Acquiring a distressed company can offer substantial opportunities, from acquiring valuable assets at a lower cost to entering new markets whether geographical or product based. However, these deals also come with unique challenges and risks that demand careful planning and strategic decision-making. Whether the acquisition occurs outside of bankruptcy or through a court-supervised process, here’s what potential buyers need to know.
Out-of-Court Distressed Company Acquisitions
At first glance, acquiring a distressed company outside of bankruptcy may seem similar to traditional mergers and acquisitions (“M&A”). However, beneath the surface lie critical distinctions that buyers must address to ensure a successful transaction.
1. Deal Structure
An out-of-court transaction can take the form of an asset sale, equity sale or merger.
- Asset Sales are often preferred by buyers as they allow the exclusion of unwanted liabilities.
- Buyers must remain mindful of potential successor liability claims, which may hold them responsible for the distressed company’s excluded liabilities.
- Tax implications arising from the chosen structure can significantly impact the transaction’s economics and should be carefully evaluated by a licensed tax attorney.
2. Due Diligence
Thorough due diligence is critical for understanding the distressed company’s liabilities and the condition of its assets.
- Investigate whether deferred maintenance or cost-cutting measures have degraded key assets.
- Review state and local records for liens, lawsuits, and encumbrances on desired assets.
- Examine physical assets, such as real estate, for their value and operational utility.
3. Third-Party Consents
Securing third-party approvals, such as from stockholders, lenders and contract counterparties, may be necessary to finalize the acquisition.
- Negotiations with lenders whose loans are not fully repaid at closing can be particularly complex.
- Buyers must be prepared to balance competing interests among these parties.
4. Purchase Price Adjustments and Indemnities
Buyers should be cautious about relying on post-closing adjustments and indemnities from a financially unstable seller.
- Risk mitigation strategies include escrow accounts, holdbacks, or obtaining guarantees from creditworthy affiliates.
- In some cases, assets may be purchased on an “as-is, where-is” basis with limited recourse.
5. Fraudulent Transfer Risks
To avoid a transaction being reversed as a fraudulent transfer:
- Ensure the purchase price reflects fair consideration or reasonably equivalent value for the assets.
- Consider obtaining a fairness and solvency opinion and ensure the sale process is competitive and transparent.
6. Timing Considerations
Buyers should aim for a simultaneous signing and closing to mitigate risks associated with the distressed company entering bankruptcy before the deal closes. In such cases, the purchase agreement could be rejected, leaving the buyer with limited remedies.
Distressed Sales in Bankruptcy Court
Unlike out-of-court sales, bankruptcy court-supervised transactions—particularly under Section 363 of the Bankruptcy Code—offer unique advantages and protections. These include acquiring assets free of liens and streamlined approval processes for certain contracts. However, they also present their own challenges and they require a specialized attorney with experience in bankruptcy law.
1. Advantages of Section 363 Sales
- Liens and Successor Liability: Assets are sold free and clear of liens, minimizing successor liability risks.
- Fraudulent Conveyance Protection: The bankruptcy court’s approval of the sale ensures the purchase price is deemed fair, mitigating fraudulent transfer concerns.
- Streamlined Consent Process: Most contracts can be assigned without counterparties’ consent, and lender or stockholder approvals are not required.
2. Stalking Horse Bidder Considerations
A stalking horse sets the initial bid in a Section 363 sale, providing a price floor for the auction.
- Pros: Early access to due diligence and negotiation of deal protections.
- Cons: Risk of overbidding and higher purchase price.
- Protections: Seek court approval for termination fees, expense reimbursements and bid procedures to safeguard your position as the stalking horse.
3. Bid Procedures and Auction Strategy
Stalking horse bidders should ensure:
- Reasonable bid increments to discourage frivolous competing bids.
- Approval of bid procedures that affirm the sale’s finality, preventing further challenges post-auction.
4. Limited Representations and Indemnities
Bankruptcy sales are typically conducted on an “as-is, where-is” basis, with minimal representations or warranties.
- Buyers should factor these limitations into their valuation and risk assessment.
5. Treatment of Executory Contracts
Debtors can reject burdensome executory contracts while assigning valuable ones to the buyer.
- Buyers must be prepared to cure monetary defaults as part of the assignment process, with costs often factored into the purchase price.
In short, distressed company acquisitions—whether out of court or in bankruptcy—demand meticulous planning and expert guidance. Buyers should focus on:
- Structuring the deal to minimize liabilities.
- Conducting comprehensive due diligence.
- Addressing third-party consents and legal requirements.
- Leveraging the unique benefits of bankruptcy sales when appropriate.
With proper preparation and strategic execution, these transactions can deliver substantial value while mitigating risks.
