Monthly Archives: May 2009

M&A Strategies for Bankruptcy and Distressed Companies

The beginning of the credit crisis in mid-2007 and other recent economic trends have increased the number of distressed companies that are seeking to sell assets as part of their plans to improve their financial condition or undergo other corporate debt restructurings. Based on recent financial data, the number of distressed companies soared from the fall of 2007 to the summer of 2008, as have the number of downgrades of corporate bonds.

Companies with sound fundamentals may become available at attractive prices in the coming years, particularly compared to the sometimes-inflated valuations attached to many companies in the non-distressed market. However, buying distressed assets and companies inside or outside of bankruptcy court poses certain potential dangers and challenges that do not present themselves in the non-distressed M&A market, but also offers more significant upside opportunities for potential purchasers. To capitalize on these opportunities, buyers need to be especially focused on identifying distressed sellers and conducting the acquisition process in a manner that minimizes these dangers while maximizing these opportunities as much as possible.

As more fully discussed in our chapter entitled “Important Tools in Distressed M&A Transactions,” the Chapter 11 process may provide both buyers and sellers with tools that will help them make the best of a distressed merger and acquisition transaction. Among other topics, the chapter considers practical considerations for buyers in distressed M&As, agreements in distressed M&As, and acquisitions pursuant to a ‘363 Sale’ or a confirmed chapter 11 plan.

The chapter is available here.

PWC 2008 Securities Litigation Study

This post is by Grace Lamont of PricewaterhouseCoopers.

In PricewaterhouseCoopers’ 13th annual evaluation of private securities class action lawsuits, one thing is glaringly obvious: While 2008 was an extraordinary year for litigators, it also demonstrated how extremely vulnerable giant financial institutions and entire economies are to fissures in the financial system.

In the seemingly free-falling economic environment of the latter part of the year, we witnessed unprecedented events: Major failing institutions, systemic breakdowns in the financial system, and record government bailouts throughout the globe. All of this set the stage for notable litigation activity and trends.

US regulatory authorities focused on the players within various areas of the financial markets: mortgage companies, investment banks, broker-dealers, and insurance companies. The SEC secured some of the largest settlements in its history from firms charged with misleading investors. At the close of the SEC’s fiscal year, 50 investigations relating to the financial crisis were ongoing. The SEC and DOJ secured record settlements for FCPA violations. Both regulatory bodies pledged to continue pursuing FCPA violations going forward.

Fuelled by the financial crisis, federal securities class actions increased for a second year, and, not surprisingly, the financial services industry group was the most frequently sued, replacing high-technology companies for the first time since the passage of the PSLRA. Public and union pension funds continued to be the most active lead plaintiff in institutional investor filings, and a number of filings alleging Ponzi schemes emerged in the latter part of the year.

We also observed certain downward trends: The number of accounting-related cases as a percentage of total filings declined, and, likewise, the number of settlements recorded declined to the lowest number in any year this decade. Similar declines in settlement values, however, did not follow.

On the foreign securities litigation activity front, federal securities class actions filed against foreign private issuers (FPIs) jumped to an all-time high since the passage of the PSLRA. The number of FPI accounting-related cases doubled to 16 cases in 2008, while the average settlement value of FPI cases overall decreased. The number of foreign companies registered with the SEC continued to slide downward for a third year.

While the ramifications for 2009 and beyond remain to be seen, one thing is certain: The worldwide economic crisis will transform the financial industry and shape future regulation and enforcement.

As editor of the 2008 Study, I am appreciative to a handful of exceptional team members in the PricewaterhouseCoopers Securities Litigation and Investigations Practice, particularly my co-author, Patricia Etzold, for her scrutiny of global litigation activity. I extend additional thanks to Laura Skrief, Luke Heffernan, and Kevin Carter, who all provided meticulous analysis of the 2008 filings and invaluable contributions to the project at large.

Lastly, we are tremendously grateful for the editorial contributions from the law firms Hunton & Williams LLP and Sullivan & Cromwell LLP, in addition to Tricia Howse from the SFO, for the UK perspective on international regulatory cooperation.

The study is available here.

Linking to the PricewaterhouseCoopers site does not imply any endorsement by PricewaterhouseCoopers of the services or products being offered by Harvard Law School.

Obstacles to a Quick Chrysler Bankruptcy

Editor’s Note: This post is based on an op-ed piece by Professor Mark Roe in today’s Wall Street Journal.

Yesterday, Chrysler filed for Chapter 11 bankruptcy protection in preparation for a partnership with Italy’s Fiat. President Barack Obama says he hopes the bankruptcy proceeding will be quick and efficient, done in 30-60 days. I hope so too. But a Chrysler bankruptcy has many moving parts — and with Chrysler unable to make money selling cars, it just doesn’t have enough nongovernment cash to grease those moving parts to facilitate a smooth bankruptcy. Chrysler is in worse shape than GM. And remember, Fiat has yet to offer a penny for its 20% share in Chrysler.

