In the meantime, banks, as well as the other sources for capital, discover their balance sheets reflect increasingly under-performing assets. The lending standards continue to increase, resulting in the widely-publicized shortage in commercial lending. The alternative sources of capital, such as private equity financing or the market for public securities, are not available for many businesses. This has led to more and more companies are facing a severe liquidity crisis and many needing protection in bankruptcy cases.
The Administrative Office of the U.S. Courts states that more than 43,000 companies declared bankruptcy in 2008, and the American Bankruptcy Institute reports over 14,000 bankruptcy filings filed by companies at the beginning of the 2009 quarter, which is a rise of about 30 percent annually.
In the same way as the previous point, all Indian banks’ Q3 FY10 financial results have seen an increase of both net and gross NPA. Each bank has a separate department that is under the General Manager, who addresses issues that arise from NPA as well as the power to sell these items in the form of Asset Reconstruction companies.
While the current economic environment presents challenges for distressed businesses, however, it could also offer the opportunity for economically stable companies to purchase critical assets or areas of the company at bargain costs. However, are these deals too attractive, to be honest? Unfortunately, there isn’t a “one-size-fits-all” answer. However, there are some critical questions to be asking yourself when thinking about the purchase of distressed companies:
Have you thought about the cost that goes beyond the price of purchase?
Acquiring Distressed Assets is lengthy and costly both in terms of management attention as well as the cost of outside counsel. Because of this, directors often believe that the purchase of a healthy business is more beneficial than buying Distressed Assets because it involves fewer transaction costs and takes lesser time for close. Once you consider the charges, such as legal proceedings, as well as the additional requirements for acquiring NPA via ARC or directly from a bank, when they are accounted for, the price that the purchaser believed it was getting might not be quite as appealing.
Are you getting a bargain or an opportunity to save money?
If the Potential buyer follows the direction of the management and agrees to the purchase of essential assets from a competitor in distress without taking over the entire company, There are other aspects to take into consideration. However, the buyer may make use of the leverage in negotiations provided by the financial crisis of the target; however, it is also essential that the purchase must be fair in the value of the assets to be acquired. This is due to the fact that it will be granted free and unlimited non-ligation title to the assets purchased and also the potential for parties, including creditors, to assert that the transaction was fraudulent or fraudulent and that the amount that was paid did not reflect a commercial value taking into account all circumstances. Critical questions for directors were raised without regard to whether or not there was a motive on the part or on behalf of any party in order to fraud creditors. There is no one-size-fits-all term that defines “reasonably equivalent value”; however, courts often consider what the fair value assets purchased and make adjustments that are deemed to be appropriate in the circumstances of the transaction is. Even in the event that the fraudulent conveyance argument is unsuccessful, defending against an assertion may result in significant expenses.
Who are the creditors of the target? If dealing with a distressed company, potential buyers must be aware of the company’s creditors and the nature and scope of the debt. If the business has debt that is secured through its asset, it is not possible to purchase those assets free and clear of lien without the help of a debt recovery tribunals without making the debt payment in its entirety or making an agreement in conjunction with the secure creditor. Another option is arriving at a settlement with secured creditors and then make them a part of the transaction.
Although a company may not have secured creditors, any potential buyer must also take into account the trade and other unsecured creditors of the company that is being targeted. These creditors are typically service providers or suppliers who are essential to the running of the company’s target. If the worth of the acquired assets is dependent on the goodwill and longevity of these creditors, the buyer should carefully think about how these creditors’ rights will be handled during the purchase. If the creditor base is disorganized and scattered, it is possible that the buyer will be more successful in negotiating individual deals that keep good relations with the creditors following the closing. If, instead, your creditor base is tight-knit and well-organized, the buyer must deal with creditors as a whole and may hinder the purchase from negotiating the deal with the terms it would prefer.
There is also an opportunity that the creditors of the target company may make an involuntary bankruptcy filing which could force the company to declare bankruptcy. Knowing the creditor base of the company prior to filing a bankruptcy petition can help directors determine which creditors stand the most significant benefit from this type of action.
Are you covered following the purchase?
Another aspect to consider when dealing with a distressed business is the possibility of the liability of a successor after the purchase, and what, in the event of an indemnification, will be offered for the purchaser. While the buyer must try to structure the investment to minimize the risk of liability which it will be liable for, a prospective buyer may be exposed to claims from angry creditors. This is because by buying any assets owned by the distressed business and taking on the obligations of that company. Indemnification under contract may not provide much security in these circumstances in the event that the company in distress might not be able to fulfill any indemnification obligations pursuant to the purchase agreement, especially if the business is in bankruptcy after the purchase.
The structure of the transaction so that the buyer buys assets and does not assume any liabilities is crucial. However, such a plan may not be tax-efficient, and generally, it is not able to allow buyers to modify tax credits that were offered to a seller. It typically also requires the payment of a significant amount of stamp duty for such sales. Whatever the case, whether a transaction with a distressed entity has attached liabilities or not, buyers may seek a post-closing escrow or purchase price holdback in order to protect any indemnification obligations of the seller. Practically speaking, the funds that are being escrowed, or held back, will most likely be the sole funds available to cover the damages incurred from breaches of seller’s warranties and representations. Analyzing a transaction with a distressed business requires a variety of practical and legal issues. Directors should consider these aspects to ensure they don’t get higher than what they anticipated. However, with an in-depth analysis and negotiation, financially sound companies could discover opportunities to purchase important businesses or assets for a bargain price.
When buying the distressed asset, you must not seek out a bargain. The transaction’s structure is essential from the perspective of unanticipated liabilities and obtaining valuable tax benefits. The contract for purchase should include a post-closing escrow.