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FORUM: Considerations when structuring distressed investments 

January 2014  |  SPECIAL REPORT: DISTRESSED M&A AND INVESTING

Financier Worldwide Magazine

January 2014 Issue

January 2014 Issue


FW moderates a discussion on distressed investments between Barry A. Chatz at Arnstein & Lehr LLP, Martin Gudgeon at Blackstone, Geoffrey Frankel at Huron Consulting Group, Partha Kar at Kirkland & Ellis International LLP, James Stonebridge at Norton Rose Fulbright, and Van Durrer at Skadden, Arps, Slate, Meagher & Flom LLP.

FW: Reflecting on the past 12 months, what key trends have you seen in distressed M&A and distressed debt investing? How would you describe activity in general?

Chatz: Activity continues to occur within the distressed investing and merger and acquisition arena. The activity is competitive as there are a number of funds and other interested parties interested in buying pools of assets or loans on an individual or small number basis from federal banking institutions. The parties involved are diligent and the pricing is competitive. The purchasers are wise in their ability to analyse the product they are reviewing, which are brought before many parties seeking to purchase these assets in the marketplace. 

Gudgeon: There has been limited classic restructuring activity over the last 12 months. Unprecedented global stimulus has expanded government balance sheets and driven down the cost of borrowing to near-record lows. The number of distressed credits has therefore fallen in 2013. Buoyant financing markets have allowed opportunistic amend-and-extend transactions and refinancings. There has been particular liquidity coming from the high yield and non-bank market and a notable increase in the prevalence of HoldCo PIK, financed in part by an increase in US hedge fund activity. US investors are seeking to capture current valuations and bet on a European recovery. It is likely that subdued activity levels may continue in the medium-term but the company-level credit issues remain and 2015 may be a critical year. The European banks remain significantly overleveraged – two to three times the leverage of US banks – and have enormous amounts of commercial real estate debt on balance sheet. They continue, albeit slowly, to offload distressed assets into the secondary market. 

Frankel: The past 12 months have not produced activity levels or trends that are fundamentally different than market conditions over the past three or four years. The persistent and artificially low interest rate environment, caused primarily by US monetary policy, remains the key driver to distressed M&A and debt investing. Overall, distressed M&A activity levels remain relatively low. Given the current interest rate environment, lenders continue to prefer an ‘amend and extend’ strategy for distressed borrowers, rather than forcing distressed sales where losses may have to be recognised and capital is recycled into lower interest rate opportunities – except in cases where borrowers require new capital that none of the existing stakeholders are prepared to contribute. Likewise, distressed investing opportunities remain relatively low as existing stakeholders prefer to hold onto credits rather than trading out and recycling capital to lower return opportunities. As a result of this relative scarcity in supply of distressed M&A and distressed investing activity, what few opportunities have come to market tend to draw significant interest and relatively strong valuations from the seller or borrower perspective. 

Kar: The main trend in distressed investing over the last 12 months has been that secondary debt acquisitions and restructurings of leveraged companies have slowed right down. There is a perception that debt in the current market is overpriced – buoyed by liquidity and a strong bond market. Activity in distressed investing over the past 12 months has been fairly muted and, although there are deals being done, fewer restructurings have taken place over the period. 

Stonebridge: Distressed M&A has not been as active as originally anticipated. We would describe the markets as sluggish with relatively few opportunities. There is a tendency to talk-up the return of greater opportunities in this space but this needs to be approached with caution. 

Durrer: Credit terms have continued to loosen and the high yield and leveraged loan markets have grown to levels that, in the aggregate, exceed 2007 levels. At the same time, the Federal Reserve continues to ponder not so much whether, but when it will taper bond purchases and quantitative easing. This is a recipe for increased distressed investing activity which may play out during the next 12 to 18 months. The existing loose credit terms – so-called ‘covenant-lite’ deals – may suppress a near-term increase in default levels, but the fact is that this distressed inventory is building. 

Concerns arise with such sales in ensuring that the best value is obtained for the assets sold when there is an inherent lack of transparency for creditors.

FW: Have there been any recent regulatory and legislative developments that will have an impact ondistressed investing going forward?

