A Strategic Method of Acquiring Distressed Assets
By: Laurence M. Smith
The following article was submitted for publication in the June 7, 2010 issue of Bank and Lender
Liability.
The following article was submitted for publication in the June 7, 2010 issue of Bank and Lender
Liability.
The economic downturn that commenced in 2008 and, in many industries, continues
today has sounded the death knell for weak or over-leveraged companies, while at the same
time presenting opportunities for buyers. If your company is a strategic buyer involved in the
target company's industry or a financial buyer without any industry-related experience, what is
the preferred means of acquiring the assets of a target that is in financial distress?
today has sounded the death knell for weak or over-leveraged companies, while at the same
time presenting opportunities for buyers. If your company is a strategic buyer involved in the
target company's industry or a financial buyer without any industry-related experience, what is
the preferred means of acquiring the assets of a target that is in financial distress?
For myriad
reasons, a secured party transaction under Article 9 of the Uniform Commercial Code (the
“UCC”) may be the acquisition method of choice.
An Article 9 secured party transaction is an out-of-court process by which a secured
lender realizes on its lien encumbering the borrower’s personal property assets and thereby
effectuates a transfer of title to those assets. The transfer may be to a third-party purchaser
through a public or private disposition—known as a secured party sale—or the transfer may be
to the secured party itself who retains the collateral in full or partial satisfaction of the underlying
indebtedness—known as a strict foreclosure.1 Common features of each method of disposition
are that (1) there is no operative agreement with the target company which, along with its
principals is peripheral to the process and (2) the transfer of assets can often be completed
within 30 days, without the scrutiny of a bankruptcy court or creditors’ committee or the publicity
and cost attendant to sales under Section 363 of the bankruptcy code.
reasons, a secured party transaction under Article 9 of the Uniform Commercial Code (the
“UCC”) may be the acquisition method of choice.
An Article 9 secured party transaction is an out-of-court process by which a secured
lender realizes on its lien encumbering the borrower’s personal property assets and thereby
effectuates a transfer of title to those assets. The transfer may be to a third-party purchaser
through a public or private disposition—known as a secured party sale—or the transfer may be
to the secured party itself who retains the collateral in full or partial satisfaction of the underlying
indebtedness—known as a strict foreclosure.1 Common features of each method of disposition
are that (1) there is no operative agreement with the target company which, along with its
principals is peripheral to the process and (2) the transfer of assets can often be completed
within 30 days, without the scrutiny of a bankruptcy court or creditors’ committee or the publicity
and cost attendant to sales under Section 363 of the bankruptcy code.
While not affording all of
the protections of a sale order entered by a bankruptcy court, a secured party transaction
results in the termination of the senior lien that is being foreclosed, as well as the termination of
all subordinate liens2; title to the assets being acquired are thus cleansed as part of the process.
Moreover, as the secured party who holds the first, paramount lien on the debtor’s assets often
does not receive payment in full, the risk that an unsecured creditor will attempt to challenge the
process as a fraudulent transfer or otherwise is usually not great, due to the realization that any
recovery would first inure to the benefit of the secured lender before any such funds are
available to satisfy unsecured claims.
the protections of a sale order entered by a bankruptcy court, a secured party transaction
results in the termination of the senior lien that is being foreclosed, as well as the termination of
all subordinate liens2; title to the assets being acquired are thus cleansed as part of the process.
Moreover, as the secured party who holds the first, paramount lien on the debtor’s assets often
does not receive payment in full, the risk that an unsecured creditor will attempt to challenge the
process as a fraudulent transfer or otherwise is usually not great, due to the realization that any
recovery would first inure to the benefit of the secured lender before any such funds are
available to satisfy unsecured claims.
The absence in a secured party transaction of a definitive purchase agreement with the
target company is logical but, at the same time, presents challenges. As neither the company
nor its equity holders are likely to receive any of the proceeds resulting from a disposition of the
company’s assets, they are not the principal stakeholders in the transaction; the secured lender
is.
target company is logical but, at the same time, presents challenges. As neither the company
nor its equity holders are likely to receive any of the proceeds resulting from a disposition of the
company’s assets, they are not the principal stakeholders in the transaction; the secured lender
is.
