Tag: Distressed companies

Quadrant v. Vertin: Determining Rights of Creditors

Steven Epstein is a partner and Co-Head of the Mergers & Acquisitions practice at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank publication by Mr. Epstein, J. Christian Nahr, Brad Eric Scheler, and Gail Weinstein. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In Quadrant Structured Products Company, Ltd. v. Vertin (Oct. 20, 2015), the Delaware Court of Chancery, in a post-trial decision, rejected Quadrant’s challenges to transactions by Athilon Capital Corp., with Athilon’s sole stockholder (private equity firm Merced), after Athilon had returned to solvency following a long period of insolvency. Merced held all of Athilon’s equity and all of its junior notes; and both Quadrant and Merced held the company’s publicly traded senior notes. Quadrant challenged Athilon’s (i) repurchases of senior notes held by Merced (the “Note Repurchases”) and (ii) purchases of certain relatively illiquid securities owned by Merced (the “Securities Purchases”). A majority of the Athilon board that approved the challenged transactions was viewed by the court as non-independent (with two directors affiliated with Merced; the Athilon CEO; and two independent directors). Vice Chancellor Laster, applying New York law, rejected (i) Quadrant’s claims that the Note Repurchases (a) were prohibited by the indenture and (b) were fraudulent conveyances; and (ii) Quadrant’s derivative claim that the Note Repurchases and the Securities Purchases constituted a breach of the directors’ fiduciary duties.


Illegality and Hardball in Government’s Nationalization of AIG

Lawrence A. Cunningham is Henry St. George Tucker III Research Professor of Law at George Washington University Law School. This post builds on Professor Cunningham’s recent article published in The National Interest, available here. Professor Cunningham is co-author with Hank Greenberg, former chairman and CEO of American International Group (AIG), of The AIG Story.

Suppose your bank offers to lend you money to buy a home, and even if you repaid the loan, the bank would retain ownership of your home as well. Would you sign up? Would you expect a business organization to accept equivalent loan-plus-forfeiture terms? I don’t think so but that is what the U.S. government’s “bailout” of American International Group (AIG) involved and one reason a federal judge has declared it an illegal exaction in violation of the Constitution of the United States.

In the fall of 2008, Treasury Secretary Henry Paulson and New York Federal Reserve President Timothy Geithner demanded the permanent surrender of nearly an 80% stake in AIG as “security” for a usurious loan. They then fired AIG’s CEO, replaced its board members, took control of all the company’s affairs, and divested nearly half the company’s worldwide assets in a series of fire sales—all while using subterfuge and deception to avoid a shareholder vote the officials agreed was required and promised would be held.


Delaware Court of Chancery Revisits Creditor Derivative Standing

Paul K. Rowe and Emil A. Kleinhaus are partners at Wachtell, Lipton, Rosen and Katz. This post is based on a Wachtell Lipton memorandum by Mr. Rowe, Mr. Kleinhaus, William Savitt, and Alexander B. Lees. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In a significant decision, the Delaware Court of Chancery has rejected several proposed limitations on the ability of creditors to maintain derivative suits following a corporation’s insolvency. In doing so, however, the Court reaffirmed the deference owed to a board’s decisions, regardless of the company’s financial condition, and the high hurdles faced by creditors in seeking to prove a breach of fiduciary duty. Quadrant Structured Prods. Co. v. Vertin, C.A. No. 6990-VCL (May 4, 2015).

Quadrant, a creditor of Athilon Capital, brought a derivative action claiming that when Athilon was insolvent, its directors violated their fiduciary duties, including by authorizing repayments of debt owed to Athilon’s equity owner. The defendants moved for summary judgment on the basis that Quadrant lacked standing to sue under the Delaware Supreme Court’s decision in North American Catholic Educational Programming Foundation, Inc. v. Gheewalla (see memo of May 24, 2007), which permits creditors to sue directors for breach of fiduciary duty only on a derivative basis, and only once the corporation is insolvent.


Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act

Dirk Hackbarth is Associate Professor of Finance at Boston University. This post is based on an article authored by Professor Hackbarth; Rainer Haselmann, Professor of Finance, Accounting, and Taxation at Goethe University, Frankfurt; and David Schoenherr of the Department of Finance at London Business School.

