09/22/2009 05:08:33 PM EST
Distressed Acquisitions: Brave New World or Variation on a Familiar Theme?
Distressed M&A activity continues to be one of the most active segments of the deal market despite signs of improvement in the economy and recovery in the credit markets. Discussions of rights plans and "go shops" are being replaced by fraudulent conveyance risk, 363 sales and plans of reorganization and the "failing company" defense.
The authors write: Increasingly, distressed sales head to bankruptcy court for approval and the bankruptcy sale process, in which a bankruptcy court approves a sale "free and clear" of claims, liens and interests, if not squarely in the mainstream of distressed M&A activity, has at least become a more visible and effective tool for consummating the sale of a business as a going concern. A sale under section 363 of the Bankruptcy Code can preserve concern value for a company that lacks the liquidity to sustain itself through a reorganization plan. Moreover, in the current litigious environment where acquisitions consummated outside of bankruptcy are aggressively attacked on fraudulent transfer or other grounds, the ability and willingness of bankruptcy courts to approve emergency sales outside of a plan context are often presented as the only viable option to the liquidation of a business.
Usually, the primary motivation for dealing with a financially troubled seller is the opportunity for a bargain and basic principles of contract law include the right of each party to a contract to enjoy the benefit of the bargain. Obtaining that benefit from a solvent seller poses little risk that the sale will be successfully challenged or set aside as a fraudulent transfer. The buyer typically seeks to preserve the benefit of its bargain by obtaining valuable representations, warranties and covenants regarding the nature of the business purchased that usually survive the closing of the transaction. When the purchase is financially troubled, however, the risk that the transaction will come under subsequent scrutiny and attack as a fraudulent transfer or otherwise increases dramatically, while the utility and value of commercially customary representations decline materially.
Conventional wisdom has been that consummating the acquisition after a formal bankruptcy proceeding has been initiated, either as a part of a proposed plan of reorganization or as a sale approved under Section 363 of the United States Bankruptcy Code (the "Code"), effectively immunizes the transaction from subsequent attack as a fraudulent transfer. It is a truism that the power of the bankruptcy court to order that a sale "free and clear" of the claims, liens and interests in the assets of the seller or the business sold provides the best traditional protection from known or hidden liabilities following an acquisition. While a bankruptcy court order provides the best title obtainable to the buyer of a distressed business, the ever larger sales compressed into ever shorter time frames in the current environment, whether or not approved by a bankruptcy court, have resulted in a litigation littered landscape among the constituencies in the seller's bankruptcy. [footnotes omitted}