Editor: Please describe your practice areas. What has been your relationship with technology companies that are seeking assets of financially stressed or bankrupt companies?
Gilden: I have been practicing law with technology companies for approximately 25 years; for the last 13 years, together with Ernie. Our technology clients are based off-shore as well as in the United States. We have an active practice representing Israeli technology companies engaged in M&A and securities transactions in the United States.
Wechsler: While we both represent a number of technology companies, I am also active in representing a number of investment funds in M&A, distressed company investing and restructuring activities. Together with our Corporate Restructuring and Bankruptcy Department, our group has conducted 363 transactions on behalf of U.S.-based and offshore clients in the technology, manufacturing, financial services and many other industries, including representing the official committees of unsecured creditors with respect to the 363 sales of GM and Chrysler.
Editor: How has M&A activity evolved in the technology arena during this unprecedented period?
Gilden: We are seeing two parallel drivers. One is purchases of businesses before the "fire sale" where companies may acquire businesses with a strategic fit for prices which normally would be substantially more than today's prices. We have seen quite a few of those transactions, particularly where the acquirer has available cash. There are also other strategic transactions among tech companies where a more resilient and larger enterprise results. Because of the absence of leverage, the deals are dramatically different from a few years ago.
Editor: Are you seeing private equity funds active in buying 363 assets?
Wechsler: If you are in the business of doing M&A, which the private equity funds are, then you look at what the available product is - and in these economic times it's distressed companies. I do not think private equity funds are any more inclined than other buyers to favor 363, but this is the vehicle of choice for acquiring distressed companies.
Gilden: As a strategic buyer, we see private equity companies that have made an investment in a particular area seek to provide more bulk to a portfolio company, adding a related company to shore up the original investment.
Editor: How has the economic environment shaped the expectations of the parties and the dynamics of the transactions?
Gilden: There are a couple of dynamics. Obviously, the deal structures have to be modeled to take into account the current economic environment, and on the buyer side there is a particularly strong incentive and ability to drive down the price. On the other hand, on the seller side the inclination is to say "if we are selling at this price, I don't want any lingering liability. I want to cut the representations and warranties down, I want to walk away with whatever cash I can get and not have to worry about the future." There is a push back on the traditional warranties and indemnification provisions to limit the seller's exposure.
Editor: Why is Section 363 of the Bankruptcy Code a favorite means today for a technology company with cash to acquire viable assets of a bankrupt company? What advantages does Section 363 offer over a plan of reorganization from both a buyer's and seller's point of view?
Wechsler: If you look at a target that is in distress, there are basically three ways to try to buy it: (1) you can try to buy it before the company files; (2) you can buy its assets through a 363 sale post-filing; and (3) you can acquire it through a plan of reorganization which requires that the acquisition be part of the plan that the requisite percentage of creditors must approve. While the other two ways may be appropriate under certain circumstances, the 363 process has distinct advantages. First, if you acquire a distressed company pre-filing, you face the risk that other creditors will view the amount that you paid to be insufficient, resulting in a fraudulent conveyance. So the very thing that makes it an appealing acquisition - that it's being acquired at a bargain basement price - also makes it vulnerable to a fraudulent conveyance claim. When you buy assets under the 363 process, you basically get a court order that eliminates the risk of fraudulent conveyance claims, and otherwise stipulates that the assets are acquired free and clear of all liens and claims. A couple of other considerations: a 363 obviates the need for a target's shareholders to approve the deal and provides greater protection for the board.
The principal downside to a 363 as compared to purchasing the target pre-filing is that the 363 purchase contract is subject to better and higher offers under a court-approved auction process. In addition, relative to an acquisition of the target pre-filing, the 363 transaction is often more time-consuming and results in greater professional fees to navigate through the bankruptcy court.
The 363 is a much more surgical process, however, compared to acquiring the target through the plan of reorganization. In a 363 transaction, the buyer does not involve itself in all the issues dividing sale proceeds among the creditors, which is really the crux of a plan of reorganization. A strategic buyer is not really interested in how the assets are divided among creditors, but only with buying certain assets. The 363 can be done in as short a period as two to three months, whereas an acquisition through a plan of reorganization may take anywhere from three months (at best) to a year-plus. With the 363, compared to a plan process, there are significantly lower professional costs because you're not involved in the plan of reorganization process with intercreditor issues. Acquiring a target through the plan of reorganization is most often, and most effectively, done by distressed debt investors experienced at implementing so-called loan to own and other strategies to take control of the target. It is less likely to be the structure of choice for a strategic acquirer.