In our article, Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act, forthcoming in The Review of Financial Studies, we examine how bargaining power in distress affects the pricing of corporate securities. The nature of Chapter 11 makes bargaining an important factor in distressed reorganizations. Reorganization outcomes depend on the relative bargaining power of the parties involved. A number of papers document that shareholders receive concessions in distressed reorganization even when creditors are not paid in full despite of their contractual (junior) status as residual claimants (Franks and Torous 1989; Eberhart, Moore and Roenfeldt 1990; Weiss 1990). To this end, our research exploits an exogenous variation in the allocation of bargaining power between shareholders and debtholders due to the 1978 Bankruptcy Reform Act to examine how the ex post allocation of cash flows in distress affects the ex ante pricing (return and risk) of corporate securities, such as risky debt and levered equity.


Corporate Distress and Lobbying: Evidence from the Stimulus Act

The following post comes to us from Manuel Adelino of the Finance Area at Duke University, and Serdar Dinc of the Department of Finance and Economics at Rutgers University.

In our paper, Corporate Distress and Lobbying: Evidence from the Stimulus Act, forthcoming in the Journal of Financial Economics, we contribute to the long literature on corporate behavior in distress, as well as to studies of the consequences of financial distress. Using the financial crisis in 2008 as a negative shock to nonfinancial firms’ financial conditions, we document a novel fact on the relation between firms’ financial health and their lobbying activities. We compare the lobbying activities of firms before and after the onset of the crisis and find that firms with weak financial health—as measured by their CDS spread—lobby more. This result is robust to controlling for such firm-specific variables as size, profitability, and market-to-book ratio, all the firm characteristics that remain unchanged during the short window before and during the passage of the stimulus act, sector-wide time trends, and the adoption of different time windows for comparison in the difference-in-differences framework.


Cross-Border Schemes of Arrangement and Forum Shopping

The following post comes to us from Jennifer Payne, Professor of Corporate Finance Law at University of Oxford.

The English scheme of arrangement has existed for over a century as a flexible tool for reorganising a company’s capital structure. Schemes of arrangement can be used in a wide variety of ways. In theory a scheme of arrangement can be a compromise or arrangement between a company and its creditors or members about anything which they can properly agree amongst themselves. It is common to see both member-focused schemes and creditor-focused schemes. In practice the most common schemes are those which seek to transfer control of a company, as an alternative to a takeover offer, and those which restructure the debts of a financially distressed company with a view to rescuing the company or its business.

In recent years schemes of arrangement have proved popular as a restructuring tool not only for English companies but also for non-English companies. A number of recent high profile cases have allowed non-English companies to make use of the English scheme jurisdiction to restructure their debts, including Re Rodenstock GmbH [2011] EWHC 1104 (Ch), Primacom Holdings GmbH [2012] EWHC 164 (Ch), Re NEF Telecom Co BV [2012] EWHC 2944 (Comm), Re Cortefiel SA [2012] EWHC 2998 (Ch) and Re Seat Pagine Gialle SpA [2012] EWHC 3686 (Ch). Typically, these cases involve financially distressed companies registered in another EU Member State making use of an English scheme of arrangement without moving either their seat or Centre of Main Interest (COMI). In general, the main connection to England is the senior lenders’ choice of English law and English jurisdiction as governing their lending relationship with the company.


Dealmaking in a Distressed Environment

David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on the introduction of a Wachtell Litpon publication, titled “Dealmaking in a Distressed


The topic of this outline is mergers and acquisitions where the target company is “distressed.” Distress for these purposes generally means that a company is having difficulty dealing with its liabilities—whether in making required payments on borrowed money, obtaining or paying down trade credit, addressing debt covenant breaches, or raising additional debt to address funding needs.

Distressed companies can represent attractive acquisition targets. Their stock and their debt often trade at prices reflecting the difficulties they face, and they may be under pressure to sell assets or securities quickly to raise capital or pay down debt. Accordingly, prospective acquirors may have an opportunity to acquire attractive assets or securities at a discount. This outline considers how best to acquire a distressed company from every possible point of entry, whether that consists of buying existing or newly-issued stock, merging with the target, buying assets, or buying existing debt in the hope that it converts into ownership.

