New England Biz Law Update
Buyers of assets in bankruptcy have the opportunity to get them at potentially attractive prices if they are willing to tackle the added complexity of these types of acquisitions. But many financial and strategic buyers unfamiliar with the bankruptcy process avoid serious consideration of buying distressed assets.
A distressed mergers and acquisitions transaction can effectively expand an existing platform or be a way to enter new markets. Acquirers simply cannot afford to overlook the potential that exists today.
Indeed, a properly structured asset purchase would be ideally free of any liens and the buyer need not assume any liabilities. On the downside, distressed asset buyers need to reconcile themselves to increased time and cost of complying with the bankruptcy sales process. Nonetheless, for those willing to invest the time and effort, distressed M&A can be an effective acquisition strategy.
Changed Dynamics
The marketplace has become more comfortable with the Chapter 11 bankruptcy process as a business tool that is sometimes needed to effectively restructure a troubled business. The common historical view that Chapter 11 was synonymous with liquidation or a failed business has been challenged by the filing and later emergence from bankruptcy proceedings of well known names such as Kmart and US Airways.
Filings today can involve good companies with bad balance sheets. The underlying business of the debtor may remain a viable business model but the long-term viability may be jeopardized because of excessive debt levels or other business issues that the provisions of the Bankruptcy Code can be used to ameliorate. For distressed-asset acquirers, being able to differentiate between the broken and the terminal requires an intensive due diligence process.
The approach of creditors to Chapter 11 debtors has led to an increase in distressed M&A opportunities. Creditors are increasingly focused on assuring that the Chapter 11 process is a means of permanently resolving a problem credit. For this reason, creditors are less inclined to support a debtor’s emergence from Chapter 11 unless there have been significant changes in how the business is operated.
In the past, creditors found themselves supporting reorganization plans with limited chances of long-term success. Companies would emerge from Chapter 11 and several years later would file for bankruptcy a second time. To avoid this outcome, creditors are more likely to push for a sale of either the entire company or non-core assets to generate cash that can be dedicated to satisfying the claims of creditors.
Another factor behind an increase in distressed-asset sales is the expansion of the secondary market for bank loans since the last credit cycle. This has given banks the ability to sell their problem loan rather than incur the time and expense of a lengthy workout process.
Secondary purchasers of distressed bank loans are likely to be financial buyers with limited interest in being a long-term lender. This group of buyers has a financial incentive to press the debtor for a more comprehensive resolution that maximizes the timing of payments to creditors and thereby enhances the ultimate value of their loan purchase.
Never Underestimate The Complexities
Smart buyers see these types of deals as an opportunity to buy operating assets without assuming unrelated liabilities. However, buyers should not underestimate the additional complexities inherent in such transactions.
Traditional M&A transactions are largely a product of bilateral negotiations between the buyer and seller. Asset purchases in Chapter 11 involve multiple constituencies and a more complicated sales process. In addition to the debtor, buyers need to be responsive to the needs of the secured lenders, the unsecured creditors committee and the bankruptcy judge.
Because the judge’s responsibilities include assuring that the assets of the estate are maximized for the benefit of all creditors, asset sales will generally take the form of a court-supervised auction.
Buyers should always try to position themselves as the “stalking-horse” bidder. As the stalking horse, the bidder is able perform due diligence and negotiate the terms of the asset purchase agreement prior to other bidders.
The debtor then uses the stalking-horse bidder’s asset purchase agreement as the basis for soliciting other bids from interested parties. Stalking-horse bidders can negotiate to include break up fees and expense reimbursement in the asset purchase agreement as compensation in the event their final bid is not successful.
Other bidders will not have these same protections and can face compressed due diligence time frames and the need to live with the closing conditions included in the stalking horse bidder’s asset purchase agreement if they wish to make a competitive bid.
Relationship Building Is A Key Strategy
Acquirers who are interested in bidding on distressed assets need to make a dedicated effort to develop the right contacts to optimize their ability to source these opportunities and try to position themselves as the stalking-horse bidder.
One of the best means for prospective buyers to increase distressed deal flow is to build relationships with professional advisors in the bankruptcy field. Prospective bidders should not expect every cold call to result in an immediate opportunity but need to build a network with the right group of professionals that understand the potential buyers objectives.
Investment bankers who specialize in advising debtors on distressed asset sales are always interested in identifying additional qualified bidders to maximize the banker’s chance of successfully executing a sale.
Additionally, turnaround professionals hired by distressed companies to rehabilitate the company’s operations need to develop options to effect a turnaround. Knowing who are potential buyers and what these buyers have as investment objectives can help the turnaround professional develop options which might include a sale.
Jack Bradley is president of Bingham Strategic Advisors LLC, a subsidiary business of Bingham McCutchen LLP in Boston. Bingham Strategic Advisors provides M&A advisory services. With more than 23 years of experience in commercial and investment banking, Jack has advised clients in various industries as well as in numerous cross-border transactions.
