Free and Clear Stock Sales in Bankruptcy May Leave the Assets of the Acquired Company Vulnerable to Creditors
 
February 15, 2007
 
Peter Alan Zisser - New York

Section 363 of title 11 of the United States Code, 11 U.S.C. §§ 101 et seq. (the Bankruptcy Code), is the section under which bankruptcy courts may authorize the sale of a debtor’s assets “free and clear” of any interest that an entity has in the property. For example, a sale under section 363 permits a buyer to take ownership of property without concern that a creditor’s lien continues to attach to the property or that a creditor will file suit against the buyer based on successor liability theory. In Amphenol Corp. v. Shandler (In re Insilco Tech., Inc.), 351 B.R. 313 (Bankr. D. Del. 2006), the Bankruptcy Court for the District of Delaware rendered a decision that should be a wake-up call for anyone believing that because of section 363, sales of assets in bankruptcy are, by definition, “free and clear” of all interests.

During the course of its bankruptcy case, the debtor, Insilco Technologies, Inc. (Insilco), sold 100 percent of the stock of its non-debtor subsidiary, Precision Cable de Mexico (PCM), to Amphenol Corp. The proceeds from the sale provided a significant portion of the funds needed to successfully confirm a chapter 11 plan of reorganization for Insilco. After the plan was confirmed by the Court, Chad Shandler, as trustee for the Insilco Liquidating Trust (the successor-in-interest to the unsecured creditors’ committee), commenced an action against PCM, seeking to avoid and recover an alleged prepetition preferential payment from Insilco to PCM of approximately $1.2 million. Amphenol filed an adversary proceeding seeking a declaratory judgment (and injunctive relief), arguing that section 363 of the Bankruptcy Code, the sale agreement and the sale order precluded such a claim. The trustee thereupon filed a motion to dismiss the declaratory judgment action.

In granting the trustee’s motion to dismiss, the Court pointed out that the language of the sale agreement provided for a stock sale, not an asset sale. Thus, under section 363 of the Bankruptcy Code, only the stock of PCM could be sold free and clear of all interests, which it was; no creditor could take any action or assert any claim against the PCM stock. The Court held, however, that Amphenol, while owning 100 percent of PCM’s stock, did not have any direct ownership interest in PCM’s assets, which were not sold free and clear.

Further, the Court held that the language of the sale agreement, while clearly releasing Amphenol, as “buyer,” from any liability, did not release PCM, which was neither included in the definition of “buyer” nor a party to the sale agreement.

What’s the Point?

Any entity interested in purchasing assets out of bankruptcy needs to add a bankruptcy professional to the team, not just those from the M&A side. Amphenol, by not doing so, got a harsh lesson both in proper bankruptcy deal drafting and the lack of a clear understanding of how section 363 and the Bankruptcy Code actually works.

For more information, e-mail Peter A. Zisser at peter.zisser@hklaw.com or call toll free, 1-888-688-8500.