Surgalign Holdings, Inc. – Sale Hearing for Digital Assets Postponed as Debtors Name New Successful Bidder and Draw Furious Objection from Earlier Presumed Auction Winner; Judge Lopez Left to Rule on Late Exercise of Fiduciary Out

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August 8, 2023 – Following the receipt of a post-auction bid for their "Digital Assets" (see description of Digital Health Business below), the Debtors have thrown a wrench into what appeared to be a small, straightforward sale by naming latecomer Surgical Theater, Inc. (“Surgical Theater,” $1.5mn bid*) as their new successful bidder. That decision drew a furious response from the earlier declared winner Augmedics, Inc.* ("Augmedics") and leaves Judge Christopher Lopez to make some interesting calls on a debtor's ability to exercise a fiduciary out where bidding procedures appear to close the door to entertaining post-auction bids unless a debtor has first obtained Court authority to do so. That assessment (which Augmentics argues "poses a very clear and fundamental question: is the integrity of the Court [and implicitly the Court] approved bankruptcy sale process worth $600,000?) is to be made at a sale hearing now delayed until August 10th. 

On July 28th, the Debtors notified the Court that, absent the receipt of any further qualified bids for their "Stalking Horse Hardware Assets," (ie, assets relating to hardware and biomaterials business in the United States as described further below) they had named stalking horse Xtant Medical Holdings, Inc.* (NYSE American: XTNT, “Xtant” or the “Stalking Horse Bidder,” $5.0mn cash bid), as the successful bidder for those assets [Docket No. 290].

The notice also designated Augmetics ($900k purchase price) as the successful bidder for the Debtors' "Digital Assets," this coming after the receipt of several qualified bids and a July 27th auction at which Brainlab AG was named as the back-up bidder and Surgical Theater was nowhere to be seen.

*Arlington Heights, Illinois-based Augmetics "pioneers cutting-edge augmented reality technologies to improve surgical outcomes."

In announcing the switch in successful bidders, the Debtors noted: "….subsequent to the conclusion of the Auction and announcement of the Successful Bidders, the Debtors received an unsolicited bid for the Digital Assets from Surgical Theater, Inc. ('Surgical Theater') for an aggregate purchase price of $1,500,000 and the assumption of certain liabilities, as set forth in the applicable asset purchase agreement with substantially identical terms to that of the Augmedics Bid….in an exercise of their fiduciary duty to maximize the value of their estates, the Debtors designate Surgical Theater as the new Successful Bidder and Augmedics and Brainlab as the Back-Up Bidders for the sale of certain of the Debtors’ Digital Assets.3"

That footnote 3 carries the Debtors' legal argument as to their authority to make the switch: "See Bid Procedures § XVII ('Notwithstanding anything to the contrary in these Bid Procedures, nothing in these Bid Procedures shall require the Debtors, after consulting with counsel, to take any action or refrain from taking any action with respect to any Potential Transaction if taking or failing to take such action would be inconsistent with applicable law or their fiduciary duties. The Debtors maintain their rights to exercise their fiduciary out at any time prior to the entry of the Sale Order.”).

The Augmetics objection tears into the breadth of that fiduciary out and is not at all subtle about putting Judge Lopez on the spot as to a big call on a small sale. From that objection: "The non-compliant bid put forth by STI well-beyond the 11th hour and without any colorable justification poses a very clear and fundamental question: is the integrity of the Court approved bankruptcy sale process worth $600,000?

STI submitted its bid on August 7, which is 12 days after the Bid Deadline, 11 days after Augmedics prevailed in competitive bidding at the Auction, and less than 24 hours before the Sale Hearing. As of almost 10:30 a.m. Central time on August 7, Augmedics effectively had finalized the documentation of its Successful Bid with the Debtors (including the proposed sale order) and was getting ready for what it justifiably expected to be an uncontested Sale Hearing and a quick and smooth closing. Augmedics did so in good faith reliance on the Bidding Procedures Order, which Augmedics diligently followed to the letter.