Editor: Why is there competition among buyers to be the "stalking horse" to set up the initial terms of the 363 transaction? What risks does the stalking horse undertake in laying out the first bid?
Wechsler: Being the stalking-horse bidder gives you the ability to set the terms of the transaction. For example, if you're buying a collection of assets from a large conglomerate, you, together with the target, can choose the group of assets that is going to be subject to the bid. Second, you often get more time for due diligence. In addition, if the stalking-horse bidder is outbid in the auction, it will typically be entitled to a break-up fee (in the area of three percent of the purchase price) and expense reimbursement. This offsets the cost of engaging in a transaction that does not close.
Editor: Assume you're buying the assets of one of the subsidiaries of a large conglomerate that is in bankruptcy: would the rest of the pieces of the conglomerate go through the regular bankruptcy procedure?
Wechsler: Correct. Assume the bankruptcy estate consists of businesses A, B and C, and you're buying business C. The estate of the bankrupt entity afterwards is A and B plus the cash that was paid for C. The 363 process traditionally had been used when only a piece of a business was purchased. More recently it has been used for the very quick purchase of substantially all the assets of the bankrupt entity. That started with Lehman and it continued with Chrysler and GM. There had been limitations to doing that kind of deal, especially as quickly as these deals have been done, but extreme economic conditions have caused the debtors to say, and for the court to agree, that there really is no alternative. If a deal for the entire business were not to be done quickly, the value of the business would go down significantly, and the creditors would be damaged.
Editor: Please describe the mechanism for bringing about such a transaction starting with the potential buyer and the DIP (Debtor-in-Possession) working together to commence a transaction.
Wechsler: Usually the initiative is with the target company, which is approaching bankruptcy or is in bankruptcy. The target, with the help of a financial advisor, comes up with a plan to maximize the value for the creditors - often by selling some or all of the business. So the target serves as an intermediary between the potential purchasers and the DIP provider. The DIP provider is mainly interested in having the assets sell quickly at a high price, since it is reimbursed first and in full. The buyer will negotiate a purchase agreement with the target. The DIP lender would review the agreement, focusing on pricing, the provisions of the purchase agreement that govern how the auction will be run for higher and better offers and conditions to closing. The DIP provider wants to see an efficient auction process. It wants to see an APA that has few conditions to closing that would offer an exit for the buyer.
Editor: What has your experience been in securing "free and clear" transfer of assets without some major adjustments in sales price or documentation?
Wechsler: Usually if you are purchasing a distressed company, the price will reflect the risk involved and the time and resources necessary to turn the target around. It is typical to have more limited representations and warranties in the purchase agreement and for there not to be any surviving indemnities post-closing. There are some limited circumstances whereby if there is a particular contingency which the buyer and seller cannot evaluate, they may set up an escrow for part of the sale proceeds.
Editor: There are certain conditions under which Section 363 does not work, i.e., where the value of the assets are insufficient to cover all liens. Are there any other means short of a reorganization by which creditors can realize on their assets?
Wechsler: It is correct that if the consideration doesn't cover the liens, then the lender that has those liens can object to the sale. But usually the lender will be realistic. If it's believed that the proposed sale is at the highest price that these assets can fetch, even if it doesn't cover the lender's lien, there is not a lot of incentive for the lender to ultimately block the sale. If the lender does object to the sale, there are still other provisions of the Code that would allow the target to argue for approval of the sale. At the end of the day the fact that the consideration does not cover the lien is not typically a bar to selling the business. Another way that secured lenders can realize on the collateral is to accelerate the loan and foreclose on the collateral. If there is a real risk of this foreclosure occurring, the company would typically seek protection by filing for bankruptcy. Once a company files, there is an automatic stay on all the actions that creditors can take against the company, including realizing on the collateral. Filing enables the company to maximize the value for all creditors on a more orderly basis.
Editor: What has your experience been with cross-border interest in purchasing assets of distressed tech/telecom companies?
Gilden: We have been representing foreign companies that are in the 363 process but we have also been representing U.S. companies looking at similar transactions in Europe and elsewhere. Interestingly, one of our clients did a 363 and turned around literally the next month trying to do the same type of transaction in France, but encountered a severe educational shock. Like American executives, foreign executives have difficulty understanding the 363 process. Every country is a completely different learning experience. The 363 formula we have developed in the U.S. is probably the most time-tested and easily accessed set of rules anywhere in the world.