Buying distressed companies in formal insolvency proceedings
January 2015 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
Purchasing a distressed business inside an insolvency proceeding has its own unique deal elements. If executed properly, however, such transactions can be quite valuable because often a distressed business can be purchased for much less than would be required otherwise, with the same assets and workforce being acquired.
As with ordinary acquisitions, distressed acquisitions can be implemented by way of a share or asset purchase structure, although asset deals are far more common because they are considerably easier to implement. Share deals are typically called ‘plan sponsor transactions’ in North America because the purchase price paid to the debtor is used to effect distributions to creditors pursuant to a plan of compromise or arrangement that is voted on by creditors and approved by the court. Part of such plans often involve extinguishing all or most of the existing equity and issuing new equity to the acquirer or plan sponsor. As noted, a plan sponsor transaction requires the requisite majority of creditors to vote in favour of a plan and, if approved, to also be sanctioned by a court. A plan sponsor transaction also usually involves internal reorganisation steps as part of the plan so that only the desired business and associated assets are, in effect, transferred to the plan sponsor. An asset transaction can be implemented without the need for a plan and creditor vote.
Such transactions are often commenced by means of a court-approved sales process. Under Chapter 11 in the United States, the sales process must be by way of an open auction in which bids are solicited against ‘a stalking horse purchase agreement’. That is, the Chapter 11 debtor enters into an asset purchase transaction with a third party (the stalking horse) that knows that its transaction will be made the subject of an open auction to see if any better deal can be obtained. The stalking horse is typically provided with a break fee if it ends up losing the auction. The stalking horse transaction is often approved by the court at the same time as the bidding procedures for the auction are approved.
In Canada, sealed tender sales processes are by far more common although there is no statutorily mandated process that must be followed. Sealed tender processes involve a solicitation of offers to be delivered on a sealed basis. Accordingly, none of the bidders know if there are any other bidders and, if so, who the other bidders are. Often separate negotiations with the top two or three bidders take place so that the seller can negotiate a better deal privately. Ultimately, the best deal is accepted and a motion is brought to court to have the agreement approved.
Other than for the court-approval process, these sales processes involve the familiar steps of signing a non-disclosure or confidentiality agreement in order to receive a confidential information memorandum and be entitled to data room access. This is followed by the potential buyer submitting an expression of interest or letter of intent followed by a more comprehensive diligence period and, then, a formal offer deadline. Again, such sales processes are generally detailed in a court order approving them.
In addition to the court approval and oversight of the sales process, two key differences from an ordinary acquisition transaction involve the conveyance mechanic and representations and warranties. Although statutory provisions deal with the conveyance of title in a ‘363 sale’ within a US Chapter 11 proceeding, in Canada the conveyance ordinarily is effected by way of a court order known as a ‘vesting order’. A vesting order vests title to the purchaser free and clear of all security interests and other listed encumbrances. Vesting of title is relevant because distressed transactions are typically ‘as is, where is’ deals and involve no to very few representations and warranties. Even if representations and warranties are given by a debtor, they are of little value as the party providing them is insolvent and there will be no valuable recourse in any event. Accordingly, in a distressed acquisition, a purchaser must manage its risk through its diligence process and its pricing. If there are certain issues that must be addressed by a covenant or indemnification, they should be dealt with by way of a holdback to the purchase price or some form of escrow or trust arrangement.
In seeking the court’s approval of a deal, one should also keep in mind that only creditors − not disappointed bidders − have standing to object in Canada. Perhaps more important, court approval is very much focused on process. Accordingly, particularly if a sealed tender process was utilised, a Canadian court will not entertain last minute bids on the eve of or at the court hearing. In the end, the fairness of the process will matter more than the fairness of the price.
Finally, from an overall deal perspective, one should also remember that certainty and speed to closing are very valuable to the insolvent debtor. In other words, a bird in the hand will almost always win over two in the bush. In this sense, a bidder for a distressed acquisition should know that a deal with a lower price may well win if that deal is more certain to close and can close quickly.
Robin B. Schwill is a partner at Davies Ward Phillips & Vineberg LLP. He can be contacted on +1 (416) 863 5502 or by email: firstname.lastname@example.org.
© Financier Worldwide
Robin B. Schwill
Davies Ward Phillips & Vineberg LLP