Unbeknownst to Augmedics, the Debtors apparently received an expression of interest from STI at some unspecified point following the Auction. Also unbeknownst to Augmedics, the Debtors granted STI access to the data room, allowed STI to conduct diligence, negotiated a bid with STI on the very same form of revised APA that Augmedics had negotiated with the Debtors, and accepted a cash deposit from STI. All of this after the Debtors filed their notice designating Augmedics as the Successful Bidder and without any disclosure to Augmedics, or most importantly, this Court.

As the Court will no doubt anticipate, the Debtors’ explanation for all of this is that they had a fiduciary duty to maximize value, which is specifically referenced in Section XVII of the Bid Procedures. Yet Section XI of the Bid Procedures specifically states that ‘Unless the Bankruptcy Court orders otherwise, the Debtors will not consider any Bids or Subsequent Bids submitted after the conclusion of the applicable Auction, and any and all such Bids and Subsequent Bids will be deemed untimely and will under no circumstances constitute Qualified Bids.’ 

If a party could simply submit a higher price bid after the conclusion of the Auction to trigger a fiduciary out under Section XVII of the Bid Procedures, then Section XI would be completely meaningless (and therefore entirely misleading to diligent bidders like Augmedics who indisputably relied upon it in good faith).

Therefore, if there is going to be any integrity to the bankruptcy sale process, the standard for considering a non-compliant, last-minute bid must be more than just an incremental increase in price. The case law bears this out, with a focus on balancing the extent to which a compliant bidder’s rights and expectations have been reasonably established against other factors that might cut against the integrity of the process (like fraud, collusion, lack of competitive bidding or other factors indicating a grossly inadequate auction price).

Here, the balance weighs overwhelmingly in favor of honoring Augmedics’ Successful Bid… Whereas entertaining the STI bid would do great and irreparable harm to the integrity of the sale process not only in these cases, but potentially in a host of cases to come.”

Sale Background

Bidding Procedures Motion

The motion provides: “[The] Motion seeks relief in three stages. First, the Debtors seek entry of the Bid Procedures Order, substantially in the form attached hereto, approving the Bid Procedures for the sale of all or substantially all the Debtors’ Assets or any other Potential Transaction, authority for the Debtors to enter into the Stalking Hose Agreement, authority for the Debtors to conduct an auction, if necessary, and scheduling a Sale Hearing to approve any resulting sale transaction.

Second, the Debtors request that the Court schedule a hearing no more than 14 days after the commencement of these chapter 11 cases, or as soon thereafter as practicable, to consider entry of the supplemental order in the form filed with this Motion (the ‘Bid Protections Order’) approving, if and to the extent payable, the Bid Protections (as defined below). Third, pursuant to the Bid Procedures and following a duly noticed Sale Hearing, the Debtors seek entry of an order (the ‘Sale Order’), in substantially the form filed with this Motion (as modified pursuant to the terms agreed upon with the Successful Bidder pursuant to the Bid Procedures), approving any proposed sale and related transactions to the successful bidder. Expedited approval of the Bid Procedures, including with respect to authorization of the bid protections related to the Stalking Horse Agreement and any other stalking horse agreement for the Debtors’ other assets that is executed prior to the auction, is necessary to maintain and ultimately maximize the value of the Debtors’ assets.”

The motion continues, “[t]he Debtors’ business assets consist primarily of the Debtors’ hardware and biomaterials business in the United States, and equity interests in non-Debtor entities related to the Debtors’ hardware business outside of the United States, and a digital and artificial intelligence business….