Frankel: The most significant legislative or regulatory driver of distressed investing activity continues to be the impact of Dodd-Frank and the related regulatory environment for financial institutions. Incumbent lenders continue to resist recognising losses in their portfolios for as long as possible when forcing a sale or refinancing at a loss could adversely affect reserve requirements under the prevailing regulatory environment. But, as a result of Dodd-Frank and related regulations, new lenders to distressed or underperforming companies – particularly in the middle market, where borrowers are unable to access public sources of capital – have required a substantial cash cushion as a condition to new lending.

Kar: The main impact on distressed investing going forward is likely to be the prevalence of bond debt being a key part of the capital structure on future distressed investing targets rather than bank debt. This increases the importance of issues such as public vs. private, regulatory compliance, market liquidity and identification of creditors, among others, which will have some effect on how restructurings are implemented going forward. This increases the importance of issues such as public vs. private, regulatory compliance, market liquidity and identification of creditors, among others, which will have some effect on how restructurings are implemented going forward. 

Stonebridge: The regulation of pre-packaged administration sales is subject to review by the Insolvency Service which is expected to report in Spring 2014. Pre-packaged administration sales arise where a sale of a business or assets is agreed with a company and then the company is placed into administration immediately prior to the completion of the sale. Where a selling company is insolvent, pre-packaged administration sales can be useful to facilitate a quick sale of part of a business as a going concern, leaving the less viable parts of a business in the hands of a subsequently appointed liquidator to distribute to creditors. Concerns arise with such sales in ensuring that the best value is obtained for the assets sold when there is an inherent lack of transparency for creditors. Statement of Insolvency Practice 16 sets out a best practice code of conduct for administrators to follow for the protection of creditors, but the area remains under review. 

Durrer: Appellate-level courts in the US have issued recent opinions holding private equity firms responsible with respect to certain pension obligations of their portfolio companies in the US. As a consequence, private equity firms are spending time examining their relationships with and among their portfolio companies in order to manage the risk associated with being responsible for these pension liabilities at the parent company level. This is an important exercise, because private equity firms typically do not model such exposure into their business plans, so such exposure could have a substantial effect on their performance overall, if they do not address it properly and efficiently. 

Chatz: On a federal level, I am unaware of any regulatory or legal impact upon this marketplace. However, the demands on lenders seeking to foreclose on collateral have increased on a local basis as municipalities and counties have sought to assure the protection of their neighbourhoods. Certain municipalities have required homes be boarded up, fences be erected and other safety requirements when there has been abandonment of property by those who have suffered economic distress. These circumstances have had an impact on pricing. 

Gudgeon: The new leverage and capital rules for banks have created opportunities as banks seek to deleverage through disposals, and they have reduced the amount of capital available for distressed finance, which has in-part driven the increase in non-bank lending. With regard to legal frameworks, there have been various recent attempts to modernise restructuring legislation across Europe, including changes in Spain, Italy and Germany; however, the UK Scheme of Arrangement remains the pan-European tool of choice to more effectively execute transactions. Finally, there has been an increased incidence of US investors in Europe providing distressed funding secured in part by US assets and governed by the US bankruptcy code, which those investors can more easily access in a downside scenario. 

The major legal issue that arises when buying distressed assets are how to acquire the assets free of the legacy obligations of the seller, and how to avoid restrictions on transfer that require the consent of an entity that is not party to the transaction.

FW: Could you outline some of the major legal issues that arise when buying distressed assets? Whatare the essential areas to address during the process?

Kar: Distressed investors like certainty. This is often difficult with a distressed asset as accurate current and historical information may not be available and, depending on the asset, modelling future outcomes may also be problematic which makes it difficult to understand risks and model a bid price. From a legal perspective, clients can only get so much comfort from things like asset and encumbrance registers, and so on. A distressed investor may also be interested in understanding how a particular asset could be most effectively and efficiently utilised going forward, and this may also require legal input such as looking at a restructuring, and so getting a full understanding of the local, legal and practical impacts of any such action once an asset is acquired. 

Stonebridge: Gaining good title to distressed assets can be difficult and often the reduced pricing will reflect that the seller is unwilling to give any warranties as to title. Buyers may find themselves competing with secured lenders, holders of retention of title claims, holders of liens arising by operation of law, or other purchasers claiming to have acquired assets. Sellers of distressed assets – often administrators or liquidators – will want to achieve a clean sale with no deferred consideration or subsequent warranty claims. A lot of distressed M&A and investing involves a cross-border element. This means understanding different insolvency regimes and local law implications for strategy and timing. Having local law advice is essential in any multi-jurisdictional distressed M&A deal. The legal documentation in a distressed M&A deal can be complex and heavily negotiated as buyers strive to protect themselves against the uncertainty of purchasing a distressed business and sellers attempt to force confidentiality, exclusivity and standstill provisions on buyers. With distressed debt investing the documentation is more standardised, but, because speed is often of the essence, it is important that both parties are familiar with this. 

