Quick flip sales in insolvency proceedings
January 2014 | SPECIAL REPORT: DISTRESSED M&A AND INVESTING
Financier Worldwide Magazine
The keys to a successful sale of distressed assets are time and cost. It is critical for the debtor’s stakeholders that the sale, including any associated process, is fast and the professional fees of the seller are minimised. In Canada, this can be achieved by conveying the assets on the same day or shortly after an insolvency proceeding is commenced, affectionately referred to as a ‘quick flip sale’. A quick flip sale involves the appointment of a receiver and the immediate approval of an already negotiated (or ‘pre-packaged’) sale transaction without any further marketing of the debtor’s assets and with limited notice to stakeholders. Quick flips are attractive to restructuring professionals for the same reason that they are highly scrutinised by the supervising courts: they allow for the sale of distressed assets free and clear of any encumbrances, but without the added requirement of an extensive and potentially lengthy court-ordered sales process. In short, quick flips achieve the same result as other, more conventional asset sales in a fraction of the time and at a fraction of the cost.
So why are quick flips the exception and not the norm? Unsurprisingly, because courts are loath to approve sales negotiated prior to the court’s involvement and without stakeholder knowledge as compared to a sale which satisfies the court’s traditional desire for transparency and oversight. As a practical matter, it is the obligation of the restructuring professionals involved to explain why a further marketing of the debtor’s assets and a court-ordered sales process would be unnecessary or even harmful in the circumstances.
When is a quick flip transaction appropriate? Courts begin by considering the established factors applicable to sales processes and sale transactions in insolvency proceedings. Coined the ‘Soundair principles’ in Canada after the case from which they originate, these are: (i) whether the debtor made a sufficient effort to obtain the best price for the assets; (ii) the interests of all parties; (iii) the efficacy and integrity of the process by which the debtor obtained offers; and (iv) whether the process was unfair.
In a conventional sale of distressed assets following a court-ordered sales process, the inquiry quite simply begins and ends with the Soundair principles. By contrast, the abridged timelines and relative lack of visibility mean that the Soundair principles are just the first stage of the analysis in a quick flip sale. This article will focus on the additional factors that are relevant in a quick flip situation.
The primary concern in a quick flip is that a court-ordered sales process would result in a substantively different and better outcome for the debtor’s stakeholders. Often, a debtor has insufficient cash to conduct an extensive marketing of its assets. While certainly very important, this is not enough. Substantial consideration will also be given to the relative priorities of the company’s creditors with a view to determining which creditors have an economic interest in the assets. In particular, the court will consider what creditors could reasonably expect to recover in a more conventional liquidation.
For example, where the net realisable value of the distressed assets is less than the amount owed to the senior secured creditor, it will be very difficult for any other creditor to argue that it will be prejudiced by the quick flip sale (since it would receive nothing in any event). Almost counter-intuitively, where the purchase price in the proposed quick flip sale is more than the amount owing to the senior secured creditor, courts may be hesitant to approve the sale without a further sales process. This is because other creditors could argue that they would receive more if a more fulsome sales process garnered a higher bid.
The next consideration is whether a marketing process has already occurred, albeit in an out-of-court setting. Where a debtor has engaged in a comprehensive sales process prior to the receivership, courts are more likely to conclude that no further process is required. In this instance, a debtor will need to explain: (i) how potential investors and purchasers were identified; (ii) what solicitation materials were used; (iii) when potential investors and purchasers were contacted; (iv) whether professionals were engaged to carry out the marketing process; and (v) whether and to what extent any party expressed interest in purchasing or making an investment in the debtor’s business. Obviously, the more thorough the process, the more likely a court will conclude that a court-ordered sales process would not likely have produced a higher bid than the purchase price in the proposed quick flip sale. In our experience, a sales process which has been conducted by a reputable third party is also more likely to satisfy the court.
Another important consideration is the urgency of the sale. If a delay of the transaction will diminish the going concern value of the debtor’s business (perhaps because of the nature of the debtor’s assets or the negative publicity surrounding its financial situation), a court will be more inclined to approve a quick flip sale. This is particularly the case where there is a senior secured creditor and a lengthy court-ordered sales process would effectively erode the creditor’s security. In such a situation, a quick flip sale may be the only way to provide maximum recovery for the senior secured creditor.
Finally, it is useful to obtain a liquidation valuation of the distressed assets being sold prior to seeking court approval of the quick flip sale. A court will be more comfortable with the sale if the net realisable value of the assets is less than or equal to the purchase price in the proposed quick flip.
Ultimately, a court must be satisfied that a quick flip sale will produce the same realisation on the distressed assets and will not prejudice the respective positions and proposed treatment of various stakeholders. So how does an insolvency practitioner prove that a further court-ordered sales process would be unnecessary or even harmful in a particular receivership proceeding?
The first step is to demonstrate that the debtor does not have sufficient cash to fund another marketing process. This is not a difficult task where a company is insolvent. Second, it is helpful if there is a creditor with clear priority over all other creditors who supports the quick flip sale. Third, the fact that the going concern value of the distressed assets may diminish if they are not immediately sold is a factor that may sway a court to approve a quick flip. Finally, an insolvency practitioner should ensure that the assets have been professionally valuated prior to seeking court approval of the sale.
Two additional issues warrant comment: credit bidding and the sale of assets to a related party. A credit bid is an offer made by a creditor to purchase the debtor’s assets through a reduction of the indebtedness owed to the creditor. In situations where the entire proceeds of sale of the debtor’s assets would accrue to a senior secured creditor, it makes no difference whether the purchase price is paid in cash or by means of a credit bid. In situations where there is a prior ranking secured creditor, a credit bid will often be combined with sufficient cash to cover any prior ranking claim not being assumed by the purchaser. As a result, credit bids are usually not problematic in quick flip sales.
By contrast, given the potential for abuse in a non-arm’s length sale, a sale to a party related to the debtor causes great concern for the courts, particularly in a quick flip situation. This does not mean that related party sales are prohibited; it simply means that they are subject to greater scrutiny by the courts. In such situations, it is helpful for the receiver to provide a report confirming that: (i) it has taken steps to verify the transparency and integrity of the marketing and sales process preceding the quick flip; and (ii) efforts were made to find an arm’s length buyer.
Practically speaking, all of this means that an insolvency practitioner seeking approval of a quick flip sale should come to court equipped with a comprehensive documentary record that justifies an immediate sale of the debtor’s assets. Courts have accepted that quick flips have their place and, in the appropriate circumstances, they can be very useful. However, it must be remembered that a quick flip is an exceptional remedy and not just a way to avoid the costs of running a court-ordered sales process. The moral of the story: quick flips are one of the many tools available in an insolvency practitioner’s toolbox, but there are stringent legal and evidentiary requirements that must be met before a court will entertain the idea of approving a pre-packaged sale that was negotiated with absolutely no judicial oversight.
Natasha MacParland is a partner and Dina Milivojevic is an associate at Davies Ward Phillips & Vineberg LLP. Ms MacParland can be contacted on +1 (416) 863 5567 or by email: email@example.com. Ms Milivojevic can be contacted on +1 (416) 367 7460 or by email: firstname.lastname@example.org.
© Financier Worldwide
Natasha MacParland and Dina Milivojevic
Davies Ward Phillips & Vineberg LLP