12 Apr Distressed M&A: Two Perspectives, One Conculsion
A recent MONDAQ article by Bryan S. Gadol and Wendy R. Kottmeier of Dorsey & Whitney’s Irvine, California office discusses financially distressed acquisitions and covers some of the high points attendant to an out-of-court “bargain basement” purchase:
– Fraudulent Transfer Claims: “[I]t is imperative for a buyer acquiring assets at a discount from a seller that is insolvent, or may become insolvent, to evaluate whether the purchase price is of a reasonably equivalent value based on a variety of factors, including the marketability of the assets at the time of the sale and the level of interest, if any, from other potential buyers.” Without such a determination, the acquisition is subject to attack from disgruntled creditors and the purchaser may be required to return the acquired assets (or their fair market value).
– Successor Liability Claims: “[U]nder certain legal theories purchasers of assets can sometimes be held liable as a successor for certain environmental, products liability, tax, employee benefits and labor and employment claims. Creditors of the insolvent seller have a greater incentive to look elsewhere to satisfy the seller ‘s unpaid debts, and consequently may choose to pursue successor liability claims against a purchaser.”
– Fiduciary Duty Claims: Until very recently, the boards of distressed corporations were routinely advised of their fiduciary duties to creditors, which arise when the corporation is in the “zone of insolvency.” This means that the boards of distressed companies are obligated to act in the best interests of the corporation’s creditors – an obligation which extends to management’s decision to sell distressed assets “on the cheap.” As discussed by Gadol and Kottmeier, recent Delaware case law has narrowed this liability by suggesting such fiduciary duties do not arise until the precise moment when the corporation becomes insolvent. However, such “precision” may do nothing more than afford corporate boards a false sense of security, since the concept of “insolvency” is itself subject to multiple definitions – and the question of specifically when a corporation becomes “insolvent” is, at best, often a subjective one.
Though somewhat cursory, the overview from Dorsey’s transactional lawyers is timely: Financial distress arising from the present economic downturn promises a wide range of opportunities for those companies poised to make strategic acquisitions. As noted by a more extensive piece appearing in late February in The Deal Magazine, journalist Suzanne Stevens and prominent Los Angeles practitioner (and UCLA Law School professor) Kenneth Klee note:
For companies that stay financially healthy, the wave of corporate distress now building promises plenty of targets. S&P predicts a record default rate of 13.9% by issuers of high-yield bonds this year, for example. Among other factors, the late, great buyout wave is expected to produce many opportunities for corporate dealmakers, sometimes for assets that they earlier battled private equity buyers to win.
Who are the strategic buyers best positioned to take advantage of these buying opportunities? Klee and Stevens identify at least two types:
– Purchasers who find their key suppliers in trouble.
– Foreign buyers looking to improve their positions in the U.S.
There are undoubtedly more. Klee and Stevens also touch on some of the various types of deals likely to result, including:
– Acquisition of the target company’s debt and the offer of a much-needed capital infusion.
– Bidding for the assets, either out of court or in connection with a “Section 363” sale inside a Chapter 11 case as a “stalking horse” or as a third-party participant. Though the “stalking horse” bidder typically takes on the risk of being “cherry-picked” by a late-comer to the bidding process, most prospective “stalking horse” purchasers are able to protect both their due diligence investments and their positions through the imposition of “break-up fees” as a part of the sale price to a third party.
What do strategic buyers have to contend with in consummating a successful acquisition? In addition to the potential liability outlined by Gadol and Kottmeier, Klee and Stevens highlight the often-complex nature of such acquisitions:
‘Straightforward’ is not the first word these deals bring to mind. In a field renowned as legalistic and technical, and with so many variables to consider – the target’s capital structure, creditor mix, supplier and customer relationships, among others – it’s easy for a dealmaker unfamiliar with distressed deals to put a foot wrong.
Even so, with enterprise and asset valuations growing cheaper and the synergies available from a well-thought-out acquisition negotiated at bargain prices, the attraction of such a purchase makes putting a foot in worth the risk.