Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Restructuring & Insolvency, November 2010
Credit bidding allows a secured creditor to use its debt as currency in a competitive sales process. The traditional court-supervised sales process in proceedings under the Companies' Creditors Arrangement Act (CCAA) contemplated the solicitation of offers for a debtor's business, with all offers to be submitted by a court-prescribed deadline. The debtor and/or its court appointed monitor would then select the highest and best offer among those bidders that submitted offers by the deadline and otherwise complied with the terms of the sales process. The traditional sales process provided no opportunity for potential purchasers to submit overbids at a later date.
In recent years, the U.S. stalking horse method has been widely adopted in Canada, particularly in connection with cross-border sales. The stalking horse process contemplates that an agreement of purchase and sale will be executed at, or near, the commencement of the marketing process, and this stalking horse agreement will serve to establish a floor price, while higher and better offers are solicited. If other "qualifying offers" are received in accordance with court-approved bidding procedures, an auction is then held to determine the winner among the qualifying bidders. The stalking horse, as of right, is entitled to participate in any auction.
In September 2009, the CCAA was amended to expressly authorize a court to approve the sale of assets, outside the ordinary course of business. Prior to the enactment of new section 36 of the CCAA, the sales processes, described above, were approved by courts pursuant to their inherent jurisdiction and/or discretionary authority. Section 36 now codifies that authority and directs a court to consider a list of non exhaustive factors, prior to approving a sale. At the top of the list of factors is whether "the process leading to the proposed sale or disposition was reasonable in the circumstances". Accordingly, in the post-amendment world, the sales process and its integrity will remain at the forefront at the court's judicial mind.
If one of the bidders in any such process is a secured creditor of the seller, such creditor may seek to satisfy the purchase price by giving the seller a credit against the amounts that are owing to the creditor. Unlike Chapter 11 of the U.S. Bankruptcy Code, the CCAA does not expressly provide secured creditors the right to credit bid their debt in this manner. The practice, however, has been widely accepted in Canadian insolvency proceedings. The theory behind credit bidding is that if the secured creditor paid cash for the assets, the cash would then be distributed to the secured creditor to satisfy its secured claim. Instead of recycling funds in this manner, the secured creditor should be allowed to simply bid its debt, up to its face value. To the extent there are liens or charges that rank in priority to the credit bidder's security interest (or if there are any assets to be purchased not subject to the credit bidder's security), a cash component will have to be included in the bid. Cash payments would also have to be made to cover any accrued but unpaid post-filing payables or cure costs payable in connection with the forced assignment of contracts.
Creditors consider making a credit bid for three principal reasons:
- Creditors can put forward a credit bid as the culmination of a long-term "loan to own" strategy;
- Creditors can own and operate the business for an interim period of stabilization, outside of formal insolvency proceedings, with a view to selling the business for a higher recovery when market conditions improve; and
- Creditors can put forward a credit bid as a stalking horse or reserve bid, with a view to encouraging higher bids in an auction environment or to owning the business if no such higher value materializes.
- "Loan to own". A "loan to own" strategy involves the tactical deployment of capital with a view to converting debt into an equity position in a distressed company. The primary candidates to pursue this strategy are hedge funds, private equity sponsors and other providers of private capital which, in many spheres, have replaced traditional cash flow lenders as the principal providers of commercial capital. These funds are often able to acquire secured debt in the secondary market on a discounted basis and then bid the full face value of the debt as part of a credit bid. This strategy allows them to maximize the financial leverage in an economically efficient manner. Although there are obvious risks in acquiring debt that may never be repaid, these private equity investors have a far greater appetite for commercial risk in the pursuit of potentially lucrative acquisition opportunities, than their predecessors.
- Stabilization. Other credit bids develop not out of design from the outset of the loan or acquisition of the debt, but from a perceived necessity in the face of a distressed credit. Many corporate debtors have debt structures that were put in place at the height of the previous business cycle. Debtors fitting this profile often include the portfolio companies of private equity funds. Typically, the assets of the portfolio company itself were used to secure a substantial amount of the acquisition financing. Thus, these companies are carrying a heavy secured debt burden of acquisition financing in addition to traditional working capital loans. With the turn of the business cycle, asset values in many industries have collapsed and revenue has decreased significantly. Accordingly, a business, although viable and potentially profitable, might be distressed because of unsustainable secured debt levels.
If such a business was sold to a third party in the current economic environment, the lender may be facing an immediate and unacceptable loss. The preferable alternative may be for the lender to acquire the assets of the business, rationalize its debt structure, hold for a period of stabilization and recovery, and then sell the business in a more favourable economic climate. In circumstances such as these, credit bidding can be used defensively, to protect and preserve value, if only for a finite amount of time.
- Reserve Bid. In yet other circumstances, a lender may have identified a level of recovery on the debt owed to it by a distressed debtor that represents an acceptable loss. Below that amount, however, the lender would prefer to adopt the strategy outlined above: hold the assets and sell at a later time. In light of the alternatives, a creditor may be willing to bid its debt, or some portion thereof, in order to establish a baseline value for the business in an auction process. This initial salvo may be necessary to give customers and other stakeholders of the distressed business confidence that the lender supports the business and will continue to operate the business if it is the successful bidder, while at the same time creating a competitive environment to encourage higher bids. In other words, credit bidding allows a lender to establish itself as a stalking horse and open the bidding by delineating a threshold value for the debtor's assets.
Whatever the motive of the creditor, the credit bid must be put forward in a process that is fair and transparent, and that demonstrates that the appropriate value has been given for the business and that the credit bidder did not assert any undue influence or control over a process through which it seeks to benefit.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.