Thus, the incentives for a company and its principals to negotiate an asset purchase
agreement in good faith, with an acceptable level of responsiveness and truthfulness, are
lacking, as is their willingness or financial wherewithal to provide adequate indemnification to
the buyer. Rare are the situations in which the time and cost of negotiating an asset purchase
agreement directly with a failing company are justified by the protections garnered by the
purchaser in the process.
agreement in good faith, with an acceptable level of responsiveness and truthfulness, are
lacking, as is their willingness or financial wherewithal to provide adequate indemnification to
the buyer. Rare are the situations in which the time and cost of negotiating an asset purchase
agreement directly with a failing company are justified by the protections garnered by the
purchaser in the process.
A secured party transaction, therefore, redirects the primary
negotiations away from the debtor and toward the secured lender.
But the secured lender’s knowledge of the debtor company and its operations is not coextensive with the knowledge of the company’s principals. Further, in the context of a secured
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party disposition and the agreements by which it is memorialized, the foreclosing lender will
make few, if any, representations about the company itself, with affirmative representations
being limited to the secured indebtedness that is the basis for the disposition. How can this
knowledge gap be bridged? How can the purchaser—and, in particular, a financial purchaser,
who may have limited familiarity with the industry in question—obtain the relevant information
and assistance that is critical to resuscitating the failed business? The answers to these
questions underscore the interdisciplinary nature of making acquisitions through secured party
transactions.
negotiations away from the debtor and toward the secured lender.
But the secured lender’s knowledge of the debtor company and its operations is not coextensive with the knowledge of the company’s principals. Further, in the context of a secured
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party disposition and the agreements by which it is memorialized, the foreclosing lender will
make few, if any, representations about the company itself, with affirmative representations
being limited to the secured indebtedness that is the basis for the disposition. How can this
knowledge gap be bridged? How can the purchaser—and, in particular, a financial purchaser,
who may have limited familiarity with the industry in question—obtain the relevant information
and assistance that is critical to resuscitating the failed business? The answers to these
questions underscore the interdisciplinary nature of making acquisitions through secured party
transactions.
That an expertise in Article 9 of the UCC is a prerequisite to navigate a secured party
transaction successfully should be apparent: essential to the process are performing due
diligence to ensure that the lender has a first priority lien; eliciting representations and
warranties to confirm that the lender has not transferred, encumbered or otherwise
compromised the rights that are the predicate to the secured party transaction; verifying that
landlord liens have been subordinated and the landlord has granted a right of entry that will
allow the removal of tangible collateral from the target’s facility; monitoring or, perhaps, directing
the sale process to ensure that all facets are commercially reasonable and in compliance with
statutory requirements3; and ascertaining impediments to the purchaser acquiring all critical
assets due to the limited nature of the secured lender’s lien or the scope of coverage of Article
9. However, mastery of Article 9 of the UCC must be supplemented by an expertise in merger
and acquisition (“M&A”) transactions: the former enables the purchaser to acquire the target
company’s assets for the agreed-upon consideration, while the latter facilitates the rebuilding of
the business with minimal disruption, cost and delay.
transaction successfully should be apparent: essential to the process are performing due
diligence to ensure that the lender has a first priority lien; eliciting representations and
warranties to confirm that the lender has not transferred, encumbered or otherwise
compromised the rights that are the predicate to the secured party transaction; verifying that
landlord liens have been subordinated and the landlord has granted a right of entry that will
allow the removal of tangible collateral from the target’s facility; monitoring or, perhaps, directing
the sale process to ensure that all facets are commercially reasonable and in compliance with
statutory requirements3; and ascertaining impediments to the purchaser acquiring all critical
assets due to the limited nature of the secured lender’s lien or the scope of coverage of Article
9. However, mastery of Article 9 of the UCC must be supplemented by an expertise in merger
and acquisition (“M&A”) transactions: the former enables the purchaser to acquire the target
company’s assets for the agreed-upon consideration, while the latter facilitates the rebuilding of
the business with minimal disruption, cost and delay.
