Although a growing body of evidence—from job numbers to stock price figures—suggests that the Canadian economy is set for strong growth this year, there will always be companies (and industries) that get left behind for one reason or another. Where those companies that cannot meet their obligations have otherwise attractive assets, it presents an opportunity for those with cash on hand to pick up such assets (or companies) at a discount.
However, purchasing a business or assets out of a bankruptcy or other insolvency process does present challenges that are quite a bit different from those more commonly encountered in transactions in a more normal (non-insolvent) context. With that in mind, the following sets out some of the key issues that potential acquirers ought to consider when contemplating such a deal by way of direct acquisition:
No recourse for reps and warranties
Though a complete “kicking of the tires” is always an important part of the M&A process, conducting a thorough diligence investigation is of even greater significance in an insolvency context where there will in all likelihood be no possibility of meaningful recourse if a seller’s rep or warranty turns out to be untrue post-closing. For this reason, and particularly also when the sale is being conducted by a receiver or trustee (who will therefore be new to the assets), sales in an insolvency context take place almost always on an “as is, where is” basis, with only minimal reps and warranties. This reality means that purchasers need to place a significant emphasis on conducting effective due diligence before executing on any acquisition out of insolvency. However, because of liquidity constraints that will typically be on the seller, potential purchasers will be pressured to complete their diligence in a relatively short period of time.
Although the risks that result from this will typically be factored into a reduction of the purchase price offered by the seller, it remains nevertheless critical for a prospective purchaser to conduct enough due diligence to satisfy itself as to all relevant matters to the assets being purchased.
Given the need to conduct diligence on an accelerated basis and the “as is, where is” nature of the sale, purchasers will almost never proceed by way of a share purchase given its potential to expose a buyer to all manner of unknown and/or unwanted liabilities, and will almost always transact under an asset purchase model. Transacting via asset purchase also allows a stepped up value for tax purposes (the shares of an insolvent company being necessarily valueless).
Of significance also is the decision of when to execute the sale. Whether the sale is conducted in advance of an insolvency filing or after, the sellers (be they the company itself, or creditor vendors such as a trustee, or receiver) will need to ensure that a proper sale (read auction) process was conducted with integrity and fairness to obtain the best overall offer possible in the circumstances. Where the sale is to be conducted following an insolvency filing, this process is necessary to ensure the receipt of court approval of the sale, and where it is in advance of the filing, it should be done to ensure that it cannot later be challenged by a trustee in bankruptcy or dissatisfied creditor that the transfer of assets was at undervalue.
Although a full sale process is not necessarily needed if the sale is conducted ahead of an insolvency filing, to minimize the risk of attack, a prospective purchaser should consider (a) establishing that “fair consideration” or “reasonably equivalent value” was paid (e.g. by obtaining a fairness opinion from a reputable investment bank; and (ii) ensure that adequate arrangements are made to pay-out the target’s ranking creditors, or that they are otherwise signed off on the transaction.
Other considerations – cash, closing risks and timing
In the insolvency context, purchase price will not be the only primary factor in assessing a prospective purchaser’s bid or negotiating a transaction. As a general matter, whether one is dealing with a secured creditor, receiver or trustee, sellers will typically prefer the bid that has the lowest closing risk, can be completed the fastest with the least amount of expenses and will maximize the case that will be available to be freely distributed to creditors on closing. Accordingly, transactions that contain escrow or holdback provisions to address adjustments in a purchase price, or a large number of onerous closing conditions will typically diminish the attractiveness of a deal from the perspective of such a seller. For this reason, potential buyers who are serious about winning at the auction would do well to spend as much time thinking about how to meet the needs of a debtor’s key stakeholders, and primarily its ranking creditors, as they do about the purchase price.
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