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Notes from Chris Kinslow
and Colleen Smith of Deutsche Bank—Presentation to SBU Finance Club, Introduction— |
n The purchase of a distressed target, or select assets of a distressed target, may be effected in five general manners (see next page)
n Regardless of which method of transaction is used, there are general considerations in purchasing a distressed business, whether inside or outside of bankruptcy
– fiduciary duties of directors, officers and management
– directors and officers of an insolvent company have fiduciary duties not only to shareholders but to all creditors
– auction of company
– directors and officers of a troubled company must act in accordance with their fiduciary duties, which may or may not require an auction depending on the facts
– a bankruptcy sale is always public because court approval is required after notice and a hearing
– constituencies
– a potential acquirer will have to negotiate with, or address the concerns of, a variety of stakeholders including trade creditors, bondholders, shareholders, lessors, employees, the bankruptcy court, etc.
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How the process works |
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Each bankruptcy case is unique
n Strategic purchasers have an advantage if the bankrupt Company is not a viable stand-alone entity
n Potential bidders must propose transactions directly to the Company. The bankruptcy court serves as the arbiter and cannot propose solutions itself (i.e., strategic acquirer needs to be in alliance with either the Company or a creditor)
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There are benefits to approaching the Company
during the four-month period of exclusivity and proposing a sealed deal to the
court and creditors
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Acquisition alternatives |
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Processes of acquiring distressed businesses |
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Plan of Reorganization |
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A Chapter 11 Plan of Reorganization provides the method by which all of the seller’s assets will be administered and/or distributed, and its liabilities satisfied |
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Comments |
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Requirements of the Code |
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n Plans are subject to numerous requirements set out in Chapter 11 of the Code. Major requirements include compliance with all of the provisions of the Code, proposal in good faith and not forbidden by law, disclosure of all payments to be made under the Plan, satisfaction of the “best interests” of creditors test, acceptance by each class of the Plan(1), and feasibility |
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Disclosure statement |
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n The Plan must be fully described in a written disclosure statement supplied to creditors and other interested parties. A hearing must be held to determine the adequacy of the information contained in the disclosure statement |
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Solicitation of votes |
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n Votes on the Plan must be solicited from holders of claims against, or interests in, the seller |
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Confirmation hearing |
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n A hearing on confirmation of the Plan must be held to determine whether all requirements for confirmation have been met |
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Notice |
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n There are various notices required in order to confirm a Plan. Courts can shorten these time requirements for good cause |
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Closing the transaction |
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n An acquirer through a Plan will have to wait eleven days after the entry of the confirmation order to close |
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(1) In instances where not all classes accept the Plan, the Plan proponent may attempt a “cram-down” on non-accepting impaired classes of creditors and equity holders. To “cram-down” a plan, a seller must obtain the acceptance of at least one non-insider impaired class and must satisfy the Absolute Priority Rule (no junior class receives or retains any consideration under a Plan until all classes senior to that class have been paid 100% of their claims). |
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Plan of Reorganization (continued) |
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Benefits/advantages |
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Risks/disadvantages |
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ü Best protection against unwanted liabilities ü Comprehensive restructuring ü Unlike in a Section 363 sale, an acquirer may participate in the decision of how to allocate the purchase price among creditors specified in the Plan ü Securities in a reorganized seller, or its successor, that are offered or sold under a Plan in many circumstances are exempt from the registration requirements of the federal securities laws |
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x The greatest disadvantage to purchasing assets through a Plan is the uncertainty of the time involved – can take a few months to a few years to complete depending on the seller involved x Due to the nature of the process, the time to completion can be considerably longer than that of a Section 363 sale x More complex restructuring than Section 363 sale x Potential for litigation in case of competing Plans |
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Pre-packaged plan |
n Pre-packaged plans are similar to the traditional Plan of Reorganization, but the solicitation of votes on a plan occurs before the Filing
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Benefits/advantages |
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Risks/disadvantages |
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ü Minimization of disruption to business due to shortened time in bankruptcy ü Negotiations over purchase occur free from court process ü An acquirer can close in less time than when purchasing through a traditional Plan ü Transaction costs are less than in a traditional Plan |
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x An acquirer must become intimately involved in the bankruptcy process to a much greater extent than a Section 363 sale acquirer x More time consuming than purchasing assets through a Section 363 sale x The lengthy pre-bankruptcy process creates uncertainty with trade creditors x An acquirer often must obtain consent from an informal pre-bankruptcy committee of creditors |
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Purchase of claims |
n It is possible to effect an acquisition of all or a significant part of a seller’s assets or business by purchasing a sufficient amount of claims against that seller
– must acquire a block of claims substantial enough to make it a necessary material player in Chapter 11 Plan negotiations
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Benefits/advantages |
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Risks/disadvantages |
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ü Influence over the process ü Reduction in cost of acquisition ü Hedge against being outbid |
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x The amount paid to acquire the claims is committed before the desired result is certain x Purchased claims are subject to defenses, i.e. if the claim includes unmatured interest or original issue discount, the purchased claim may not be allowable in its full amount x Concerns over class voting requirements – because the Code requires that 50% in number of claimants in a class must vote in favor of a Plan to constitute approval, as an acquirer purchases claims, the number of claimants of a particular class are arguably reduced; thus, the greater number of claims in a class that an acquirer purchases, the more leverage holdout creditors have to extract higher payments for their claims |
