Distressed M&A Forecast: A Mix of Sun and Clouds

Mathieu: Hi, I’m Mathieu Rompré.

Peggy: And I’m Peggy Moss. This is the Continuity podcast. Since the beginning of this podcast series, we’ve tried to look at the bright side.

Mathieu: It’s true. After all, not everything is doomed because of the pandemic. It all depends on your perspective. There’s sun after the rain, and as Yogi Berra would say, it ain’t over until it’s over.

Peggy: Hm-hm. When things go south, businesses have to look at their options, which may include solutions like refinancing, restructuring or selling.

Mathieu: As we always say, a friend in need is a friend indeed.

Peggy: Okay, Mathieu, cut it out. What’s going on? Are you uncomfortable because of today’s topic? You don’t want to talk about distressed M&A?

Mathieu: Me? What? No! Not at all! Why would you say that? It’s important, you know. It takes two to tango…. Ugh. I think I’m lost in my metaphors.

Peggy: Yeah, I think that’s right. Today, we dive into complex decisions for challenging times, and to do that, we’re joined by two seasoned M&A partners who aren’t afraid, unlike my co-host, to call a cat, a cat.

Mathieu: We welcome on this episode Chris Burr of Toronto and Olga Kary of Calgary.

Peggy: Chris, we’re in an unprecedented moment from an economic standpoint. What are you talking to clients about in terms of M&A?

Chris: Yeah, thanks, Peggy. And, you know, to call it unprecedented is really to put your finger on it. There’s a feeling across the board that everyone knows that this is different, that something is going on, and we’ve got this incredible amount of artificial life support for companies in the form of the wage subsidy, other stimulus packages and incentives, and it’s creating these what have been called zombie companies that are effectively getting by on what the government has been doing in order to keep them getting by. So, these programs are working. They’re doing what they’re designed to do, but they’re inevitably going to come to an end, and so the feeling in the conversations that we’re having is really about what’s going to happen when these programs do come to an end and that these companies who have been hanging on are forced into whatever comes next.

And it’s funny, you know, those listeners who were in Toronto this weekend, there [were] storm clouds and storms predicted for the entire weekend. It was supposed to rain and thunder and lighting from Friday all the way to Sunday, and it didn’t. Friday was relatively clear, and then part of Saturday was clear, but there [were] clouds in the sky, and they were getting sort of darker and thicker. And then on Sunday, everything sort of hit at the same time, and there was just this massive cloud burst, and the streets were running like rivers. And that’s really the feeling that we’re having now, which is that, you know, something should have happened by now, but it hasn’t, but it’s got to be a question of not “if” but “when.”

And against that backdrop, the kinds of questions we’re getting, the kinds of conversations we’re having, are really in the nature of clients wanting to get prepared. So, [these are] organizations who may be directly affected by this who are wanting to know, you know, what are their options, what kind of opportunities can be created through a distressed M&A process, potentially a court-supervised process, what’s out there to help once these clouds do break.

And we’re also getting the same types of questions from the other side, and that’s organizations who maybe have some cash and are engaged in looking for opportunities on the other side.

So, as much as it’s sort of a storm on the horizon, it really, you know ― the name of the game, I think, is opportunity, irrespective of which side of the equation that you’re on. And, so, what we’re seeing is clients from across the board and from all across various different sectors trying to really make sure their teams are properly prepared to hit the ground running when the inevitable strikes and something needs to actually get done, and that’s really been the bulk of the conversations for the last few months.

Peggy: So, if a business is considering an acquisition or a divestment in this climate at the moment, what should they anticipate?

Chris: So, there’s two things, I think, that really differentiate a distressed M&A process from a conventional M&A process that clients may be more used to. The first is the speed, and the second is the involvement and the role that the court will play in any process that’s being run through an insolvency regime.

So, the speed, I think, is fair to say considerably increased. Often, that’s by necessity, because if the vendor is in some kind of an insolvency proceeding and undergoing some kind of M&A process inside of that proceeding, by definition it’s insolvent, it’s got liquidity problems, and so it doesn’t have the luxury to support itself and to continue in the ordinary course for six months while suitors kick the tires, go through data rooms and undertake the same kind of diligence that they would do in a conventional setting.

But overlaid on top of that is the involvement of the court, and what we’re able to do using the court is to really fix and solve for all of the different things that would be in a conventional transaction, but that there isn’t time for. So, for example, in a conventional transaction, you’d see extensive representations and warranties. The vendor would give a representation that it owned the assets that were being sold, that there were no claims against those assets by other parties, that there were no encumbrances charged against those assets. You’d get all that through the contract. Well, in a distressed scenario, often times there isn’t going to be a vendor at the end of the transaction. Especially, if it’s a going-concern sale of all of the assets of the company. There’s just nobody left to stand behind those representations. So, they effectively become worthless on the day of closing.