What are the M&A considerations that must be addressed in parallel with, and inform, a
secured party transaction? Knowing what sales, technical, financial and other personnel are key
to ongoing business operations is usually of paramount importance; assistance from the debtor
an entity may be required to identify and negotiate retention agreements with these individuals,
some or all of whom may be owed back pay, as well as unused vacation and sick pay, may not
be subject to restrictive covenant agreements, and may be principals of the company whose
egos have been wounded and whose equity has been rendered worthless. Are there critical
vendors--such as utility companies, licensors, franchisors or suppliers of raw materials—whose
claims will have to be satisfied in order to induce them to continue doing business with the
purchaser? If the resuscitated business will be operated from the same location as the failed
company, a new lease or an assignment of the existing lease will have to be negotiated with the
landlord, which in many cases is a real estate holding company owned by the same principals
who control the operating company that has failed. To capture the goodwill associated with the
debtor’s business, the purchaser may want the rights to the name under which the debtor has
conducted business; that, in turn, will require the debtor to abandon that name by amending its
constitutional documents. Transitioning the business to the purchaser may also require
negotiating with unionized workers, complying with environmental or health and safety laws
applicable to the operations, and obtaining third-party consents from customers, vendors or
regulatory authorities.
secured party transaction? Knowing what sales, technical, financial and other personnel are key
to ongoing business operations is usually of paramount importance; assistance from the debtor
an entity may be required to identify and negotiate retention agreements with these individuals,
some or all of whom may be owed back pay, as well as unused vacation and sick pay, may not
be subject to restrictive covenant agreements, and may be principals of the company whose
egos have been wounded and whose equity has been rendered worthless. Are there critical
vendors--such as utility companies, licensors, franchisors or suppliers of raw materials—whose
claims will have to be satisfied in order to induce them to continue doing business with the
purchaser? If the resuscitated business will be operated from the same location as the failed
company, a new lease or an assignment of the existing lease will have to be negotiated with the
landlord, which in many cases is a real estate holding company owned by the same principals
who control the operating company that has failed. To capture the goodwill associated with the
debtor’s business, the purchaser may want the rights to the name under which the debtor has
conducted business; that, in turn, will require the debtor to abandon that name by amending its
constitutional documents. Transitioning the business to the purchaser may also require
negotiating with unionized workers, complying with environmental or health and safety laws
applicable to the operations, and obtaining third-party consents from customers, vendors or
regulatory authorities.
Analysis of these M&A considerations leads ineluctably to the conclusion that help from
the debtor’s principals will be required in order to effectuate a seamless transfer of the business
by means of a secured party transaction. How can that assistance be assured? While the equity
in the debtor company will likely be wiped out, the principals of the debtor company can be
compensated for their assistance through consulting arrangements, employment agreements
or, perhaps, an equity stake in the purchaser. Additionally, the principals of closely held
companies are often required to personally guarantee the corporate debt. Another inducement
2
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for the principals to cooperate is a promise that their personal guaranties will be limited in
amount or forgiven entirely, if the secured party transaction is consummated without delay or
challenge by the debtor or its principals. Relief from the specter of financial ruin and personal
bankruptcy that could result from a suit on a personal guaranty may, alone, be adequate
incentive to obtain full cooperation from the debtor’s principals.
The willingness to pay for the cooperation of the debtor’s principals, or to argue on their
behalf to obtain a release of personal guaranties, must be tempered by the realization that all
benefits flowing to those principals are likely to be scrutinized carefully and engender
resentment. A secured lender with a first position, blanket lien on the company’s assets, who is
not getting paid in full, will understandably oppose above-market compensation arrangements
with the debtor’s principals or their receipt of a substantial equity interest in the purchaser.