Chatz: The major areas of concern in these types of transactions relate to whether there are any continued obligations of the seller. The central concerns for secured lenders is assurance of an ‘as is, where is’ transaction, with a lack of any exposure going forward and an assurance that buyers understand that they have had their diligence opportunity and there are no continued claw-back rights upon the seller. For buyers, avoidance of claims of overreaching by lenders or lender liability theories that would pass with a Quit-Claim type of transaction is of utmost import. Drafting covenants as well as representations and warranties to assure sales do not come with mitigation exposure is an important component for those parties who wish to acquire these types of assets.

Durrer: The major legal issue that arises when buying distressed assets are how to acquire the assets free of the legacy obligations of the seller, and how to avoid restrictions on transfer that require the consent of an entity that is not party to the transaction – such as a licensor of intellectual property. The US bankruptcy laws provide the most advantageous platform to address both issues, but they do not provide a perfect solution. For instance, generally speaking, contract rights can generally be transferred in bankruptcy subject to all of the burdens of the contract. Thus, it is not possible to avoid the legacy obligations under a contract if the contract itself remains a valuable asset. Likewise, while most consent rights with respect to the transfer of assets are unenforceable in bankruptcy, many such rights remain enforceable with respect to the transfer of intellectual property. It is essential to focus on these issues carefully during due diligence in order to avoid pitfalls that arise in these areas. 

Gudgeon: Mitigating risk by ensuring adequate diligence is undertaken in the time afforded is critical when buying distressed assets. Particular areas of risk to address include identifying key assets and security, reviewing key operating contracts, understanding any implementation structures to be used and minimising subsequent litigation risk. 

Frankel: Whereas many, if not most, healthy sales are essentially a two-party transaction – buyer and seller – the typical distressed sale is a multi-constituency process that may even involve a court, as in receiverships and bankruptcies. As a result, the major legal issues that distinguish healthy and distressed M&A transactions typically involve resolution of the leverage that these additional constituencies have in asserting and enforcing their rights and claims in the context of a transaction. So, for example, distressed sales often require a determination of the rights of ‘legacy’ creditors at the time of the sale, rather than at some future date – for example, pension plans, environmental claimants, and potential product liability tort claimants. The specific legal rights of these third-party constituencies, and thus the legal issues that are pertinent to distressed sales, depends heavily on the context of the transaction. In a bankruptcy sale, for example, the distinguishing legal issues tend to concentrate on whether the sale of the distressed assets is consistent with the requirements of the bankruptcy laws that require maximising estate assets; and how the proceeds of the sale will be distributed among competing secured and unsecured claims. For distressed sales that are consummated outside of court supervision, the distinguishing legal issues tend to involve whether and how the transaction can be consummated over objecting creditors when there is no coercive force, such as a bankruptcy court, to compel the sale. 

Where time is constrained, it is important to understand the key and most valuable parts of the business as best you can, but also to try and get a grip on what potential big ticket liabilities or downside type risks there may be.

FW: Time constraints surrounding distressed transactions can make due diligence problematic. What is your advice to investors on overcoming this issue and adequately managing risk and potential liabilities?

Stonebridge: In a distressed sale, reliable warranty or indemnity cover is unlikely to be available or of value. When such contractual protection is hard to come by, due diligence offers a key line of defence. However, while undertaking due diligence is of paramount importance, doing so may present considerable challenges, not least in getting reliable and current information. A buyer should expect the actual position to be worse than the position revealed by, or even known to, the seller. The use of completion accounts and risk-adjusted pricing to verify the buyer’s pricing assumptions may be one way of removing some of the uncertainties and risks associated with inadequate due diligence. Structuring the sale as an asset sale may also offer the buyer some peace of mind as it enables a buyer to buy selectively and not inherit all of the historic liabilities of the business. Finally, a savvy buyer will negotiate a discount in the price of the business to take account of the absence of warranty or indemnity cover and the uncertainty resulting from insufficient due diligence. With distressed investing, one of the key issues is that the complexities of capital structures make it difficult for potential buyers to understand the detail of the investment. 