So, what the role of the court can do in that scenario is step in and, effectively, by court order, a judge just decrees all of those types of things that would ordinarily be represented and warranted. So, for example, the court will say that these assets were owned outright by the vendor and that they have been transferred free and clear of any charges or encumbrances to the purchaser. That gets you, in fact, a better result than you would get if you had been doing a conventional transaction because now you’ve got a court order that can be registered against title, and it solves for all of that.

And that’s a regimen, an approach to the transaction that is unavailable in a conventional setting where the parties are not insolvent but that can really be an asset to both vendors and for purchasers in a court supervised scenario, because there may be assets that in a conventional scenario just couldn’t be sold. Well, the court can fix that.

So, if you’re a vendor, this is a great opportunity to maybe move some of those assets that you couldn’t otherwise transact. Similarly, it’s a great opportunity if you’re a purchaser. You’ve got some cash. You want to go out into the market, and you can quickly, and with the benefit of a court order, start looking at picking up some of those assets that may have been out there that you’ve had your eye on for some time but the time just wasn’t right to move on them.

And our expectation is that, as the clouds burst, and as the inevitable comes, we’re going to see a huge uptick in those types of proceedings, and that opportunity is going to be created for both sides of the equation.

Mathieu: Olga, what are you advising clients to look out for in terms of considerations from a securities M&A perspective?

Olga: Thank you, Mathieu. One of the key characteristics of distressed M&A is the accelerated timing of any such transaction. In this regard, we remind clients that understanding applicable deadlines is key both from structuring and execution perspective and both in context of public and private M&A.

In terms of structuring, for example, it would be common for a distressed M&A transaction to be subject to court and stakeholder approvals with associated statutory and, potentially, at times, contractual procedural timelines. Identifying required approvals is important, and some but not all of such timelines can be truncated. Requirement for any regulatory approvals, for example, under the Competition Act or Investment Canada Act will also impact timing and will need to be considered.

Another differing characteristic is the greater number of stakeholders involved. In addition to typical equity holders, these often include lenders and holders of various types of debt, management, employees, supplies and so forth. Understanding each stakeholder’s rights and economic interests is critical in structuring a transaction.

As there is a high risk of litigation in a distressed M&A context, evaluating the risk and scope of potential litigation actions available to various stakeholders, including pursuant to corporate oppression remedies, is also important.

Notwithstanding some of the differences just noted, and there’s many more, we often remind clients that some pertinent transaction considerations remain unchanged. For example, directors’ duties to act in the best interest of a target corporation do not change in this context. While directors may consider interests of their stakeholders and the impact of the transaction on each group, the board’s duty remains unchanged, and it is to act in the best interest of the corporation.

Mathieu: What are some of the issues your clients, and maybe more so out West, because you are talking to us from Calgary, what are the key issues your clients are bringing to you?

Olga: We often come across companies seeking to utilize corporate arrangements in lieu of an insolvency or bankruptcy proceeding to complete a sale transaction, mostly due to the negative stigma associated toward the latter, and this is, sort of, across the country and not just characteristic of Western transactions.

And one of the considerations with a corporate arrangement is the degree of financial distress of the arranged company, as some Canadian jurisdictions have an express solvency requirement for a corporation to proceed with an arrangement. The jurisprudence has evolved such that for as long as the entity emerging from the arrangement is solvent, such requirement is considered to be satisfied. That said, in certain transactions, this may not be viable, and additional structuring considerations, for example, as continuance of the company into a jurisdiction with no solvency requirement, may be needed.

We also see clients approaching us with and expressing the need for greater flexibility in terms of structuring a transaction that could pivot from a corporate arrangement as the initial transaction to, for example, an insolvency proceeding under CCAA [Companies’ Creditors Arrangement Act] in case an arrangement cannot be implemented in cases, for example, due to lack of a requisite board or stakeholder approval. In these circumstances, parties will need to ensure that transaction documents adequately address the structures, both structures, including the triggering events to transition from one to another.

In addition, we also have come across distressed companies facing resignations by the board directors, which, in some cases, challenges the ability of such companies to complete a sale transaction more specifically and to comply with various corporate and securities requirements more generally. There’s a number of ways to address such situation, including by providing for adequate indemnities by entities that are not facing insolvency and bankruptcy.

Mathieu: Olga Kary, thank you. And thank you, also, Chris Burr.

Peggy: It’s helpful to think about the life cycles of businesses. They’re kind of like humans.

Mathieu: Yes, that’s right. But in many ways, a business is more like a phoenix than a human, as they can have many lives. In fact, that makes them more like cats.

Mathieu: Listeners, thank you for joining us, and remember a podcast doesn’t equal legal advice. Those are two very different things.

Peggy: Until next time, stay well and stay safe.