Private investment firm Searchlight Capital Partners has agreed to pay $15M for Digital Domain Productions — the key operation at Digital Domain Media Group — although the special effects company will have to put itself up for auction following its Chapter 11 bankruptcy filing. Creditors threatened last month to foreclose; Digital Domain’s been losing cash which put it in default of its loan agreements. But Hudson Bay Master Fund and other senior note holders like the deal with Searchlight: They’re putting up as much as $20M in debtor-in-possession financing. Chief Restructuring Officer Michael Katzenstein says that Digital Domain is “grateful for the cooperative assistance of our lenders, our customers and employees as we work to seamlessly transition these important businesses and other assets to financially strong and committed buyers. Their ongoing support ensures the success of these matters.” CEO Ed Ulbrich adds that the company is “on track to deliver all of our clients’ productions on schedule, on budget and at the highest degree of quality that they expect from Digital Domain.” Films in its pipeline include Lionsgate’s Ender’s Game (Digital Domain is a co-producer), New Line’s Jack The Giant Killer, and Paramount’s G.I. Joe: Retaliation.

The turmoil at Digital Domain isn’t over yet. The company just laid off about 300 employees in Port St. Lucie, Florida — the home of its Tradition Studios, which was formed in 2009 and was producing an animated feature The Legend Of Tembo. In addition, Florida state and local officials are investigating the company’s use of millions in subsidies, including funds to develop the Digital Domain Institute, a partnership with Florida State University to teach digital arts. Last week John Textor abruptly resigned the CEO job at Digital Domain saying he’s “in profound disagreement” with the decision to close its Port St. Lucie operation. Textor said that leaving would give him “greater flexibility to independently consider other strategic alternatives for the Company, the Port St. Lucie studio and the people affected.”  Textor led an investment group that in 2006 bought Digital Domain from its founders who included director James Cameron, Stan Winston, and Scott Ross.

Here’s today’s release:

PORT ST. LUCIE, Fla.– Digital Domain Media Group, Inc. (NYSE: DDMG) today announced that as part of its previously announced strategic realignment, and to ensure the long-term future of its core business and facilitate a sale of assets, it has filed voluntary petitions for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware in Wilmington (“Court”) and is also seeking ancillary relief in Canada, pursuant to the Companies’ Creditors Arrangement Act (CCAA) in the Supreme Court of British Columbia, Vancouver Registry (the “Canadian Court”). DDMG also announced that it has entered into a purchase agreement with Searchlight Capital Partners L.P. (“Searchlight”) to acquire Digital Domain Productions and its operating subsidiaries in the United States and Canada (“DDPI”), including Mothership Media (“Mothership”), subject to the receipt of higher and better offers and Court approval.

DDPI and Mothership, with studios in California and Vancouver, are focused on creating digital visual effects, CG animation and digital production for the entertainment and advertising industries and are led by recently promoted Chief Executive Officer Ed Ulbrich.

“We’re excited to begin this new chapter in our history and look forward to partnering with Searchlight,” said Ulbrich, a 20-year veteran of the company. “The capital commitment of Searchlight will enable us to continue to bring our expertise to feature films, advertising, games, and other media experiences, with a focus on what we do best – creating amazing digital productions. We remain on track to deliver all of our clients’ productions on schedule, on budget and at the highest degree of quality that they expect from Digital Domain.”

During this process, DDPI and Mothership intend to continue to operate without interruption in the ordinary course of business including adhering to and seeing through client contracts.

“We believe in the visual effects business of Digital Domain, led by Ed Ulbrich and his team, and are strongly committed to maintaining the premiere product they create for customers and moviegoers. Upon Searchlight’s consummation of the transaction, we have committed and will continue to commit our strong financial resources and expertise to ensure that this business always remains healthy and vibrant,” said Eric L. Zinterhofer, co-Founder, Searchlight Capital Partners L.P.

Under the terms of the purchase agreement, Searchlight will acquire the assets of DDPI free and clear of all claims and encumbrances pursuant to section 363 of the U.S. Bankruptcy Code for the purchase price of $15 million. The sale will be the subject of a public auction, and DDMG is required to engage in a process of seeking the highest and best bid for these assets in accordance with the proposed bid procedures as filed with the Court.

The Senior Noteholders, led by Hudson Bay Master Fund Ltd., have agreed to provide DDMG with up to $20 million in debtor-in-possession financing. If approved by the Court, DDMG, DDPI and Mothership will have access to the funds to pay normal operating expenses, such as employee wages and benefits, payments to vendors and suppliers, and other obligations.

As previously disclosed, on August 10, 2012, DDMG retained Michael Katzenstein, a senior managing director with FTI Consulting, who now serves as Chief Restructuring Officer of DDMG and its operating subsidiaries. Mr. Katzenstein’s overall responsibilities include managing the day-to-day operations of DDMG, guiding and overseeing these reorganization proceedings and ensuring that the value of the estate is maximized for creditors.

“DDMG has been working diligently to reduce costs for the benefit of stakeholders and has already implemented various strategic realignment initiatives that we believe will have a positive impact on the robust and flourishing going concerns. In tandem with Senior Noteholders and other parties, it was determined that the use of these proceedings provides the most viable opportunity for creditor recovery while also ensuring identification of buyers who recognize the true value of these assets,” said Katzenstein. “Importantly, we are grateful for the cooperative assistance of our lenders, our customers and employees as we work to seamlessly transition these important businesses and other assets to financially strong and committed buyers. Their ongoing support ensures the success of these matters.”

As of June 30, 2012, the Company had total balance sheet assets of approximately $205 million and total balance sheet liabilities in the approximate amount of $214 million.

On September 7, 2012, DDMG announced the initiation of its strategic realignment that will allow it to focus on its core business Digital Doman Productions, Inc. As part of this process, DDMG began the cessation of its Port St. Lucie, Florida operations by reducing virtually its entire Port St. Lucie workforce by approximately 300 employees and retaining approximately 20 employees. In addition, John C. Textor resigned effective September 6, 2012 from his positions as Chief Executive Officer and Chairman of the Board of Directors of DDMG and from all other positions as officer and director of DDMG’s subsidiaries.