Durrer: There are four pieces of advice I would give to a potential acquirer of distressed assets in order to mitigate the short time period for due diligence. First, it pays to be first in line. The stalking horse bidder always has a diligence advantage – take that advantage whenever you can. Second, if you intend to participate in the distressed asset arena, develop a nimble team of experts to conduct your diligence on an expedited basis. This can be an outsourced team as well as an in-house team developed over time. It is worthwhile to invest in human capital in this area. Third, draft very tight legal documentation to ensure that you are exposed to very little uncertainty. What liabilities and exposure are truly variable and unknown? Try to limit that universe as much as possible. Lastly, and this is a last resort, it is possible to place some reliance on the diligence of others – particularly if you were unable to become the stalking horse bidder. 

Gudgeon: The rigour of due diligence is determined by the time available. In the current market there are often opportunities to undertake pre-emptive diligence on many distressed opportunities. Although subsequent, more detailed work will be required, identifying early the key areas of risk is important.

Frankel: Time constraints are often the key procedural difference between healthy and distressed sales. As the timeline for completing a distressed sale is reduced – whether due to liquidity constraints, creditor pressure, or other operational or market driven issues – the distressed seller’s options narrow and valuations suffer. Whereas valuations of healthy sellers are based, primarily, on such things as generally accepted valuation metrics, valuations in distressed sales are more heavily influenced by the potential buyer’s perception of what the process will require. So, buyers of distressed assets are keenly aware of a seller’s external pressures to sell, including time constraints, and adjust their valuations to reflect the impact of these factors on the seller. The best and obvious advice to mitigate this is to recognise and acknowledge financial distress early and develop a contingency plan for exploring strategic options. We are frequently engaged to advise a client on its options at the early stages of financial distress or, even, anticipated distress. At that point, we are able to map out a solution that could involve both operational and strategic solutions. Even if a capital transaction is ultimately necessary, additional time allows for a more orderly process that does not seem to be a ‘fire sale’, allows for more competitive bidding, and may even allow the business to implement operational improvements that can enhance the valuation or outcome.

Kar: Every investor has a different risk appetite and so approaches its due diligence in a very different way. Where time is constrained, it is important to understand the key and most valuable parts of the business as best you can, but also to try and get a grip on what potential big ticket liabilities or downside type risks there may be. Distressed transactions usually do not involve any material representations or warranties of value so investors will need to price in any risk they are taking – all investors can really do is as much work as possible given the time and resources they have, and they need to ensure that they focus on both commercial and legal diligence as these will go together to create a risk profile for an asset. 

Chatz: For those investors who are nervous about time constraints relating to due diligence, it is important to understand that this market is more mature. Often, assets have been picked over and the only items remaining are those of less quality. Investors need to ask whether this is an asset pool or a singular asset to decide whether one really needs to undertake sufficient due diligence. It is not clear in any financial institution’s pool how many current assets are actually being sent to the market for sale. The freshness of the asset, the history of participation in the sale of distressed assets over recent years, and the nature of the asset pool being invested in, should all help to guide distressed investors on whether or not to even participate in a process. Understanding that funds may need to deploy money does not militate the fact that money should not be deployed if the asset pool is of such a type, kind or nature that it would place undue risk upon a purchasing fund itself. 

A buyer of assets in bankruptcy can take comfort that it is engaged in an orderly, court-supervised process that ordinarily moves on an expedited and predictable timeline.

FW: Is it preferable for buyers to acquire assets inside or outside of bankruptcy proceedings, such as the Chapter 11 process? What benefits may be available to buyers in certain circumstances?

Durrer: The US bankruptcy laws are federal laws applicable in all states as the supreme law of the land. Accordingly, a court order approving and sanctifying the acquisition of assets and carefully delineating the rights and obligations relating to such a transaction is very valuable. In addition, there is a great deal of certainty and reliability that comes with such a federal court order. The biggest disadvantage, however, of the Chapter 11 process is the notoriety and publicity. Transactions in Chapter 11 are not only subject to scrutiny and attack, but they also may be subject to overbidding. Early on, buyers should carefully compare the relative benefits and burdens among Chapter 11 as well as other forms of assets transfer processes, such as assignments for the benefit of creditors or even judicial foreclosure. 

