Acquisition of distressed businesses in Spain and ‘RIP financing’
August 2013 | PROFESSIONAL INSIGHT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Spain has been hit hard by the crisis. Many of its businesses are overburdened with debt. The new economic climate means that operating profits are no longer sufficient to repay financial debt on the agreed terms. In some cases, a simple refinancing transaction will suffice. In others, a more far-reaching restructuring process is needed. If financial creditors and shareholders fail to agree on restructuring, the business in question will end up in a formal insolvency proceeding (concurso de acreedores).
Spain’s parliament recently introduced non-consensual pre-insolvency instruments to encourage out-of-court restructuring processes. Despite this, a growing number of distressed businesses are still ending up in formal insolvency proceedings.
Although this trend is gradually being corrected, it is usually too late for Spanish distressed businesses when formal insolvency proceedings start, as it is already doubtful by that stage whether restructuring measures will be effective. Only a small percentage (5 percent) manage to approve a reorganisation plan. The vast majority (95 percent) end up in liquidation.
Until recently, the liquidation of companies in formal insolvency proceedings meant in practice the complete cessation of the business for which they were formed and the piecemeal liquidation of their assets. The amounts recovered by their creditors were paltry and the social cost of laying off the entire workforce huge (and, in turn, even further undermined recovery by the creditors, given the statutory ranking of employment claims).
The mistake of many practitioners, insolvency managers (administradores concursales) and courts was to lose a great deal of time in procedural formalities and wait too long until reaching the conclusion that the company was utterly unviable. By the time it was decided that the company was no longer viable, its production units had also failed due to being starved of credit, and the company could not even be sold off as a single going concern.
However, of late, it has been possible to sell off the profitable businesses or production units of formally insolvent companies as going concerns very soon after the insolvency order is made. Indeed, due to the exemplary work of the Barcelona commercial courts, it has dawned on all concerned that preserving value is preserving the business, and that the business is only preserved by a prompt sale to a third party capable of maintaining the production unit in question. Heavy excessive gearing has facilitated a prompt diagnosis of: (i) the unviability of many companies; and (ii) the advisability of not insisting on reviving the patient, but rather attempting to save his organs quickly while there is still some value to interested third parties.
This paradigm shift is fuelling the emergence of a highly interesting and burgeoning distressed M&A market. Spanish formal insolvency proceedings no longer just arouse the interest of junkyard dealers interested in picking up the scraps, but are also catching the eye of powerful and sophisticated investors.
Both the lawmakers and, above all, the courts in practice, on a highly local basis, are encouraging distressed M&A deals through initiatives including: (i) the creation of instruments similar to free-and-clear sales under Section 363 of the USC, i.e., sales in which production units can be transferred substantially free and clear of debts and charges and without any purchaser liability going beyond certain employment law exceptions; (ii) the possibility of using what are known in the UK as ‘pre-packs’ to implement these transactions, cutting the time between the insolvency order and the signing of the SPA to periods as short as six weeks; and (iii) the possibility of making tailor-made offers in which the buyer can ‘cherry pick’ contracts which, due to their business-critical nature, need to be assigned along with the business unit: depending on the circumstances, the commercial court can disregard the objections of the other parties to the contracts being assigned (similar to the benefit of assumption and rejection under US Chapter 11 proceedings, and its ability to override anti-assignment provisions).
In turn, also emerging in the wake of distressed M&A deals are post-insolvency financing opportunities that may take the form of strategies that either complement or stand alone from the M&A deal itself. The US offers ‘debtor-in-possession’ (DIP) financing, in which the debtor can receive post-insolvency funding to go ahead with a reorganisation plan, and, to facilitate such financing, can even create priming liens vis-à-vis pre-existing charges. In Spain, DIP financing is still fairly uncommon for a variety of reasons; however, an interesting option which can be dubbed ‘receiver-in-possession’ (RIP) financing has come to the fore. Despite its name, it has already enabled lenders to obtain within one year returns in excess of 100 percent of the original sum lent. It basically involves providing the super-senior financing that the receiver needs to keep the business afloat for as long as it takes to sell it off. There are also mechanisms for achieving effects that are equivalent to US roll-ups, thereby enabling such financing to come from existing lenders.
Naturally, distressed M&A legal instruments such as those described above are a two-edged sword for financial creditors. If they use these instruments wisely, they will recover a larger proportion of their claims. By contrast, if, unfortunately as is usually the case (at least from a taxpayer’s point of view), financial creditors do notdefend their position properly (jumping the gun and restructuring or participating in the M&A deal with their own initiatives and encouraging genuinely competitive processes), the flexibility of these instruments can backfire on them and, perhaps, in favour of the sponsor and/or skilled investor.
Jose María Gil-Robles and Adrián Thery are partners, and Alvaro Becerril is a senior associate, at Garrigues. Mr Gil-Robles can be contacted on +34 514 59 56 or by email: firstname.lastname@example.org. Mr Thery can be contacted on +34 91 514 52 00 or by email: Adrian.Thery@garrigues.com. Mr Becerril can be contacted on +34 91 514 52 00 or by email: email@example.com.
© Financier Worldwide
Jose María Gil-Robles, Adrián Thery and Alvaro Becerril