The Debtors’ Assets that are for sale can be divided into three primary categories, including the:

  • Hardware and Biomaterials Business: The Debtors have a broad portfolio of spinal hardware implants, including solutions for fusion procedures in the lumbar, thoracic, and cervical spine, as well as a biomaterials portfolio of advanced and traditional orthobiologics. Additionally, the Debtors’ hardware business has valuable long term distribution agreements with original equipment manufacturers, hospitals or other healthcare providers that allow the Debtors to, among other things, receive supply chain services or provide certain of their products to such healthcare facilities, as applicable.FN7 The Debtors seek to sell Assets encompassing the U.S. spinal hardware business and biomaterials product lines, which are subject to the Stalking Horse Agreement submitted by the Stalking Horse. Although the Stalking Horse Bid sets a floor for the contemplated bidding process, the Debtors are continuing to market their hardware operations, inventory, and intellectual property, in whole and in part, and/or in combination with other parts of the Debtors’ businesses.
  • International Business: The Debtors’ broad portfolio of spinal hardware implants described above is also marketed and sold outside of the U.S. Similar to the U.S. hardware and biomaterials business, the Debtors seek to sell the Debtors’ equity interests in their 11 non-Debtor entities related to the international spinal hardware business and biomaterials product lines, in whole and in part, and/or in combination with other parts of the Debtors’ businesses.FN8 Such non-Debtor subsidiaries that comprise the international hardware business were incorporated or formed in Germany, Austria, Switzerland, Luxembourg, Netherlands, Australia, Singapore, United Kingdom, and Spain. The Debtors are also marketing their equity interests in the non-Debtor subsidiaries related to the international digital business, which include non-Debtor subsidiaries in Poland.
  • Digital Health Business: The Debtors developed an artificial intelligence (‘AI’) and augmented reality technology platform that connects the continuum of care from the pre-op and clinical stage through post-op care and is designed to achieve better surgical outcomes, reduce complications, and improve patient satisfaction. The Debtors’ AI-based platform was developed to function as intelligent anatomical mapping technology designed to assist surgeons by allowing them to remain in safe anatomical zones and to enhance surgical performance. The Debtors are seeking a buyer or an investor with whom to partner as the Debtors continue their digital product development and are open to all proposals in connection with the digital health business line, in whole or in part, and/or in combination with other parts of the Debtors’ businesses.

The Bid Procedures will allow the Debtors to market-test the Stalking Horse Bid and confirm whether any additional value exists for the Debtors’ unsecured creditors on account of the Stalking Horse Hardware Assets. The Stalking Horse Agreement benefits the Debtors’ estates by setting a floor for the competitive bidding process that will allow the Debtors to identify any higher and otherwise better offers that might exist. Even if no higher and otherwise better offers are identified through this process, the Purchaser has agreed to purchase the Stalking Horse Hardware Assets, which will provide value to the estates to the benefit of all stakeholders. 

… The Debtors believe that the proposed Bid Procedures and the related relief requested in the Motion will allow the Debtors to (i) pursue a value-maximizing sale or other Potential Transaction process in the chapter 11 cases and (ii) provide an efficient and quick resolution to these chapter 11 cases.”

Marketing Process

The motion provides: “Prior to the Petition Date, the Debtors determined that it was prudent to sell their hardware business.

To that end, the Debtors conducted an initial sale process for its assets on or around late 2021 into 2022 and then ran a second process in December 2022 through May 2023. During the second process, approximately 60 potentially interested parties were contacted, resulting in 4 parties that submitted non-binding indications of interest. While the second process did not lead to a sale of all the Debtors’ assets, it culminated with the sale of its Coflex and Cofix product lines, which were part of the Debtors’ U.S. hardware and biomaterials business unit.

Approximately four weeks prior to the Petition Date, the Debtors, with assistance from A&M, began a third, more targeted marketing process and reached out to third parties to gauge market interest in pursuing a potential sale of the Debtors’ U.S. hardware and biomaterials and digital health businesses.

During this period, the Debtors and their advisors updated the marketing materials to reflect the sale of the Coflex and Cofix assets, included financials for fiscal year 2022 and first quarter of fiscal year 2023, and engaged in extensive dialogue and due diligence with several potentially interested parties regarding the sale of the U.S. hardware and biomaterials business. The parties contacted were primarily those that during the prior process expressed some interest in all or some of the Debtors’ assets. Following outreach to approximately 13 parties, approximately 11 indicated interest and executed (or had previously been executed during a prior process) non-disclosure agreements.