Gudgeon: There is a separate set of issues and benefits with each alternative. Acquiring assets from inside a bankruptcy process does offer a potentially ‘cleaner’ transaction, although value will be lost in process costs. It may be preferential to pre-negotiate a deal with secured creditors then execute the deal via a formal process to reduce stakeholder consent requirements. 

Chatz: It is always preferable, as a buyer of assets of any type, kind or nature that is subject to any distress or issues of creditor claims, to purchase through a bankruptcy code Section 363 sale process. A Section 363 sale provides a buyer with a court order reflecting that the assets are purchased free and clear of any liens, claims and encumbrances, assuming that notice to the parties involved in the proceeding is appropriate. There is a significant, but necessary cost attendant to this process. However, in order to properly protect a purchaser from potential future claims of price collusion, or to preclude any party from making a claim to those assets, it must be of material and instrumental benefit for a purchaser. 

Frankel: From a buyer’s perspective, there are many unique advantages to acquiring assets through a Chapter 11 bankruptcy process. The most important set of benefits is the ability to acquire the assets free and clear of all creditors’ claims. Because, by operation of law in bankruptcy, most liens, claims and encumbrances will attach to the sale proceeds, a buyer is able to purchase assets with a ‘clean’ balance sheet except to the extent that it expressly chooses to assume the debtor’s liabilities. Likewise, a buyer of assets in bankruptcy can take comfort that it is engaged in an orderly, court-supervised process that ordinarily moves on an expedited and predictable timeline. But the legal advantages to bankruptcy acquisitions come with a price. Often, the most important price that is paid through a bankruptcy sale process is the exposure of the seller’s otherwise confidential information to the marketplace – including its customers and competitors. The bankruptcy process inherently puts the debtor in a fishbowl. The debtor, inescapably, must reveal information that it would otherwise prefer to keep confidential. This can have consequences, potentially long-term, on the debtor’s market position, as well as its relationship with customers, vendors, and employees. 

Kar: My experience is buyers generally prefer to acquire assets with a blanket of some sort of local bankruptcy or insolvency proceedings to ensure minimal claw-back risk, certainty, and so on. Some buyers however, may not be too worried about this if they think they can get an advantage by agreeing a deal directly with the company before bankruptcy and avoiding things like public auctions and marketing processes – this really depends on the asset, the buyer and the process. Avoiding a bankruptcy sale may be attractive for some creditors as it likely to be less costly and less time consuming, although the seller or board liability will be a real issue and representations, warranties and indemnities may have to be given to the buyer to deal with things like claw-back risk.

Stonebridge: Where a seller is insolvent, it is often preferable for a buyer to acquire particular assets or part of a business from an administrator or liquidator; it would not be sensible for a buyer to acquire the whole company or business subject to its ongoing liabilities. Further, this can provide protection both for the buyer from potential challenges to the transaction as well as for the directors of the seller who would otherwise leave themselves with unpaid liabilities post-sale. Where any part of a business is acquired as a going concern, an administrator is able to continue to trade the company whilst the terms of a sale are agreed. As noted, in order to minimise the costs of that period of trading in administration, and to limit the deterioration in value of a business whilst trading in administration, it is often the case that the terms of a sale are agreed with the company and then an administrator appointed immediately prior to the sale – known as a pre-packaged administration sale. 

It is also important to minimise risk of a transaction being voided, subject to claw-back or carrying residual claims forward. Using an in-court implementation process can help to mitigate this risk.

FW: What steps can acquirers take to manage potential risks and liabilities associated with distressed transactions?

Chatz: Effective due diligence, including active review of the product to be acquired, is clearly necessitated in the process of acquiring any distressed paper or other assets. It is not sufficient for an asset purchaser to think that it may be able to ‘walk away’ from properties that are subject to liens or claims acquired. The diligence comes at a cost. If there is not a sufficient team in place, outside experts may be relied upon and this comes at a cost as well. 

Stonebridge: Purchasing assets or a business from an appointed insolvency practitioner rather than directly from a company can limit the risk of inheriting unwanted liabilities associated with the business or assets acquired. A simultaneous signing and closing will avoid risk during the pre-closing period. If this is not possible – for example where shareholder or regulatory consent is required – try to have substantial and thorough closing conditions, for example, a MAC clause and extensive rights of access or control up to closing. There is a risk with any financially-troubled company that if the seller goes into formal insolvency proceedings the liquidator or administrator may seek to overturn a transaction which took place at an undervalue in circumstances where the transferring company was insolvent at the time, or as a consequence, of the transaction. To avoid this, the directors of the selling company should satisfy themselves, and record in the minutes of the board meeting approving the transaction, the basis on which they believe that it is an arm’s length transaction achieving the best price reasonably obtainable in the circumstances. 

