This article is based on the Wachtell Litpon publication, Dealmaking in a Distressed Environment. This publication is about mergers and acquisitions of distressed target companies. Distressed means that a company is having difficulty paying its liabilities such as payments on loans, obtaining or paying down trade credit, addressing debt covenant breaches, or raising additional debt. The distressed companies can be attractive acquisition targets.
These companies are fairly easy to recognize because their stock typically trades at prices that represent their difficulties. Generally they are under pressure to sell their assets or securities as quickly as possible in order to raise capital or pay down debt. As such, acquirers have an opportunity to purchase attractive assets or securities at a discounted price. The purpose of this publication is to show you every possible point of entry when acquiring a distressed company. This could involve buying existing or newly issued stock, merging with the target, buying assets, or buying existing debt with intentions to convert it into ownership.
Before going into the practice of distressed acquisitions, a review of corporate responses to debt crisis is needed. Each response can give way to an entry point for would-be acquirer and a basic understanding of how companies first respond to distress is needed in to help the acquirer. Forbearance agreements and waivers and amendments of bank and bond debt are considered the mildest responses to distress. A non-bankruptcy solution may still be available if the financially distressed company takes other measures, when the measures previously discussed don’t produce the desired results.
Non-bankruptcy solutions include a dilution or change in the equity-holder’s control of the distressed company or its assets. This will provide opportunities for investors to acquire interests and assets from the distressed target or even ownership. For example, investors can purchase assets, make PIPE investments, make rights offerings, negotiate debt repurchases or restructurings, make exchange offers and purchase foreclosures. However, there are numerous risks for any investor when dealing with a company in this stage.
Out-of-court deals cost less and consume less time than in court transactions. Typically they require shareholder approval or creditor consensus and it’s difficult to force non-consenting parties to changes in their rights. For example, requesting a reduction of principal or interest of a loan obligation or an extension of maturity on a loan obligation would not be conceivable to a lender. In contrast, transactions under the United States bankruptcy code don’t require shareholder approval and can bind non-consenting parties. Therefore, it’s imperative for companies experiencing acute distress to seek in- court solutions.
Alternative solutions such as prepackaged or pre-negotiated reorganization plans are also discussed. If the company has sufficient lead time (before it reaches acute distress) to negotiate out-of-court transactions, these reorganization solutions are more appropriate than in-court transactions. These types of solutions are cheaper, faster and result in less confrontational bankruptcies with less collateral damage. Sometimes dissenting creditors will agree to out-of-court solutions, if they are aware that a borrower is prepared to file bankruptcy.
The publication also discusses acquisitions of targets in and through bankruptcy. Asset cells in bankruptcy can be expedited pursuant to section 363 of the bankruptcy code. These types of sales are commonly referred to as 363 sales and traditionally have been less favorable if assets are a significant portion of the target company’s business and moving quickly is not a necessity. Major 363 sales are currently more common, because several large debtors have been allowed to sell a substantial amount of their assets despite having a lengthy liquidity runway. Another reorganization alternative is for creditors or outside investors to acquire a bankrupt company or a significant portion of it.
Specific considerations regarding trading in claims against distressed companies are also discussed. Claims’ trading is a strategy for obtaining control. For example, buying claims that receive ownership of the restructured company under a plan of reorganization or that can be used as consideration in a 363 sale. Claims trading can also be an investment opportunity for the trader with a short-term horizon. Regardless of the type of investor, claims’ trading has risks and opportunities that typically don’t exist when acquiring claims against non-distressed targets.
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