Distressed M&A Works Best Through 363 Salesįor companies fortunate enough to have ample cash on hand, a macroeconomic or industry-specific crisis could provide an ideal environment to purchase assets from bankrupt competitors at bargain prices. Even if the buyer expects to ultimately prevail in fraudulent transfer litigation, the costs, distraction, and hassle of litigation should create a significant deterrent. If a deal sounds too good to be true, it probably is! While buying assets from a distressed seller at a pre-bankruptcy auction may reduce fraudulent transfer risk, acquiring the seller’s assets through a post-bankruptcy 363 sale is the best practice. Overall, buyers should be particularly wary of any sweetheart deals when dealing with a distressed seller. Since defining these terms requires a subjective judgment by the courts, buyers should analyze and thoroughly document buyer-seller communications and recent comparable transactions to defend against any subsequent fraudulent transfer accusations by disappointed creditors in a subsequent bankruptcy proceeding. While reasonably equivalent value may be approximated by net orderly liquidation value, such estimates may involve considerable speculation. In general, courts will view reasonably equivalent value as not necessarily equal to fair market value but generally more than a fire sale price or forced liquidation value. “Less than reasonably equivalent value” is an intentionally ambiguous term that is not defined in the Bankruptcy Code, enabling courts to interpret it on a case-by-case basis. Since any pre-bankruptcy M&A transaction carries fraudulent transfer risk, buyers should proceed with caution when approaching a distressed seller prior to an impending bankruptcy filing. During bankruptcy, if the seller’s creditors suspect a fraudulent transfer has occurred, they may initiate litigation against the buyer to unwind the deal or hold the buyer liable for economic damages. Additionally, fraudulent transfer law in nearly all states allows a four-year lookback period. A fraudulent transfer occurs if the seller was insolvent at the time of the transaction (or became insolvent as a result of the transaction) and the transaction involved “less than reasonably equivalent value.” Any transfer of assets that occurred within two years prior to the seller’s bankruptcy is at risk of being reclassified as a fraudulent transfer under federal law, meaning the transaction could be voidable. Pre-bankruptcy: Beware Fraudulent Transfer Riskīefore purchasing assets from a distressed business, it is important to be aware of fraudulent transfer risk. However, it also brings a major challenge: How do you assess the value of businesses with risky strategies, dwindling liquidity, limited resources, and uncertain prospects? Before considering a distressed purchase, a prudent investor must diagnose the primary cause of distress, evaluate a target company’s overall financial health, recognize whether its operations can be saved, and if so, acknowledge the amount of time, effort, and capital required to turn a business around. Bankruptcy often presents an opportunity for qualified bidders with access to cash to purchase quality assets at bargain prices.
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