Originally published in Blakes Bulletin on Business Law, October 2007
The casualties of the current market turbulence will bring about a next wave of mergers and acquisitions opportunities in the form of distressed M&A. How many and what kinds of distressed M&A opportunities arise will be dependent on how long the current credit crunch lasts and how far into the economy it spreads.
This next wave of distressed M&A activity will be different in nature and scope. There are new main players and different rules of the game. Those who are able to understand and navigate the new rules of the game in the distressed environment will be strategically better placed to respond to these opportunities as they arise.
The relentless demand of financial buyers for investment opportunities and the abundance of cheap credit have fuelled record M&A activity over the last few years. During this time, distressed investors have had relatively few opportunities. Funds specializing in distressed investing have been quietly bulking up their insolvency expertise and war chests in preparation for a correction. Markets are sending conflicting signals at the moment, but there are signs that the global credit crunch will increase distressed investment opportunities. Funds specializing in distressed investments, however, will not be the only players in this next wave of distressed M&A. The market correction will also bring opportunities for strategic investors who had been squeezed out of opportunities in the overheated M&A market by aggressive competition and inflated multiples.
Where will the opportunities be? In Canada, the triple whammy of offshore competition, a weakening U.S. market and the rise of the Canadian dollar will continue to have a negative impact on the manufacturing and auto parts sectors. The hospitality, gaming and tourism-related sectors are also likely to be hit hard as many Americans stay at home. The Canadian forestry industry will continue to struggle with the effects of an increased Canadian dollar and a declining U.S. housing market. Certain segments of the energy sector may present opportunities due to over-aggressive expansion.
The two most common methods of selling or acquiring a distressed business in Canada are through a court receivership or a "liquidating CCAA."
Although the Companies’ Creditors Arrangement Act (CCAA) is Canada’s principal restructuring statute, most of the recent CCAA filings have had as their real objective the sale of the business. In recent years, we have seen an increased use of this "liquidating CCAA" mechanism rather than a court receivership due to concerns about successor employer liability risks for court-appointed receivers who operate a business in a unionized workplace while seeking a buyer for the business. This has been particularly relevant in the heavily unionized auto parts and manufacturing sectors.
There are many advantages to selling or acquiring distressed assets through a formal insolvency process. These include a court-supervised process, court approval of the sale, the ability of the seller to convey assets free and clear of almost all liens, encumbrances and claims and, from a buyer’s standpoint, the ability to get a "good deal." There are downsides as well. These include the requirement for market exposure of the business, the public nature of the sale process, the lack of representations and warranties by or recourse to the seller, intense scrutiny by the court, the seller’s creditors and other key stakeholders, and the risk of being outbid by higher and better bids. Timing considerations are also an important factor (i.e., how long does a buyer have to conduct due diligence, put in a bid and close), which, depending on the seller or buyer’s objectives, may be a good or bad thing.
Acquiring a distressed business can have significant rewards for buyers, but it is not without risk. Therefore, it is critical for investors to understand the intricacies of the Canadian distressed M&A sale process.
The process for acquiring assets from distressed companies in Canada is a fluid and evolving one. As with almost every aspect of Canadian life, the American influence is increasingly being felt in the Canadian restructuring arena. From U.S.-based hedge funds and private equity firms to American lenders and purchasers, all are reshaping the distressed M&A process in Canada.
The Canadian commercial loan market, once dominated by the big five Canadian chartered banks, has opened up significantly over the last five years, resulting in an increased number of suppliers of liquidity in the marketplace. Non-traditional lenders, particularly those with U.S. roots, now play a leading role in the commercial lending market in Canada. The capital structure of many companies is now more complex than ever. In addition to a general increase in loan syndications, which has resulted in multiple holders of a particular loan, a company may also have additional levels of second and junior lien debt, a myriad of other debt instruments and a complicated set of intercreditor arrangements. On the equity side, in recent years private equity firms, hedge funds and pension funds have become key players in the marketplace.
These changes complicate the dynamics of restructurings. These new players, with different liens and priorities, will have different objectives. As a result, insolvent corporations are having a more challenging time negotiating with and reaching a consensus among these different stakeholders. From both an economic and business perspective, many distressed companies will not have the luxury of time or money to endure a long, formal restructuring process. For them, abandoning the restructuring option and opting instead for a quick going-concern sale of all or part of the business may be a more practical solution to their immediate financial woes. From an M&A standpoint, this is a favourable development that will increase opportunities for distressed sales.
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