In the wake of the economic stress created by COVID-19, we have seen increased opportunities for buyers looking to acquire distressed companies and assets in Canada. Increased deal flow in industry sectors that have been hit hardest by COVID-19, including retail, hospitality, travel, cannabis, and oil and gas has occurred, and with the passage of time other sectors will be affected. Distressed M&A transactions can be structured in a variety of different ways - a sale of shares, assets or debt or a combination thereof, and potentially through a formal insolvency process overseen by a court. This article addresses ten common questions buyers have when considering distressed M&A transactions.
- Where do you source
distressed deals? Someone interested in acquiring
distressed assets will need to understand: (a) who the potential
vendors are; (b) how to get access to these deals; (c) when to get
involved in a transaction; and (d) how to successfully navigate the
process. There is often low supply and high demand for
"good" distressed assets, resulting in a highly
competitive market for the best deals. Most distressed deals
circulate within a small network of restructuring professionals
including licensed insolvency professionals, investment bankers,
private equity funds, special accounts units at banks, lawyers,
chief restructuring officers and accountants. This network can be
an invaluable source for buyers to gain access to distressed
opportunities.
- How do distressed deals
differ from traditional M&A? Three key differences
separate traditional M&A from distressed M&A: timetable,
risk profile, and potential involvement of a court.
- Timetable - Distressed M&A often happens quickly over an accelerated timetable, which means buyers need to be well-organized and prepared to make key decisions rapidly – often over the course of days.
- Risk Profile - Buyers frequently close transactions with the increased risks associated with limited due diligence, incomplete information, weak financial performance of the target and limited or no representations and warranties.
- Court Involvement -
Although many distressed M&A transactions are conducted through
a formal insolvency proceeding overseen by a court, a large number
of deals close outside of a court process as part of an informal or
consensual workout.
- What does a typical
distressed M&A transaction look like? There is no
"one-size-fits-all" acquisition structure in distressed
M&A. Because each transaction is unique, prospective buyers of
distressed assets need to look creatively at each
transaction. A traditional path of purchasing assets might be
appropriate in some cases, but creative approaches could put the
buyer in a similar position while significantly increasing the
chances of success. Potential transaction structures include
purchasing assets, acquiring debt (either in respect of debt
previously held by the purchaser or acquired by the purchaser
immediately before the transaction), a "pre-pack"
consummated through a formal insolvency proceeding, a hive-down
transaction, or completing an amalgamation with the target.
- What are the most common
types of formal insolvency proceedings? The most common
types of formal insolvency proceedings for corporations in Canada
are proceedings under the Companies' Creditors
Arrangement Act (the "CCAA"),
Division I proposal proceedings and bankruptcies under the
Bankruptcy and Insolvency Act (the
"BIA"), and receivership proceedings
under the BIA and certain related provincial legislation. CCAA
proceedings and Division I proposal proceedings are in most cases
"debtor-in-possession proceedings" where the company and
its management remain in control of the company's assets during
the proceedings up to and during the sale of its assets. In
receivership proceedings and bankruptcy proceedings, the
company's assets, on commencement of the proceedings, will vest
in a third party receiver or trustee, as applicable, who will in
turn negotiate and conclude any transaction as seller on behalf of
the company's creditors and other stakeholders.
- What are the benefits of
completing a transaction inside a formal insolvency
proceeding? In a transaction completed through a formal
insolvency proceeding, the court overseeing the proceeding will
have the power to issue an order (commonly referred to as an
"approval and vesting order"), vesting out (i.e.
discharging) all pre-existing interests in the assets being
acquired including the interests of any secured and unsecured
creditors of the seller. This allows a buyer to acquire assets free
and clear of any third party interests, irrespective of whether or
not the proceeds from the transaction are sufficient to pay out the
seller's existing's creditors. A buyer and seller may
additionally be able to use a formal insolvency proceeding to: (i)
force the assignment of a contract of the seller to the buyer over
the objections of the counter-party to the assigned contract; and /
or (ii) right size the business by using certain statutory powers
to terminate / disclaim unprofitable contracts of the seller
notwithstanding that the seller may not otherwise have the
contractual right to do so.
- Are transactions outside a
formal insolvency proceeding more risky? Under the BIA and
certain supplementary provincial legislation (commonly referred to
as fraudulent preference and conveyance legislation), a transaction
completed outside of a formal insolvency proceeding can
subsequently be voided or deemed void by a court at a later date if
it is determined to have met the criteria of a fraudulent
preference or fraudulent conveyance. This legislation, which is
designed to prevent an insolvent seller from consummating a
transaction that is prejudicial to its creditors, will have to be
carefully considered in a transaction completed outside of a formal
insolvency proceeding in order to properly understand, and where
possible limit, the risks associated with this legislation.
- What are the drawbacks of a
formal insolvency proceeding? The potential rewards
associated with a distressed deal come with an increased level of
risk. Buyers, especially in the context of a sale in a formal
insolvency proceeding, will not be able to conduct comprehensive
due diligence on the target's assets. Due diligence will
have to be conducted quickly and be limited to key aspects of the
transaction. If a transaction is being consummated through a formal
insolvency proceeding it is standard for buyers to receive limited
to no representations and warranties from the seller (i.e.
transactions are completed on an "as is where is basis").
It is important to note that a transaction in a formal insolvency
proceeding will be on the public record regardless of whether or
not the buyer or the seller is a public company. The court does
retain and often exercises its power to seal certain deal terms
from the public until closing, however the identity of the buyer is
unlikely to be sealed. A transaction in a formal insolvency
proceeding may be heavily scrutinized and, in certain
circumstances, opposed by the seller's creditors and other
stakeholders. A court will generally not approve a sale in a formal
insolvency proceeding unless it has comfort that the assets being
sold have been properly and thoroughly marketed and the transaction
being proposed is in the best interests of the seller's
creditors.
- What kind of due diligence
can a buyer do? Financial due diligence will be
critical to assess the pricing and structure of the deal, as well
as whether there are any potential deal breakers. However, legal
diligence is also important and buyers should retain experienced
advisors who can quickly identify and focus on the most material
issues. In addition to the typical legal diligence requests, it is
useful in distressed M&A to:
- Identify, as fully as possible, the assets that come with the purchase;
- Review key contracts and licenses;
- Meet the management team (provided a trustee or receiver has not been appointed);
- Consider third party consents; and
- Examine other areas of risk exposure including environmental, employee and other common liabilities.
For some buyers, transaction certainty and an ability to close quickly may be more important than completing fulsome due diligence.
- What is a sales and investor
solicitation process? In both formal insolvency
proceedings and informal workouts, a seller may, as part of its
restructuring process, undertake a compressive sales and investor
solicitation process ("SISP") to solicit
offers from potential investors and / or purchasers for all or part
of the assets of the seller. In a formal insolvency proceeding this
will often be done in accordance with an order approved by a court
setting out the guidelines of the SISP. A SISP may or may not
include a stalking horse bidder, whose offer to acquire certain or
all of the assets sets a minimum bid threshold for the market, in
consideration for certain accommodations provided to the stalking
horse bidder including, in many circumstances, a break fee.
- What is a buyer's first step? A good first step when considering a transaction with a distressed company is to hire legal counsel that are familiar with the insolvency process and are connected to the network of insolvency professionals in the target's jurisdiction. Gowling WLG has strong relationships with insolvency advisors, licensed insolvency professionals at the major accounting forms, investment banks and turnaround specialists, which can be drawn on where required.
"Read the original article on GowlingWLG.com".
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.