Actionable Ideas for Companies and Sponsors 

Expected Uptick in Defaults Will Lead to Increased Distressed M&A Activity

The anticipated increase in the default rate should translate into more distressed investment opportunities, including acquiring companies under Chapter 11 protection. The acquisition of a company in a Chapter 11 proceeding can provide the purchaser with outsized returns, and the acquisition is principally consummated either as an acquisition of assets pursuant to Section 363 of the bankruptcy code or by sponsoring a Plan of Reorganization. A buyer enjoys several advantages under section 363 of the bankruptcy code, including the ability to acquire assets selectively, to exclude legacy liabilities and unprofitable contracts, and to complete the purchase "free and clear" of all liens and encumbrances, thereby limiting successor liability. These advantages would otherwise be very difficult to achieve in a regular acquisition. In addition, since 363 sales are asset sale transactions, the buyers enjoy a step up in tax basis as well. 

Sponsoring a Plan of Reorganization can be a creative way for private equity investors, hedge funds and strategic acquirers to take control of a distressed company when it emerges from Chapter 11. Such a plan is often the best alternative to a 363 Asset Sale or plain vanilla Chapter 11 plan in situations where: (i) an asset sale will result in negative tax consequences, (ii) the solution to the restructuring requires new equity capital to execute a business plan, or (iii) when pre-petition creditors want to partner with a third-party investor and retain interest in the reorganized company through a new money investment.  

A Plan Sponsor transaction is one in which a private equity firm, existing creditor, or strategic acquirer agrees to invest new money in conjunction with a Plan of Reorganization. The new money is typically used to: (i) pay certain creditors in exchange for revoking their claims and an affirmative vote in favor of the plan of reorganization, and/or (ii) fund capital investment in the Company. In certain Plan Sponsor transactions, creditors receive a combination of cash from the new money investment plus a security interest in the reorganized company.