You are eyeing a company that is about to go down the proverbial drain and want to acquire its assets. Insolvent or near-insolvent companies often present an opportunity to purchase assets at significantly discounted prices. A purchaser acquiring assets from such companies wants to make sure it isn’t also buying the troubled company’s liabilities: at least not those it has not bargained for. An asset purchase in such a situation poses a number of risks to the purchaser, including:-
- Fraudulent transfer allegations, which can be based on:
- actual fraud, where the company’s transfer of assets to the purchaser was actually intended to hinder, delay or defraud the company’s creditors, or
- fraudulent preference, in which the transaction is deemed fraudulent if the transaction is for an undervalued consideration and the company was insolvent or became insolvent as a result of the transaction;
- Risk of successor liability claims arising from the assets purchased;
- Risk due to limited recourse against company (what value, if any, is there to a troubled company’s representations and warranties, to its agreement to provide further assurances, or agreement to indemnify for losses/breach of representations, warranties or covenants); and
- Risk of loss of key employees.
The risks involved in an asset purchase transaction can be significantly mitigated, either through (a) formal proceedings, like liquidation/bankruptcy; or (b) outside formal proceedings, with appropriate due diligence and structuring of the deal. The right approach depends greatly on the particular facts and circumstances of each transaction, and is best done in consultation with professionals like lawyers, accountants and valuers. A summary of the advantages and disadvantages of each of the approaches are set out below.
The liquidator or bankruptcy trustee may sell assets of the company pursuant to powers granted by the courts or in statutes. There are many advantages using such proceedings:
- Reduced risk of later challenges, including challenges that the transaction is a fraudulent transfer;
- The sale of assets may be free and clear of many third party liens and interests, and can be accomplished even over objections by shareholders or unsecured creditors;
- Once the sale has been approved and becomes final, the liquidator or trustee may only avoid the sale in very limited circumstances (example if there is collusion among potential bidders that affected the sale); and
- The liquidator or trustee may avoid those onerous executory contracts that neither the liquidator//trustee nor buyer wants to keep.
Of course, there may also be reasons to avoid a liquidation/bankruptcy. Chief among them:
- Cost – Such proceedings are expensive and the troubled company loses control of the sale process. Because the seller may not have the funds for the proceedings, a buyer may have to consider financing the proceedings through loans that the buyer may have to recover later from the company.
- Delay – While the courts may set expedited hearing dates, completing a sale often takes months. The delay could increase risk of loss of key employees or opportunities.
- Lack of Confidentiality – Such a sale is usually subject to higher and better offers, because the goal is to maximize value. Generally, the liquidator/trustee will sell to the highest bidder, unless there is an important reason to accept a lower offer, and the views of the creditors’ committee may also be considered. To obviate the risk of being outbid after sinking time and money into a deal as a “stalking horse bidder”, a buyer may seek various protections from the courts to ensure that its bid will have a higher chance of success and for reimbursement of expenses.
- IP Issues — Liquidation/Bankruptcy could cause the seller company to lose licensee rights under patents or copyrights licences. Thus, obtaining any licensors’ consent could be important.
- Stigma — Sometimes management of a troubled company may fear perceived negative consequences of a liquidation/bankruptcy. While the benefits of such proceedings may outweigh any perceived stigma (including fulfilling management’s duties to creditors), a buyer may need to convince the seller company of the advantage of liquidation/bankruptcy.
Purchasing Assets Outside Formal Proceedings
A buyer may opt to proceed outside liquidation/bankruptcy proceedings. This approach has the advantage of eliminating the transaction costs of a formal proceeding, and keeps the process fully in the control of the seller and buyer – it is a private transaction. In addition to the risks outlined above, however, other disadvantages to this approach include: the inability to obtain financing with priority over existing debt without consent of prior lenders, no automatic stay of hostile creditor actions and inability to bind non-consenting creditors and others.
Although it is not possible to eliminate these risks, buyers may try to manage the risks in various ways, including:
- Obtain seller/board approval of the transaction.
- Insist that there be an adequate mechanism to assure that the seller’s creditors are paid and that key creditor releases are obtained as a pre-condition to closing/completion.
- Escrow funds as source for payment to seller’s creditors or as holdback for any claims based on seller’s breach of representations/warranties or any seller indemnification obligations.
- Search applicable registers to determine creditors with liens against assets and obtain releases from such creditors as condition of closing/completion.
- Obtain a solvency opinion from third party expert, if appropriate.
- Consider representations and warranties from seller concerning solvency and prior bids for the assets.
- Obtain third party appraisal of assets and/or opinion that transaction is at “market value”.
- Determine which of seller’s employees, if any, are needed by buyer so that appropriate steps can be taken to retain their services.
- Obtain assignments of key contracts, including employee proprietary rights/confidentiality agreements and licenses (or assess likelihood of obtaining them after closing/completion).
- Consider third party guarantees (eg from founders, key shareholders and/or directors) as to indemnity or other seller obligations.
The prospect of purchasing assets from a troubled company at a discount can be tantalising. Nonetheless, a prudent buyer will assess the risks posed by such a transaction and take appropriate steps to mitigate those risks in a manner consistent with its objectives.