Nearly two years after the onset of the coronavirus pandemic, as the automotive supply chain continues to be disrupted not only by the pandemic but also by port and logistics delays, shortages in materials such as semiconductors, steel, resin and foam, and rising costs (including labor especially), there exist opportunities for growth through acquisition. Companies that were perhaps propped up with government support early on during the pandemic (through PPP loans or other government aid) are beginning to feel increased pressure as they face financial and operational challenges. Lenders who previously provided extensions of credit and forbearance of defaults are becoming increasingly active in asserting their rights and remedies in the case of a default. The cash flow and credit issues these companies face may result in opportunities to purchase them at depressed valuations. While these deals may appear to be hard to come by, shrewd investors will be well served by considering both out-of-court and bankruptcy acquisitions of the distressed companies that are under pressure due to the current environment.

Checklist of Certain Key Considerations for an Out-of-Court Acquisition

  • Often structured like a normal asset deal.
  • Due diligence is even more critical to understand in order to avoid and creatively address potential liabilities.
  • Specify assumed liabilities and excluded liabilities.
  • Include indemnification and escrow where possible (but seller might not be able to perform under indemnification).
  • Negotiations with creditor constituencies can reduce exposure.
PROS

- Fast; no court approvals required.
- Less expensive than a court process.
- Buyer can sometimes achieve more control/certainty and purchase protections than in a court process.
- Can obtain traditional M&A protections (e.g., escrow, representation and warranty insurance, indemnity).
- Typically does not require an auction with competitive bidding.
- Potentially helps to support on customer/supplier relationships (subject to contract terms).
CONS

- Cannot “cherry pick” contracts as easily as in bankruptcy.
- Cannot force support from and bind non-consenting creditors (e.g., lenders).
- Risk of possible successor liability (vs. “free and clear” sale in bankruptcy).
- Often need shareholder consent.
- Fraudulent transfer risk where seller does not receive reasonably equivalent/fair value while insolvent, but consider these protections:
- Arm's-length sale process with consent of key parties.
- Valuation opinion.
- Structure through a friendly foreclosure/Article 9 sale.

Checklist of Certain Key Considerations for Bankruptcy Sale

  • Buyers often seek to avoid possible successor liability and other risks, and require the sale to occur in a Chapter 11 to maximize buyer protections/rights.
  • Section 363 of the Bankruptcy Code permits a debtor to sell substantially all of its assets if supported by reasonable business judgment, free and clear of all liens, claims, and encumbrances.
  • Section 365 of the Bankruptcy Code permits a debtor to assume and assign, or reject, certain contracts and unexpired leases notwithstanding restrictions on assignment in such contracts.
  • Upon a bankruptcy filing, the “automatic stay” arises and protects the seller's assets from creditor collection efforts and contract terminations to enable a transaction to occur.
PROS

- Court-approved sale is “free and clear” of liabilities, and balance sheet is clean.
- Shareholder approval not required.
- Eliminates fraudulent transfer risk.
- Enhanced successor liability protection.
- Contracts can be “cherry picked” and bad ones left behind, regardless of consent.
- Fast (sales can be approved within 30-60 days after a bankruptcy filing).
- Closing likely, regardless of objecting creditors.
- Buyer can achieve “stalking horse” advantages: enhanced information, bid protections to protect itself and enhance purchase prospects (e.g., breakup fee [~3-3.5%] and expense reimbursement, and bid increased by same), minimum bid increments, and tight timeline for the sale.
- Tactic: If buyer owns secured debt, it can credit bid for increased control.

 

CONS

- Sale will be to the “highest and best bid;” an auction is generally required and, notwithstanding stalking horse advantages, marketing process may yield an alternative winning bidder.
- Secured lender can credit bid its debt to set the floor.
- More expensive than an out-of-court acquisition.
- Unsecured Creditor Committee appointed in Chapter 11 may delay sale and seek to extract more value.
- Purchase is “as is” — diminished escrow/no indemnity.

 

The automotive industry has faced incredible headwinds, many of which persist into 2022. As companies look to grow their revenue and profits, these headwinds may well present opportunities for growth through acquisition.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.