Gudgeon: Even in a limited due diligence situation, it is important to understand the validity of the underlying business and understand the key operating risks. This is more challenging in distressed or restructuring situations as, unlike in traditional M&A, there are limited reps and warranties provided by management. It is also important to minimise risk of a transaction being voided, subject to claw-back or carrying residual claims forward. Using an in-court implementation process can help to mitigate this risk. 

FW: What role does insurance play in protecting buyers of distressed assets? Are you seeing an increasing use of insurance to protect against successor liability claims?

Frankel: The use of insurance products to facilitate distressed sales has increased noticeably over the past few years. We have seen insurance most often in the context of creating a source of recovery for the breach of representation or warranty. Typically, the seller of distressed assets lacks the financial capacity to make good on claims for a breach of a representation or warranty in the purchase agreement. Indeed, many distressed sellers choose to wind up their corporate existence after selling all or substantially all assets. Most buyers are unwilling, however, to acquire assets without at least some ability to claw-back on the purchase price for breaches of the reps and warranties. We have found that rep and warranty insurance can be useful in certain circumstances to bridge this gap.

Stonebridge: Insurance policies can be taken out by a buyer of distressed assets to indemnify against various potential losses, in particular to gain protection for breach of the sale and purchase agreement where the seller is unable or unwilling to give warranties or indemnities. Distressed sales are often made without the protection of warranties and indemnities by the seller, particularly where the seller may be insolvent and unable to meet any subsequent liabilities post sale. A buyer may obtain insurance to indemnify it against losses for particular circumstances arising which might in a non-distressed sale be subject to a warranty or indemnity given by the seller. For the seller’s part, this provides a clean exit and in the case of a seller in administration or liquidation, this is important so that sales proceeds can be distributed to creditors without withholding amounts for payment of future claims. Where real estate assets are purchased in circumstances where there is insufficient time to conduct adequate due diligence, a buyer may wish to insure against defective title risks.

Chatz: I have not run across utilisation of insurance to protect asset purchases with respect to distressed properties or assets. I have also not seen any increased use with respect to any successor liability claims. 

Gudgeon: Using tail insurance to mitigate successor liability is more common in the US, whereas Europe does really not have a market for such products. 

Kar: We have seen American investors try to use insurance in European distressed transactions, albeit without much luck in our experience. Generally they have asked for sellers to provide representations and warranties and then have tried to obtain representation and warranty insurance – which the investor has funded – however, the deal has ended up not closing this way because the general European practice is that distressed sellers do not provide such representation and warranties, notwithstanding insurance. We do know that investors are pushing harder on this and I would not be surprised if it becomes more acceptable in Europe, although it may take some time. 

One does not know everything about every market, and if cash flows or other analysis with respect to troubled loans is thought to easily be analysed in-house, such overconfidence can lead to material losses.

FW: What final advice can you offer to distressed investors on navigating the issues associated withdistressed M&A and debt investing?

Kar: Investors try to get certainty before bidding for assets in circumstances where information may be limited or not of the highest quality. They are unlikely to get representations and warranties from the seller and they are also probably going to be part of a highly competitive sale process, bearing in mind the amount of liquidity in the market and the number of investors chasing limited attractive distressed opportunities at the moment. Many investors in the current market seem to focus on sourcing off the run type deals and looking at different opportunities like direct lending – including junior notes to allow partial refinancing – and building new business platforms in previously depressed sectors which are expected to rebound at some stage soon. 

Stonebridge: Distressed deals are, by nature, risky and can get messy, so preparation is key. Ensure you know who you are buying from – banks will have a very different game plan to corporate sellers; approach lenders or security holders at an early stage to ensure you are aware of any conditions attaching to the release of security; and do as much due diligence as possible within the timeframe. With debt investing, one needs as best one can to understand the capital structure of the borrower, its guarantee and security position, voting thresholds and the local insolvency and restructuring regimes. 