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Standard M&A transaction |
n A potential acquiror of a distressed target may have the ability to engage in a non-bankruptcy purchase of assets
n A non-bankruptcy transaction is executed along the lines of a standard M&A transaction
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Benefits/advantages |
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Risks/disadvantages |
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ü Can be accomplished more quickly and economically than a post-bankruptcy transaction ü Minimization of damage and disruption to the operating business |
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x Where an acquirer purchases substantially all of an insolvent seller’s assets, the acquirer may inherit involuntarily some or all of the seller’s liabilities – need to specifically address assumption and non-assumption of liabilities x If the seller files for bankruptcy protection within twelve months subsequent to a transaction, the transaction may be voided on the basis that it was a fraudulent conveyance – fraudulent conveyance occurs if (i) the target was insolvent at the time of (or rendered insolvent by) the transaction and (ii) the assets are sold for less than adequate consideration x Potential inability to bind non-consenting shareholders x Unlike in bankruptcy, contracts with third parties cannot be assigned without their consent if it is required by the contracts – even if an acquirer is willing to perform under the terms of the original agreement |
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Section 363 sale |
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Benefits/advantages |
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Risks/disadvantages |
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The advantages and disadvantages are from the stalking horse bidder’s view |
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ü Significantly greater opportunity to conduct due diligence than bidders that emerge later in the process ü Set the threshold on price and contract terms – ability to accept less onerous contract terms than might otherwise be the case, thereby setting a barrier to entry for competing bidders ü Deal protection provisions (which can be challenged by creditors and are subject to court approval) as part of the original sale agreement – Expense Reimbursement: reasonable in relation to the deal size – Break-Up Fee: usually does not exceed 3% of the deal price – Bidding Procedures: provide standards for qualifying competing bidders and conducting the auction – include standards as to financial ability, a minimum initial overbid necessary to gain entry to the auction, minimum subsequent overbid requirements and allowing the stalking horse to match any qualifying bid – DIP Financing: acquirer can link the financing to the approval of satisfactory bid terms and auction procedures. The loan may be provisioned to accelerate if an offer is accepted by another party |
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x Substantial expense, both in terms of management time and actual out-of-pocket costs x Transaction may never be consummated due to a competing bidder x Negative publicity and potential damage to reputation if management gets outbid in bankruptcy auction |
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Section 363 sale (continued) |
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Comments |
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Process |
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n Section 363 of the Bankruptcy Code (the “Code”) permits a seller in bankruptcy to sell all or substantially all of the target’s assets outside the ordinary course of business on an expedited basis and prior to proposing a plan of reorganization (the “Plan”) or liquidation n The most common scenario is for a sale to occur in two stages: – the first stage entails the seller obtaining bankruptcy court (the “Court”) authority to proceed with a sale to a stalking horse, subject to higher and better offers at an auction, as well as the approval of procedures to follow leading up to and at the auction – the second stage consists of the auction itself, as well as a hearing to approve the results of the auction n Section 363 sales can take place promptly after filing for bankruptcy (the “Filing”) which enables the seller to – obtain the highest going concern value for the assets and – minimize damage to its business from the uncertainty of a bankruptcy proceeding |
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Notice and hearing |
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n The Code requires 20 calendar days’ prior notice to creditors and a hearing at which interested parties can object to the proposed sale n The seller will be required to publish a notice soliciting higher and better offers in a scheduled auction |
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Highest and best price |
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n Under Section 363, the seller must demonstrate that it has obtained the “highest and best” price for the assets. This generally necessitates that the seller conduct a “double auction” n Following an initial pre-bankruptcy auction, the seller will negotiate a purchase agreement with its lead bidder. The signed purchase agreement is submitted for Court approval n The price and other terms established by the lead bidder are then subject to a second auction under Court supervision |
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Section 363 sale (continued) |
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Comments |
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Timing |
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The timing of a Section 363 sale depends upon
the jurisdiction in which the bankruptcy case is filed; in – Initial Filing: Seller files bankruptcy within two days after signing the acquisition agreement – Initial Motions: Within two business days after the Filing, seller submits to the Court motions for approval of (i) the bidding procedures and the expense reimbursement and break-up fee provisions and (ii) the proposed sale – Bidding Procedures Order: Within 32 calendar days after the Filing, the Court enters an order approving bidding procedures, expense reimbursement and break-up fee – Submission of Competing Bids: Approximately 26 calendars after the entry of bidding procedures order, bids must be submitted to the seller (who provides copies to the stalking horse and creditor committees) – Auction: Approximately 28 calendar days after the entry of bidding procedures order, the seller will hold the auction for the business, which can take at least a day –
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Entry of –
Final and Non-Appealable
– Closing: Generally occurs either immediately after the entry of the sale order or immediately after the sale order has become final and non-appealable |
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Section 363 sale (continued) |
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Comments |
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Other |
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n Potential buyers with joint bidding intentions should disclose such intentions before entering the bidding process to avoid potential collusive bidding liability n Section 363 transactions are attractive to potential acquirers because desired assets can be purchased free and clear of liabilities and encumbrances –
potential exceptions are environmental
liabilities, certain tort claims and liabilities and encumbrances on assets
located outside of the |