through the due diligence process and submitting a binding “qualified” bid, could be on a court-mandated timeline that is 90 days or less. There must be immediate and intense focus on the diligence process and making a capitalization rate and value determination. Requests for extensions of time for investors to do further work are rarely granted.

Highest and Best

Unlike foreclosure sales or sales by a receiver appointed under state law, most bankruptcy sales are not privately negotiated transactions nor open bids subject only to the approval of a bank or other secured creditor. Rather, the debtor company has a duty to produce the “highest and best” bid, meaning that most times bankruptcy sales are a competitive process. Most court-approved sale procedures provide that any bid must meet a minimum threshold in order to be a qualified bid. In the event that multiple qualified bids are received, qualified bidders are then advanced to an auction process. At auction, the highest bid submitted is the opening bid, and bidding rounds then take place, with court-approved minimum bidding increments. Bidding continues until there is a winner, which most of the time is the highest bid, although in certain circumstances non-monetary considerations can lead to a bid that is not necessarily the highest in dollar amount being designated as the highest and best bid. 

In preparing for the auction, buyers should make sure they have demonstrated the financial wherewithal to close a transaction at the highest amount they plan to bid to avoid a situation where a buyer’s highest bid is not accepted as highest and best due to the appearance of closing risk.  

Stalking Horse Opportunity

One benefit to prioritizing the opportunity and making a very quick decision to submit a binding bid is the potential opportunity to serve as a “stalking horse” in the sale process. Since bankruptcy courts appreciate the certainty of locking in a “floor” bid in an auction process, courts will often approve a “breakup” fee and expense reimbursement for a stalking horse bidder in an amount generally around 3% of the total purchase price. While there are no assurances that a stalking horse bidder will ultimately be the winning bidder, for the aggressive buyer willing to commit early, the breakup fee and expense reimbursement ensure at least a consolation prize.    

Free and Clear and Credit Bidding

One of benefits of buying real estate pursuant to a bankruptcy sale is that property is conveyed free and clear of any liens, claims and encumbrances. That means that regardless of the amount of the purchase price, a bank’s lien, a judgment lien and other recorded liens are washed out in the transfer.

Buyers should note that per a 2012 Supreme Court ruling, a secured creditor may “credit bid” up to the full amount of the claim when a Chapter 11 debtor elects to sell its assets lien-free. To account for this, buyers need to determine whether they are willing to pay more than the total amount of the secured debt encumbering the property. Buyers should also inquire as to whether secured creditor(s) want to gain possession of the property through a credit bid and whether such secured creditor(s) would be willing to designate an acceptable cash price that is less than the full amount of the debt in exchange for a waiver of credit bid rights.

The Sale Hearing and Sale Order

Buyers should be aware that submitting the highest and best bid does not automatically mean that you are the winning bidder and can proceed to closing the transaction. The bankruptcy court must first approve the sale, which is subject to objections by other parties-in-interest. The court will conduct a sale hearing at which the court must determine, among other things, that the sale is in good faith, that the sale process was free of collusion, and that approval of the sale is in the best interests of the debtor’s estate and its creditors.

If the court approves the sale, it will enter a sale order. For buyers, it is important that the sale order contain all customary and case-specific findings and binding paragraphs. Specifically, buyers should ensure that the sale order clearly relieves the buyer from any successor liability, other than certain liabilities that “run with the land” and cannot be extinguished by the sale order, such as environmental liabilities. Once the sale order is entered by the court, the closing should proceed much like closings outside of bankruptcy except that it will likely be on an expedited timeline and the forum of the bankruptcy court remains in the background to resolve any disputes that arise, if needed.

Bottom Line

Failed retail Chapter 11 bankruptcies present opportunities for real estate investors. As retail bankruptcies will continue in 2019, there are likely to be plenty of opportunities for real estate investors looking for value plays. As a trusted advisor, CBIZ stands ready to help provide the right focus and guidance to execute on such opportunities. Happy hunting!

Your Team – For More Information

Jeff Varsalone is a Managing Director in CBIZ’s Corporate Recovery Services Group. Don’t hesitate to reach out to Jeff (jvarsalone@cbiz.com or 212.790.5876) on this topic and other special situations transactional issues.