1 Pitfalls In Transacting Business With Financially Distressed Parties Patrick Costello Vectis Law...
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Pitfalls In Transacting Business With Financially Distressed
Parties
Patrick CostelloVectis Law Group
Note: This format presents only the transaction scenario and the general nature of the bankruptcy risk: the full presentation describes the nature of the risks in detail and discusses potential solutions
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• Entering into a transaction with a financially distressed entity introduces insolvency/bankruptcy risks to which a corporate lawyer may not be accustomed
• Vectis’ objectives are threefold:– Identify the nature, magnitude and probability
of bankruptcy risk for the decision makers– Formulate the changes to the transaction
structure that reduce the bankruptcy risk– Assist decision makers in weighing
bankruptcy risk against cost of structural changes
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Purchase
Price
Seller Buyer
Seller’s Employees Seller’s VendorsSeller’s Lender
Assets
Cash to Seller
Payment to
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• Bankruptcy Risk: Preference
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PITFALL #2: Acquisition where seller is a corporate group
• Proposed Transaction Structure:– Assets to be acquired are split between
parent and subsidiary (e.g.: IP is parent asset and operating assets are subsidiary assets)
– Both parent and subsidiary are parties to APA and defined collectively as “Seller” and purchase price is to be paid to “Seller”
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Transfer Operating Assets
Parent
Buyer
Operating Subsidiary
Transfer IP Assets
“Seller” Purchase Price
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• Bankruptcy Risk: Constructive Fraudulent Conveyance
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PITFALL #3: Acquisition by Foreclosure Sale
• Proposed Transaction Structure:– Secured creditor of debtor sells debtor’s
assets to buyer
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Secured Party(Seller)
Debtor
Buyer
Acquired Assets
Purchase Price Paid toSecured Party
Security Interest
Acquired Assets sold under Secured Creditor’s Power of sale
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• Bankruptcy Risks:– Preference– Fraudulent Conveyance– Senior Encumbrance
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FinancingPITFALL #4: Secured Bridge Loan Where
Seniority Is Achieved By Contractual Subordination Of An Existing Security Interest
• Proposed Transaction Structure – New player (e.g., bidder, supplier, investors) will make
a secured loan to distressed company to bridge company to liquidity event.
– A secured loan from investors is in place– Seniority of new loan is to be achieved through an
inter-creditor/subordination agreement
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Debtor
New SecuredParty
First SecuredParty
Secured loan first in time
New secured loan second in time
Inter-creditor agreement provides for new secured party to be treated as first in time for all purposes
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Bankruptcy Risk: Avoidance of First-In-Time Security Interest
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PITFALL #5: The 3x Bridge Loan• Proposed Transaction Structure
– Investors are making a bridge loan to distressed company
– Loan is to be secured by security interest and is entitled to a 3x return on the sale of the Company’s assets
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• Bankruptcy Risk: Fraudulent Conveyance
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PITFALL #6: Secured Loans To Corporate Groups
• Proposed Transaction Structure – Lender makes loan to corporate parent
secured by blanket security interest in assets of parent and subsidiaries
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Subsidiary A
Lender
Debtor
Subsidiary B Subsidiary C
Grants security interest
Loan
Grants security interest
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• Bankruptcy Risk:– Fraudulent Conveyance – Suretyship Defenses
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PITFALL #7: The Software/Copyright Based Secured Loan
• Proposed Transaction Structure – Investor/lender is making a secured loan to
company– Credit worthiness of company is based in
material part on the company’s software– Software is protected by copyright, but
company for a variety of reasons has not registered the copyright – a practice prevalent in the industry
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• Bankruptcy Risk: “Unperfection” and Avoidance
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LicensingPITFALL #8: IP License From Licensor Who
Has Encumbered Its Intellectual Property• Proposed Transaction Structure
– Client is negotiating to acquire a license to IP– Proposed licensor has granted a security
interest in its IP to its lender
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• Bankruptcy Risks: • License Rejection• Senior Encumbrance
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PITFALL #9: Taking a “Springing” License• Proposed Transaction Structure:
– Manufacturer or customer, insists on a license to ensure ability to manufacture and/or distribute IP-based products in the case of a default and failure to perform
– License is to “spring” into place and becomes effective on bankruptcy, insolvency or other liquidation
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• Bankruptcy Risk: Void Under Ipso Facto Provisions
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PITFALL #10: The Developmental IP License Agreement
• Proposed Transaction Structure:– Licensee enters into license agreement that
requires licensee to pay substantial fees/royalties and make substantial investment toward IP/technology that requires material ongoing enhancement/development by licensor
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• Bankruptcy Risk: Rejection