Chatz: In order to make money, one may need to spend some to show that pricing is proper, diligence is proper and to obtain appropriate protections. The utilisation of outside professionals may provide an avenue for some recoveries should the analysis with respect to pricing or purchasing of assets be based upon less than accurate data. One does not know everything about every market, and if cash flows or other analysis with respect to troubled loans is thought to easily be analysed in-house, such overconfidence can lead to material losses.

Durrer: Distressed asset sales are not ‘one size fits all’. Every distressed transaction should be examined on its own merits to determine the structure, timing and approach that best fits the situation. Can the assets be exploited on their own merits, or does most of the value lie in the going concern? How critical is human capital not only to transition but also to the continuation of the business? How competitive will the auction process be? Is an auction necessary? Would a plan of reorganisation be a better approach or simply a more expensive approach to a Section 363 bankruptcy sale? There is an expression that when one is a hammer, everything one sees looks like a nail. Do not approach distressed acquisitions in this manner. 

Gudgeon: Ultimately, distressed investors need to get comfortable with the risks of making an investment decision with limited information. To execute transactions in Europe there is a need to understand that each jurisdiction is different. This lack of a uniform restructuring regime in Europe and the prevalence of negotiated out-of-court settlements result in less predictable process outcomes. Given these challenges we would always advocate taking specialist advice.

Frankel: In every distressed sale, the seller and its stakeholders will, of necessity, calibrate the balance of value, speed to closing, and certainty of close. Whereas in most healthy transactions, value is by far the paramount consideration, in many distressed deals speed and certainty take on much greater importance – particularly as the level of distress increases. Distressed investors should come to the game, therefore, well equipped to be compelling in terms of speed and certainty if they are inclined to minimise their purchase price. Practically speaking, this means that distressed investors should be prepared to move quickly and reliably, without protracted due diligence timelines or risky financing conditions. Although this should come as no surprise to anyone involved in distressed investing, we continue to see buyers misjudge the market by bidding with risky and time-consuming conditions and expecting to get a steal nevertheless.


Barry A. Chatz is a partner with the Chicago law firm of Arnstein & Lehr LLP, who serves as the chair of the firm’s Bankruptcy, Creditors’ Rights, and Restructuring Practice Group. He has more than 20 years of experience representing lenders, unsecured creditors, corporate debtors and trustees in numerous matters throughout the US. Mr Chatz serves as a panel bankruptcy trustee for the US Bankruptcy Court for the Northern District of Illinois.

Martin Gudgeon is head of Blackstone’s European Restructuring Advisory Practice. Prior to joining the firm in 2007, he was chief executive and head of Restructuring at Close Brothers. Mr Gudgeon is a qualified Chartered Accountant and a member of the Chartered Institute of Electrical Engineers. He undertook his training as a Chartered Accountant at Price Waterhouse and received his BSc in Engineering from Durham University.

Geoffrey Frankel has more than 20 years of experience advising troubled companies and their creditor and equity-holder constituencies in mergers and acquisitions, financings, corporate reorganisations, debt and equity restructurings, complex valuations, and litigation support services. He has advised businesses across a variety of industry segments, with particular emphasis on industrial/manufacturing, metals, retail and consumer and business services. Prior to becoming an investment banker in 1998, Mr Frankel practiced corporate/restructuring law in New York City and Cleveland, Ohio.

Partha Kar has a wide range of cross-border restructuring and insolvency experience. He has acted for financial creditors, turnaround advisers, companies and insolvency practitioners and appointees in multijurisdictional restructurings and insolvency proceedings; directors, shareholders and creditors of financially impaired companies; and for vendors and purchasers of distressed debt or equity. Mr Kar has worked on all stages of this work including contingency planning and strategy, negotiations, documentation, post-restructuring/appointment and the exit.

James Stonebridge is a banking lawyer based in London. He specialises in restructuring and insolvency matters as well as undertaking general banking transactions. Mr Stonebridge’s practice covers corporate and debt restructuring and recovery assignments acting for lenders, management and other stakeholders as well as insolvency and distressed debt matters.

Van Durrer leads Skadden, Arps’ corporate restructuring practice in the western United States and advises clients in restructuring matters around the Pacific Rim. He regularly represents public and private companies, major secured creditors, official and unofficial committees of unsecured creditors, investors and asset-purchasers in troubled company M&A and financing and restructuring transactions, including out-of-court workouts and formal insolvency proceedings.

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