(Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. He submitted this column to VentureBeat.)
A reader asks: One of our competitors just filed for bankruptcy under Chapter 11. We think we can buy their IP and other assets at bargain prices. We’re worried, though, that we might be getting in over our heads. Are there any issues we need to focus on?
Answer: Welcome to the world of distressed M&A. I started my legal career in the corporate departments of two major New York City law firms and handled a number of these types of deals.
Know going in that this is very tricky stuff and you definitely need to retain M&A and bankruptcy counsel to help you through the process. As you do that, though, here are four things to keep in mind.
A Section 363 sale is usually the way to go – The purchase of a Chapter 11 debtor’s assets may be consummated either pursuant to Section 363 of the Bankruptcy Code (a “Section 363 sale”) or as part of the debtor’s overall plan of reorganization. A Section 363 sale tends to be faster and cheaper, though, and minimizes the risk of those assets becoming less valuable or there being a shortage of working capital.
From the buyer’s perspective, a Section 363 sale is generally more attractive than a non-bankruptcy acquisition. In most cases, the bankruptcy court will approve the sale of the assets “free and clear” of all liens and liabilities (other than those liabilities that the buyer expressly agrees to assume and, arguably, certain “successor” liabilities such as environmental and product liabilities claims). Also, the approval of the bankruptcy court should bar any subsequent fraudulent conveyance challenge.
The buyer will also be able to cherry-pick assets and contracts in ways not possible in in an non-bankruptcy situation. Assumed contracts will generally be “cleansed” of non-assignability or change-of-control provisions as well. And finally, state shareholder approval laws and bulk transfer laws generally don’t apply to a Section 363 Sale.
It pays to be the stalking horse – A Section 363 sale is subject to bankruptcy court approval after interested parties are notified and a hearing is held. To ensure that the debtor has obtained the “highest and best” price for its assets, an auction will usually be conducted under the supervision of the bankruptcy court. This raises the question of whether you, as the prospective buyer, should play the role of the “stalking horse” bidder (the initial party to execute a purchase agreement with the debtor) or just wait to see the final sale terms approved by the bankruptcy court, then decide whether to make a higher bid (assuming there is such an opportunity).
There are a number of advantages to being the stalking horse. You have more opportunity to conduct an adequate due-diligence investigation. You also have the ability to set the threshold price and terms of the sale as well as the ability to negotiate certain deal protections and bid procedures (see below).
The major risk to being the stalking horse, of course, is bidding too high..
Negotiate with all of the relevant constituencies – In the non-bankruptcy context, a buyer generally negotiates solely with the distressed target’s management and doesn’t need to deal with creditors (unless he’s seeking amendments to debt documents or waivers, etc.). In a Section 363 sale context, however, there are a number of different constituencies – often with disparate interests – that the buyer may have to deal with, including secured creditors (first-lien and second-lien holders), unsecured creditors, equity holders (both preferred and common stockholders), bondholders, landlords, and indenture trustees.
It’s imperative the buyer understands the debtor’s capital structure and the dynamics of the various pieces and then keep all of the relevant constituencies “on board” throughout the negotiation process.
Focus on the bidding procedures in the purchase agreement – If, as the buyer, you’re willing to be the stalking horse, bear in mind the context of the transaction and the likelihood of a subsequent auction. The purchase agreement that the stalking horse executes must be approved by the bankruptcy court and will serve as the bid document against which other parties will submit their proposals.
Accordingly, it makes strategic sense to keep the agreement as simple as possible and for you, as the buyer, to rely on due diligence and the order of the bankruptcy court for protection rather than comprehensive representations and warranties and indemnification provisions (which will significantly discount its bid).
The most effective use of the stalking horse’s leverage is in connection with the negotiation of bidding procedures. You get a bid deadline and an auction date, qualified bidder criteria provisions (such as not being subject to financing conditions), overbid requirements and matching rights and a termination fee and expense reimbursement provisions.
As you can see it’s complex stuff. That’s why you’ll want an experienced attorney on your side.
Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.
Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.