Distressed M&A: Article 9 Secured Party Sales
Corporate & Finance Alert
December 16, 2008
As the result of the frozen credit market and economic meltdown, many companies with an otherwise sound business model are in financial distress to the point where a sale of the company is the only viable alternative. These M&A opportunities are beginning to emerge for strategic and financial buyers knowledgeable in the fast paced distressed company M&A market. This article will discuss the M&A strategy of a secured party sale of a distressed company under Article 9 of the Uniform Commercial Code and its advantages and disadvantages.
Currently, debtor in possession financing is difficult to obtain and a distressed company may not be able to finance a bankruptcy reorganization sale. As an alternative to a costly and court managed bankruptcy sale, a secured creditor, in cooperation with a buyer, may arrange a sale of a business under Article 9 of the Uniform Code. The major advantages of an Article 9 sale is the simplicity of the process, the speed at which such a sale can be accomplished and the relative lack of expense involved. Indeed, absent opposition by the debtor or a junior lien holder, an Article 9 sale will not involve judicial proceedings and the risk, delays and expenses that accompany litigation.
The basic requirements for a successful Article 9 sale are timely notice to interested parties and the conduct of the sale in a “commercially reasonable” manner. The secured creditor, or an auctioneer or other sales professional, conducts the sale. The sale need not be approved or confirmed by court action. However, Article 9 mandates that all aspects of a sale–method, manner, time, place and other terms-must be commercially reasonable. A sale is generally commercially reasonable if it is conducted (i) in the usual manner on any recognized market, (ii) at the price current in any recognized market at the time of the sale, or (iii) otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the sale. By contrast, if it can be demonstrated that any aspect of the sale led to a reduction in the value of the assets sold, the sale may be challenged as not deemed commercially reasonable.
The trigger for an Article 9 sale is the debtor’s default on its obligations to the secured creditor. Once the secured party has taken default action required by its credit agreements with the debtor, it may proceed to a sale of assets representing the collateral under the secured party’s credit agreement. Often this decision is made with the cooperation of an interested strategic or financial buyer who will participate in the sale. The secured creditor must elect whether the sale will be a public sale or a private sale with a decision made based on the recommendation of a sales professional with experience in the relevant industry to ensure commercial reasonableness and maximum value.
If a secured creditor elects a public sale, the sale should be properly advertised to ensure a meaningful opportunity for competitive bidding. The sale may be by one or more contracts, as a unit or in parcels. If the secured creditor has arranged with a buyer to sell the debtor’s business (and, therefore, all or substantially all of its assets), a single contract for the sale of the assets as a unit is used, subject to possible higher bids. The following persons are entitled to a notice of the proposed Article 9 sale: (i) the debtor; (ii) any guarantor or surety of the debtor’s obligations to the secured; and (iii) any holder of liens on the debtor’s property that are junior to the secured creditor’s lien. The parties entitled to notice of an Article 9 sale are entitled to reasonably timely notice of the sale generally at least ten (10) days before the sale. The Article 9 notice of sale will include: (i) the identity the debtor; (ii) a description of the collateral that is the subject of the sale; (iii) the manner in which the collateral will be sold (public or private); (iv) that the debtor is entitled to an accounting of the unpaid indebtedness; (v) the time and place of a public sale or the date after which a private sale can be made. The purpose of the notice is to provide parties in interest with timely notice of the sale to take action to protect their interests in the debtor’s assets. For example, a junior creditor may elect to bid at a public sale or, alternatively, the debtor, a guarantor or a junior lien holder may seek to enjoin the sale on the basis that it is not being conducted in a commercially reasonable manner or that the party’s interest are prejudiced in some way by the conduct of the proposed sale.
The sale proceeds of an Article 9 sale are applied: (i) to reasonable expenses incurred in connection with retaking, holding and preparing the collateral for sale, as well as the reasonable costs of the sale; (ii) payment of the claim of the secured creditor conducting the sale; and (iii) to the payment of junior lien claims. If there are excess sale proceeds, the secured creditor must account for and pay them over to the debtor. Typically, the secured creditor initiating the sale will reach compromises and settlements with senior lien holders before the Article 9 sale in cooperation with a targeted buyer to ensure that assets being sold are sold free and clear of liens or subject to the debt of the senior lien holder. Upon the conclusion of an Article 9 sale, the secured creditor delivers a transfer statement to a buyer that, inter alia, (i) gives notice of the debtor’s default, (ii) states that the secured creditor has exercised its post default remedies; (iii) states that by reason of the secured creditor’s exercise of its post-default rights the buyer has acquired the debtor’s rights in the assets. The delivery of this notice, after a properly conducted Article 9 sale, vests the buyer with all of the debtor’s rights in the assets.
An Article 9 sale may be a very simple means of disposing of collateral expeditiously. Assuming that junior lien holders, the debtors or guarantors do not obtain an injunction of the sale, the process could easily take place within sixty (60) days after default by the debtor under its credit agreement with the secured party. The Article 9 sale process is significantly less expensive than a judicial foreclosure of the secured party’s security interests in the assets or the sale of assets in a bankruptcy supervised sale.
A smooth Article 9 sale is dependent on either the affirmative cooperation and consent by the debtor (who may allow the sale to be held on its premises) any senior secured creditors and the prospective buyer. A distressed company with a complex debt structure (i.e., the large number of secured creditors and junior creditor constituencies) may increase the risk of objections to the Article 9 sale, thereby impacting the most important benefits of an Article 9 sale, namely, speed. Further, certain assets not covered by the secured party’s lien (for example, real estate leases, foreign assets, bank accounts, etc.) may require a separate agreement with the debtor or third parties to transfer all assets necessary for the buyer to conduct the debtor’s business. Nevertheless, properly planned and structured, secured creditors and potential buyers should consider an Article 9 sale as a viable M&A strategy for a distressed company under the appropriate circumstances.