With respect to the Debtors’ digital health business, the Debtors are continuing to run a broad marketing process. To date, the Debtors have reached out to approximately 300 strategic and financial partners and purchasers. The Debtors are in discussions with a number of potential buyers at this time. The Debtors and their advisors will continue to actively market the digital health business postpetition, including facilitating due diligence requests and management meetings, among other things, to facilitate a value-maximizing sale of the digital health business.

In a declaration [Docket No. 29] in support of bid procedures motion, George Varughese, Managing Director at Alvarez & Marsal Securities, the Debtors’ investment banker provides more on the Xtant off for the Stalking Horse Hardware Assets: “Shortly before the Petition Date, the Debtors received non-binding indications of interest from four potential purchasers for the sale of certain Assets in connection with the Debtors’ U.S. hardware and biomaterials business, each containing varying levels of specificity. None of the four potential purchasers initially offered to purchase the equity interests in non-Debtor entities related to the Debtors’ hardware business outside of the United States. Xtant was the only potential purchaser that delivered a written offer including such equity interests. The Debtors determined that Xtant’s offer to purchase substantially all of the Assets encompassing the U.S. hardware and biomaterials business and the equity interests in non-Debtor entities related to the Debtors’ hardware business outside of the United States (the ‘Stalking Horse Hardware Assets’) was the highest or otherwise best offer for the Debtors and the most value-maximizing alternative. As such, the Debtors designated Xtant as the ‘stalking horse’ bidder (the ‘Stalking Horse Bidder’) for the Stalking Horse Hardware Assets. 

On June 18, 2023, the Debtors entered into an asset purchase agreement (the ‘Stalking Horse Agreement’) memorializing the Stalking Horse Bidder’s bid (the ‘Stalking Horse Bid’) to purchase the Stalking Horse Hardware Assets in addition to the assumption of liabilities set forth therein, subject to higher or otherwise better offers being obtained at the auction contemplated by the Bid Procedures….”

Alternate Potential Transaction

The motion further provides, “Given the circumstances of these chapter 11 cases, the Bid Procedures have several features designed to maximize the value achieved for the Assets:

  1. The Bid Procedures apply to various potential transaction processes: an Asset Sale or another form of Potential Transaction in accordance with a given bidder’s preference. Rather than focus solely on one potential path to monetization, the Debtors believe the best way to maximize value for their estates within the timeline and budget of these chapter 11 cases is to continue to conduct a broad marketing process and solicit bids for any and all sale, financing, and chapter 11 plan transactions, continuing the marketing process started prior to these chapter 11 cases.
  2. Except for the Stalking Horse Bid, the Bid Procedures allow the Debtors to seek Court approval of a Bid prior to the Bid Deadline and without an Auction if the Debtors determine that doing so would best maximize value for their estates. Any such transaction will be consummated only after further notice and Court approval, which may occur concurrently with any other ongoing Potential Transaction processes outlined in the Bid Procedures.
  3. With respect to a proposed Asset Sale, the Bid must contemplate (i) entry of the Sale Order by no later than August 14, 2023 and (ii) being consummated by no later than September 1, 2023.
  4. With respect to another form of Potential Transaction (other than an Asset Sale), the Bid must comply with the Potential Transaction Milestones” set forth below:

About the Debtors

According to the Debtors: “We are Surgalign, a global medical technology company committed to the promise of digital health. We are investing to be a leader in developing and harnessing the incredible possibilities of digital surgery to redefine the very idea of ‘personalized medicine.’

We began operating as Surgalign in July 2020, but with a legacy of clinically validated surgical device and biologic innovation stretching back 30 years. We are dedicated to advancing care and elevating outcomes. Surgalign markets products in the United States and in approximately 50 countries globally.”

Corporate Structure Chart

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