There are many aspects to the purchase of distressed assets that make this type of an acquisition a unique challenge for a buyer. However, the upside of such an acquisition can be great for the educated and patient buyer.
Distressed M&A certainly has risks and it is complicated by the fact that third parties, like judges, receivers and lenders, actively participate in the sale process, which brings uncertainty and a loss of control to the process. Nevertheless, an opportunistic buyer has the potential to acquire assets at a great value and free of many claims.
As with any asset transaction, buyers must beware of taking assets subject to claims of successor liability, lawsuits, potential shareholder disputes and the risks of fraudulent transfer challenges. Navigating the distressed sale process is about positioning a buyer to enable it to balance the risk with the reward every step of the way.
The following are the most common forms of distressed sale transactions:
Bankruptcy 363 Sales. Under section 363 of the Bankruptcy Code, the seller seeks to have an auction, and often signs up a “stalking horse” bidder to create a baseline bid. The stalking horse agreement typically includes bid protections, such as a break-up fee, minimum overbids or expense reimbursements. At the end of the auction process, the court enters an order authorizing the transfer of the purchased assets free and clear of liens, claims, interests and other encumbrances and it permits the assignment of most contracts to the buyer without the consent of the other contract parties. In addition, 363 sales cannot be challenged as fraudulent transfers. However, the administrative costs of getting to a section 363 sale tend to be higher than other distressed sale options. If there is funding to get to a 363 sale, the protections, certainty and clarity of a bankruptcy sale order benefit all of the parties - especially the buyer.
Receivership Sales. State and federal court receiverships occur when a third party is appointed to liquidate the assets of a distressed seller. Receiverships do not have the benefit of comprehensive statutes or uniform case law, thus they are often modeled after the bankruptcy sale process. However, unlike section 363 of the Bankruptcy Code, the authority of a receiver to sell assets free and clear of liens, claims and interests can be unsettled and varies from jurisdiction to jurisdiction. It may also be difficult to sell free of the restrictions or claims imposed by federal or other state laws. Nevertheless, a buyer of distressed assets from a receiver gets the benefit of a court order that should provide many of the same benefits a bankruptcy sale order does at a lower cost.
Article 9 Secured Party Sales. Another avenue for purchasing distressed assets that consist of personal property (i.e., not real estate) is a secured party sale under the Uniform Commercial Code (UCC). Article 9 of the UCC provides a secured creditor with the authority to seize and sell its collateral after a default. In essence, the sale is between the buyer and the secured lender, and it can be accomplished either through a private or public sale. All aspects of the sale must be commercially reasonable to be free from challenge by the debtor or other creditors. Although not required, this process works best when the debtor company is cooperating, which is why it is often referred to as a friendly foreclosure. Buyers of assets in a secured party sale do not get the benefit of court supervision or a court order; however, the assets can be transferred quickly, free and clear of junior liens and without the need to go through court foreclosure.
Whatever form of transaction, AS IS WHERE IS is just that. Nothing more, nothing less. The buyer should understand why the seller is in financial distress and feel confident that the assets can be profitable once transferred to its operations or under its control. In addition, when assessing any distressed asset acquisition, one must be comfortable with, and rely almost exclusively on, its own due diligence. Unlike traditional M&A transactions, the insolvent seller practically disappears after the sale and the sale proceeds to go to creditors. Therefore, there are few or no representations and warranties that survive closing and typically no ongoing source of indemnification.