Unfortunately, it’s probably fair to say that many – if not most – of the M&A deals that are likely to get done in the near future are going to involve distressed targets. This Sidley memo reviews some of the unique risks associated with distressed deals, as well as some of the structuring alternatives that are available.
Risks that buyers face in acquiring an insolvent business include fraudulent conveyance and successor liability issues, but this excerpt points out that buyers may have very little contractual recourse to address these un-bargained for liabilities:
Unfortunately, notwithstanding these increased risks, it is typical that the buyer has relatively limited recourse for unwanted liabilities under the purchase agreement. It is uncommon for the purchaser of assets out of bankruptcy, for example, to receive any significant representations and warranties, let alone any post-closing recourse. Even in structures that fall short of a bankruptcy, representations and warranties, as well as post-closing recourse, are more limited than transactions involving healthy companies.
A mixture of factors contributes to this, among others: (1) the buyer’s desire to quickly close the transaction before employees find other employment, customers leave, the business disintegrates and the value of the transaction is lost; (2) a discounted purchase price; and (3) given the discounted purchase price, the relatively small amount reasonably available for escrow and indemnification.
Rep & warranty insurance may help address contractual shortcomings, and bankruptcy law may also provide the buyer with additional protections.
The memo addresses various bankruptcy & non-bankruptcy structures that may be used to effect a distressed acquisition. It reviews the differences between a Chapter 11 transaction & a Section 363 sales, and discusses non-bankruptcy alternatives such as an assignment for the benefit of creditors and a “friendly foreclosure.”
– John Jenkins