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— Judgment Call —
Given the current credit squeeze and weakening economy, a wave of distressed asset sales is anticipated. Fitch Ratings estimates that more than $500 billion in U.S. corporate bonds mature this year alone. On top of that, hundreds of billions of dollars of term loans will need to be refinanced over the next 12 months. Much of this activity will take place on the private side, but highly leveraged public companies will not be immune. EchoStar Corp.'s recent run at Sirius XM Radio Inc. will likely be repeated in numerous similar situations. Dealmakers need to understand the key drivers in distressed M&A to navigate these treacherous waters.
Distressed acquisitions present opportunities and pitfalls. In traditional M&A deals, buyers expect to obtain representations, warranties and covenants that survive the closing. But when a deal is a distressed one, the risk that the transaction will come under subsequent attack dramatically increases, and the value of these provisions materially declines. Whether the seller's financial flu is mild or severe, the immediate receipt of cash and the release of the seller from liabilities will be more critical than obtaining the highest possible price. The greatest risk in any distressed sale is that it will be set aside as a fraudulent transfer because of the bargain price that created the attraction in the first place. Fraudulent transfer laws allow creditors of an insolvent entity to challenge any transfer of assets for less than full value. Since these creditors are left unpaid, and any additional value would have been for their benefit, they are injured when the debtor accepts a bargain price. To avoid a fraudulent transfer challenge, a buyer may require that the bankruptcy court approve a sale. A bankruptcy acquisition, either as a part of a proposed plan of reorganization or as a standalone "363 sale" approved by the bankruptcy court, is effectively immunized from subsequent attack as a fraudulent transfer. In addition, the bankruptcy court has the authority to order that the sale be clear of third-party liabilities and claims. If the buyer opts for a bankruptcy-protected sale, the seller will likely require the buyer to be "locked up" before incurring the cost and dislocation of a bankruptcy filing. Although pre-bankruptcy negotiations generally include the overbid procedures and sale order, the prospective buyer quickly learns that the debtor in possession, the creditors' committee and other parties can, and almost assuredly will, revisit or challenge the negotiated terms, resulting in multiple bites at the proverbial apple. Cloaked in the garb of a fiduciary, the debtor in possession will shamelessly renegotiate the very deal that it cut before the bankruptcy filing. So while every buyer would want the benefits provided by a bankruptcy sale process, all else being equal, buyers quickly recognize that it permits creditors to attempt to renegotiate in a process that can become a competitive auction if other bidders appear. The concept of "a deal is a deal" simply does not apply until the court says it does. While previously agreed-to overbid procedures can reduce the concern that a buyer's bid is merely a stalking horse, there remains a real risk that the prospective buyer will lose control of the process and ultimately the asset. Although bidders usually negotiate protections such as breakup fees and minimum overbid levels, those are unenforceable until a bankruptcy court approves them. While approval of some forms of buyer protection is relatively standard in bankruptcy, approval of breakup fees has become controversial in recent years. Even the most optimistic forecasts indicate that the global economy may continue to deteriorate for the balance of 2009 and perhaps beyond. Whenever the recovery occurs, the massive deleveraging of the financial system will not be reversed quickly or painlessly. This means that will need to become experts in the intricacies of distressed acquisitions. Frank Aquila is a partner in Sullivan & Cromwell LLP's mergers and acquisitions group, and Hydee R. Feldstein is a partner in the restructuring and bankruptcy group. |
The last year has been humbling for those of us who live for the deal. After three years of ever-larger and more highly leveraged transactions, dealflow has slowed to a mere trickle. 
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