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A sale of the debtor’s assets can occur through a Court-approved auction under Section 363 of the Bankruptcy Code or as part of the debtor’s reorganization plan under Section 1129 of the Bankruptcy Code. Section 363 sales and sales under the reorganization plan are further discussed in the following sections, along with the advantages and accounting implications of each type of sale.

5.2.1 Section 363 sales (during bankruptcy)

Section 363 of the Bankruptcy Code provides for sales of assets through a Court-supervised auction for entities that have filed bankruptcy petitions under Chapter 11. These asset sales often involve the highest-valued assets or operations of the debtor entity. Any remaining assets, along with any remaining liabilities not assumed by the buyer, continue in the bankruptcy process. While the Code outlines a process governing Section 363 sales, the terms and conditions of each transaction will differ.
A typical Section 363 sale begins with a decision that a sale through an auction process would be the most effective and efficient way to provide value to satisfy claims against the debtor. With Court approval, the debtor and its advisors identify a “stalking horse” acquirer, with whom a purchase agreement is negotiated. A stalking horse can provide benefit to the sales process as the market for the assets to be sold is often thin and the stalking horse demonstrates to the market that there is indeed interest in these assets. The parameters of the solicitation and auction procedures are agreed upon and approved by the Court. This includes protections for the debtor-in-possession and the stalking horse. The offer included in the stalking horse proposal becomes the initial bid for the subsequent auction process and outlines the terms of the transaction, such as the assets and liabilities to be included in the sale.
Refer to Question BLG 5-1 for the advantages and disadvantages of using a stalking horse.
Question BLG 5-1
What are the advantages/disadvantages of using a stalking horse?
PwC response
A stalking horse benefits by setting the parameters for the Section 363 sale. This potential buyer usually sets the initial bid in the auction, the terms of the sale, and the assets and liabilities to be included in the transaction. Its bid serves as a minimum bid or benchmark in the marketing and sale process. The stalking horse often has more time for due diligence than competing bidders because it can perform its due diligence prior to the solicitation period imposed on other bidders. The "first mover" advantage also allows it to influence the pace and structure of the transaction and establish relationships with management and other key stakeholders of the debtor. However, since the stalking horse typically commits substantial resources to prepare its initial bid and the results of any due diligence are available to the other bidders, it faces the risk of performing a substantial amount of work without closing the deal. If another bidder is successful at auction, the stalking horse is often entitled to a breakup fee and reimbursement of its expenses.

Reporting entities should consider how stalking horse fees are structured, and how the fees may be impacted by the bankruptcy proceedings, in order to perform the appropriate accounting. Such fees may be deemed subject to compromise and may be presented as a reorganization item.
After a stalking house is identified, a public auction is held by the debtor if at least one other bidder is identified. The auction continues until a winning bid is determined. Before approving the sale, the Court must find that the sale is in the best interests of the estate and its creditors, has a legitimate business justification, was negotiated in good faith and at arms' length, and satisfies various tests and conditions for adequate assurance.
The winning bidder becomes the owner of the assets and liabilities. The winning bidder generally receives the assets free and clear of liens, but in turn accepts the assets "as is," with no representations or warranties. The proceeds from the auction go to the bankruptcy estate to satisfy debtor obligations. Advantages of a Section 363 sale include the following:
  • Assets are generally transferred free and clear of liens and claims
  • The process provides greater flexibility in structuring the transaction. For example, a buyer may acquire only those operations of the debtor that are profitable and leave behind those that are not
  • The sale requires only the approval of the Court and is not subject to voting by the creditor committees. This can allow for a much shorter process in instances when creditors cannot block the sale. In addition, a Section 363 sale of all, or substantially all, of the assets of an entity does not require shareholder approval
  • In most cases, a sale under Section 363 is less expensive than an emergence of the debtor from Chapter 11
At times, a reporting entity may file for bankruptcy protection and the news coverage may imply that the reporting entity will "emerge" from bankruptcy in an unusually short time, perhaps as little as 30 days. In most cases, the debtor is not actually emerging from bankruptcy in such a short period. Rather, the debtor is usually selling a substantial majority of its assets, and the buyer is assuming some of the debtor's liabilities, through a Section 363 sale. Proceeds from the sale are remitted to the debtor's estate, and the debtor's bankruptcy proceedings may continue for an extended period while any remaining assets are liquidated and liabilities are settled.
At times, secured creditors may participate in a Section 363 sale through a credit bid. Refer to Question BLG 5-2 for discussion of credit bidding.
Question BLG 5-2
What is credit bidding?
PwC response
In some cases, a qualified bidder's primary competition in an auction may be the reporting entity's existing secured creditors. When the value of the assets does not exceed the secured debt (i.e., when the collateral is insufficient), the secured creditors are typically able to bid the full face value of their debt, subject to some limitations imposed by the bankruptcy court. Private equity firms frequently accumulate a position in the secured debt of a bankrupt entity and actively use this as a tool to facilitate acquisition of a distressed entity's assets via a Section 363 sale or in accordance with an entity's plan of reorganization.

5.2.2 Sales under the reorganization plan (during bankruptcy)

In some instances, a debtor's reorganization plan may call for the sale of some of the reporting entity's assets to a third party in the bankruptcy proceedings. Section 1129 of the Bankruptcy Code governs this type of sale. The sale must be approved by the various creditor committees and confirmed by the Court as part of the reorganization plan.
A sale through the reorganization plan offers some of the same benefits as a Section 363 sale listed above—specifically, the ability to transfer assets free and clear of most liens and claims and, for the buyer, the ability to continue beneficial contracts while rejecting others. The primary differences between the two types of sales are the different thresholds of approval required and, in most cases, the increased time and expense of going through the bankruptcy process. The higher degree of involvement and influence of the creditor classes generally makes a sale under the reorganization plan more complicated. That said, potentially valuable tax attributes of the debtor can be realized from such a sale if completed through a stock sale. Sales under Section 363 generally do not involve the acquisition of stock, so the debtor's tax benefits rarely transfer to the new entity.

5.2.3 Accounting for sales in bankruptcy

While in bankruptcy, the debtor's accounting for a sale of certain of its operations is similar to a disposition by an entity not in bankruptcy , assuming the sale has been properly approved. The assets and liabilities included in the sale would be derecognized from the balance sheet, with any gain or loss recorded in the statement of operations when the sale has been approved by the Court. The accounting for the portion of the enterprise that remains after the sale would depend on how that portion is expected to be addressed in the bankruptcy. If the remaining portion of the entity is still expected to emerge as a reorganized entity, bankruptcy accounting would continue to be applied. However, in most Section 363 cases, the remaining assets after the sale are subsequently liquidated under Chapter 7 or Chapter 11 of the Bankruptcy Code. In these cases, a change to the liquidation basis of accounting for the remaining entity after the asset sale may be appropriate when the liquidation of the entity becomes imminent.
The seller's disposal of some or all of a bankrupt entity's assets would be accounted for as a sale of nonfinancial assets or a sale of a business if the disposed assets constitute a business. In a sale of nonfinancial assets, the seller would apply the derecognition of nonfinancial assets guidance in ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets. Refer to PPE 6.2 for more information. In a sale of a business, the seller would apply the derecognition guidance in ASC 810-10-40, which requires the reporting entity to deconsolidate a subsidiary or derecognize a group of long-lived assets as of the date the reporting entity ceases to have a controlling financial interest. Refer to BCG 1.2 for more information on this determination.

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