Some modestly distressed companies require a mere “band-aid” (such as a temporary waiver of a financial maintenance covenant when the macroeconomy has led to a temporary decline in earnings, but the company is able to meet all of its obligations as they come due). Others require “major surgery” (as where the company is fundamentally over-levered and must radically reduce debt).


2012 Distressed Investing M&A Report

The following post comes to us from David Rosewater, partner focusing on mergers & acquisitions at Schulte Roth & Zabel LLP. This post is based on a Schulte Roth & Zabel report; the full publication, including charts and figures, is available here.

Schulte Roth & Zabel is pleased to present Distressed Investing M&A, published in association with mergermarket and Debtwire. Based on a series of interviews with investment bankers, private equity practitioners and hedge fund investors in the US, this report examines the market for distressed assets at home and abroad.

Economic uncertainty brought on by the looming US “fiscal cliff” have placed companies in difficult situations where many are forced to sell assets and restructure operations and debt in order to avoid a court mandated sale further down the line. The value gained and time saved by selling assets prior to in-court restructuring and liquidation is signaled by the respondents’ shift toward dealmaking early and out-of-court.

Outside of the US, the eurozone crisis and macroeconomic concerns in the emerging markets are having a similar effect. While some are waiting for a solution to the sovereign debt crisis, distressed investors are geared to take advantage of attractively-priced assets within the region. Hyperinflation remains a concern for the markets in Latin America and India, while economic growth has slowed in Brazil and China. Both are likely to create distressed opportunities over the next 12 months.

Respondents cite the energy sector as likely to be the most active for distressed M&A in the next year. Low natural gas prices in the US are hitting the bottom line and companies are feeling the strain. Additionally, inflation concerns in Asia may expose manufacturing companies, who respondents describe as “losing the battle” against prices.

In addition to the above findings, this report provides insight into pricing, litigation, club deals, and various other issues concerning the distressed M&A community. We hope you find this study informative and useful, and as always we welcome your feedback.


A Capital Market, Corporate Law Approach to Creditor Conduct

Mark Roe is the David Berg Professor of Law at Harvard Law School, where he teaches bankruptcy and corporate law.

Earlier in October, Federico Cenzi Venezze and I posted “A Capital Market, Corporate Law Approach to Creditor Conduct” up on SSRN. Michigan Law Review is scheduled to publish the article in their next volume.

In this article, we focus on the problem of creditor conduct in distressed firms — for which policymakers ought to have the economically-sensible repositioning of the distressed firm as a central goal. This problem has vexed courts for decades, without coming to a stable doctrinal resolution. It’s easy to see why developing an appropriate rule here has been difficult to achieve: A rule that facilitates creditor operational intervention going beyond ordinary collection on a defaulted loan can induce creditors to intervene perniciously, to shift value to themselves. But a rule that confines creditors to no more than collecting their debt can allow failed managers to continue mismanaging the distressed firm, with the only real alternative to the failed incumbent management — the creditor — being paralyzed by unclear and inconsistent judicial doctrine.

The article proceeds in four steps. For the first step, we show that existing doctrines do not address themselves to facilitating efficacious management of the failing firms. Yet with corporate and economic volatility as important as ever, courts should seek to make doctrine here more functionally-oriented than it now is.


Private Equity and the Resolution of Financial Distress

The following post comes to us from Edie Hotchkiss of the Finance Department at Boston College, David C. Smith of the McIntire School of Commerce at the University of Virginia, and Per Strömberg of the Institute of Financial Research (SIFR) and Professor of Finance at the Stockholm School of Economics.

In the paper, Private Equity and the Resolution of Financial Distress, which was recently made publicly available on SSRN, we examine how private equity owners influence the outcome of distressed restructurings and the costs of financial distress. The impact of PE ownership on the likelihood or severity of distress is unclear. There are several reasons to expect a positive role for PE sponsors. The discipline of high leverage could lead to higher operating efficiency and lower the chance of financial distress. Further, if value declines, PE owners have strong incentives to correct this decline to preserve their equity stake, including by committing capital to support the distressed company. PE sponsors also have an incentive to preserve their reputation with lenders and future investors, even when they may lose an insolvent firm during restructuring. On the negative side, actions by aggressive private equity owners to boost their financial return, such as leveraging up a firm to pay large dividends, could drain needed liquidity from PE-owned firms and put these firms at a higher risk of default.


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