What is a Stalking Horse?
In the distressed M&A context, a stalking horse refers to a potential purchaser participating in a stalking horse auction who agrees to acquire the assets or business of an insolvent debtor as a going concern. In a stalking horse auction of an insolvent business, a preliminary bid by the stalking horse bidder is disclosed to the market and becomes the minimum bid, or floor price, that other parties can then outbid.
Extensively used in the United States, the stalking horse auction is different than the sealed competitive bidding process that is predominantly used in Canada. That said, stalking horse auction processes have been used in Canada in a number of cases. Most recently, in February of this year, the Superior Court of Justice of Ontario approved a stalking horse auction process in the case of In the Matter of the Receivership of Crate Marine Sales Limited et al., despite the objections of certain creditors. That Court applied the 4-part test set out in the decision of Morawetz J. in Brainhunter Inc. for approving a stalking horse auction process, namely: 1. Is the sale transaction warranted at this time?; 2. Will the sale benefit the economic community?; 3. Do any of the creditors have a bona fide reason to object to the sale of the business?; and 4. Is there a better viable alternative?
The stalking horse participates in the process knowing that it may be outbid. Accordingly, it negotiates a break fee to cover its participation costs, including its due diligence costs to put together the initial threshold bid. Typically, for a competing bid to knock out the stalking horse bid, it will have to be greater than the stalking horse bid plus the break fee. The competing bid will also have to be on substantially the same terms and conditions as the stalking horse bid, and cannot contain any onerous conditions.
What is a typical Stalking Horse Process?
A typical stalking horse sales process is as follows:
- Stalking horse negotiates a purchase and sale agreement (the “Stalking Horse Bid”) with the insolvent debtor;
- Court approves the entering into of the Stalking Horse Bid, including the break fee, and a charge on the assets of the insolvent debtor to secure the break fee. Interestingly though, in the Crate Marine Sales Limited case referenced above, the Stalking Horse Bid did not contain a break fee or for any recovery of stalking horse costs if it was outbid;
- Court also approves a set of bid procedures that provides for:
- a sales process by which superior overbids will be sought, including a short deadline for such bids;
- the test which will be used to determine if a superior bid to the Stalking Horse Bid is made by one or more other bidders; and
- a follow-up auction process, if necessary, often held on a single date, on which any bidder that made a superior bid, plus the stalking horse, may bid again in an attempt to make the best and winning bid; and
- Final approval by the Court of the winning bid and issuance of a vesting order by the Court to complete the sales transaction.
Why become a Stalking Horse?
So, why would you want to consider being a stalking horse? First, as a stalking horse, you will have the best chance at negotiating the deal terms that are tailored to meet your particular concerns. Also, as the first bidder, you will have more time to analyze and understand the debtor’s business. You will also have an opportunity to develop relationships with management, suppliers and key stakeholders in the sales process. Further, your costs of participating in the auction process are covered by the break fee that you will negotiate. As noted above, that break fee is usually secured by a special court-ordered charge against the assets of the insolvent debtor, though you will have to consider the relative priority of your charge against other charges that may have been approved by the court.
Thus, if you are considering acquiring the assets or businesses of distressed companies in the energy sector, you might want to give some thought to agreeing to be a stalking horse in a stalking horse auction process. Though Court approval of the process will be required, in cases where there is a need for speed, and for there to be certainty of the completion of a sale to provide short-term stability so that management can develop a business plan to continue the business while the stalking horse auction plays out, the stalking horse auction process may well be accepted by a Court as the best sales process.