Conferring excessive benefits upon the principals may imperil the deal or, at a minimum,
heighten the level of adversity with the secured lender, a meaningful concern if that same lender
is providing financing to the purchaser to fund the acquisition. Similarly, if junior secured
creditors or unsecured creditors become aware that excessive consideration is being paid to the
debtor’s principals, they are likely to object and may be emboldened to challenge the Article 9
transaction on that basis. The argument advanced by those creditors would be that
consideration that should have flowed to the debtor for the benefit of its creditors has been
mischaracterized and diverted to the equity holders of the debtor. Striking the proper balance—
between securing the cooperation of the debtor’s principals and not inflaming creditors whose
claims will not be paid in full—requires finesse, experience and an appreciation of the
competing concerns of all parties involved.
the debtor’s principals will be required in order to effectuate a seamless transfer of the business
by means of a secured party transaction. How can that assistance be assured? While the equity
in the debtor company will likely be wiped out, the principals of the debtor company can be
compensated for their assistance through consulting arrangements, employment agreements
or, perhaps, an equity stake in the purchaser. Additionally, the principals of closely held
companies are often required to personally guarantee the corporate debt. Another inducement
2
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for the principals to cooperate is a promise that their personal guaranties will be limited in
amount or forgiven entirely, if the secured party transaction is consummated without delay or
challenge by the debtor or its principals. Relief from the specter of financial ruin and personal
bankruptcy that could result from a suit on a personal guaranty may, alone, be adequate
incentive to obtain full cooperation from the debtor’s principals.
The willingness to pay for the cooperation of the debtor’s principals, or to argue on their
behalf to obtain a release of personal guaranties, must be tempered by the realization that all
benefits flowing to those principals are likely to be scrutinized carefully and engender
resentment. A secured lender with a first position, blanket lien on the company’s assets, who is
not getting paid in full, will understandably oppose above-market compensation arrangements
with the debtor’s principals or their receipt of a substantial equity interest in the purchaser.
Conferring excessive benefits upon the principals may imperil the deal or, at a minimum,
heighten the level of adversity with the secured lender, a meaningful concern if that same lender
is providing financing to the purchaser to fund the acquisition. Similarly, if junior secured
creditors or unsecured creditors become aware that excessive consideration is being paid to the
debtor’s principals, they are likely to object and may be emboldened to challenge the Article 9
transaction on that basis. The argument advanced by those creditors would be that
consideration that should have flowed to the debtor for the benefit of its creditors has been
mischaracterized and diverted to the equity holders of the debtor. Striking the proper balance—
between securing the cooperation of the debtor’s principals and not inflaming creditors whose
claims will not be paid in full—requires finesse, experience and an appreciation of the
competing concerns of all parties involved.
CONCLUSION
Successfully acquiring a target company by means of a secured party transaction is in
many ways akin to a game of chess. It requires knowledge of the applicable rules and the
adoption at the outset of an overall strategy, one that takes account of the various stakeholders,
anticipates the offensive and defensive moves each is likely to make and focuses on the result
to be achieved within the allotted time frame. Unlike a chess match, however, a secured party
transaction may involve the intervention of third parties whose nexus is minor but who,
nonetheless, have the potential to frustrate or delay consummation of the acquisition, unless
they can be neutralized or their concerns addressed.
1 U.C.C. §§ 9-610 and 9-620
2 U.C.C. § 9-617
3 See U.C.C. § 9-610(b)
GET OUT OF DEBT NOW! http://www.newdebtelimination.com
Successfully acquiring a target company by means of a secured party transaction is in
many ways akin to a game of chess. It requires knowledge of the applicable rules and the
adoption at the outset of an overall strategy, one that takes account of the various stakeholders,
anticipates the offensive and defensive moves each is likely to make and focuses on the result
to be achieved within the allotted time frame. Unlike a chess match, however, a secured party
transaction may involve the intervention of third parties whose nexus is minor but who,
nonetheless, have the potential to frustrate or delay consummation of the acquisition, unless
they can be neutralized or their concerns addressed.
1 U.C.C. §§ 9-610 and 9-620
2 U.C.C. § 9-617
3 See U.C.C. § 9-610(b)
GET OUT OF DEBT NOW! http://www.newdebtelimination.com
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