This could get messy and easily last longer than the 30-60 days now advertised. First off, in a bankruptcy any single creditor is entitled to get the liquidation value of its claim, under 1129(a)(7) of the Bankruptcy Code and the bankruptcy judge cannot approve a plan of reorganization that fails to comply with 1129(a)(7). So any creditor can assert that what it would get if Chrysler sold its factories quickly would be more than the 32 cents per dollar that Treasury had guaranteed Chrysler’s secured creditors before the government deal fell apart this week.

Valuation proceedings are notoriously difficult in Chapter 11. Although the judge doesn’t actually need to liquidate Chrysler, the judge must determine what it would have gone for if there were a liquidation. Some creditors appeared ready to bring that case to the bankruptcy judge. While the judge may in the end conclude that Chrysler’s liquidation value is less than the 32 cents the creditors would receive, with public estimates now varying substantially, a valuation hearing if brought, and if not suppressed with a quick estimate from the judge, is not likely to allow the proceeding to close within 30-60 days.

On top of liquidation value, the whole class of secured creditors is entitled to the fair value of their claims for any deficiency portion not satisfied by the value of the security. Usually that value is greater than liquidation value, though Chrysler may be an exception.

The government thinks the additional value issue will be resolved easily. That’s because in a bankruptcy proceeding the creditors whose claims amount to two-thirds of the total amount of debt can bind the rest to take the deal. Indeed, the judge doesn’t have to figure out whether value is fair, if the class of creditors votes in favor. And since two-thirds have already raised their hands in favor of 32 cents on the dollar, it seems to be a done deal.

But this time it might not be so easy. Not all of those who’ve already raised their hands in favor prior to bankruptcy, especially the smaller investors, will still be raising their hands inside Chapter 11. They can change their mind, and some just didn’t want any negative publicity before the bankruptcy.

Worse, there could be a legal fight over whether the vote of Citibank and the other “big four” creditors — J.P. Morgan Chase, Morgan Stanley and Goldman Sachs, who together hold 70% of Chrysler’s debt — should be counted toward the two-thirds threshold that would bind the company’s other 42 creditors. The Bankruptcy Code requires that the votes of creditors be given in “good faith.” It won’t be hard for the smaller creditors to argue that Citibank and other TARP recipients’ votes aren’t in full good faith. In agreeing to Treasury’s offer of 32 cents for each $1 of their debt, the objectors would say, Citibank and some others were influenced by the fact that Treasury was keeping them afloat with federal subsidies. If this type of litigation begins, it won’t be easily resolved.


The SEC Outlines its Enforcement Agenda

Editor’s Note: The post below by Chairman Schapiro is a transcript of remarks by her to the Society of American Business Editors and Writers, Denver, on April 27, 2009.

It’s an honor to be here with you today because in so many ways we share the same goal. We all strive to achieve an “informed citizenry.”

Through your reporting and writing, you help to make Americans smarter and wiser — not just about business in general, but about the financial markets in particular.

And, that actually makes our job at the Securities and Exchange Commission easier.

For me — and for the SEC — it is all about investors. The more high-quality, honest information investors have, we believe the better off they are.

Since becoming Chairman a few short months ago, my focus has been revitalizing the one agency whose primary responsibility is to protect investors.

The Birth of the Investors’ Advocate:

As many of you know, the SEC grew out of a tumultuous time in our nation’s financial history. Following the Great Crash of 1929, Congress passed two significant pieces of legislation whose goals were clear — protect investors and restore investor confidence.

It was 75 years ago this very day that the House Committee reported out the bill that created our agency.

That Committee report — from April 27, 1934 — references the words of President Roosevelt himself.

At the time, the President was concerned with what he called naked speculation — or investments with significant risk. He said such “speculation has been made far too alluring and far too easy for those who could and for those who could not afford to gamble.”

And he talked about his concern that workers were risking their pay checks or meager savings on transactions that they barely understood — or in his words investments “with whose true value they were wholly unfamiliar.”

That is why President Roosevelt urged passage of the legislation — legislation he said was “for the protection of investors, for the safeguarding of values, and, so far as it may be possible, for the elimination of unnecessary, unwise, and destructive speculation.”

A few weeks later the Exchange Act of 1934 passed. And, the SEC was born.

It wasn’t long before one of the early Chairmen, declared the agency the “investors’ advocate.” And, for 75 years, the agency has largely been known by that moniker. But not unfailingly, and that is part of what I want to talk to you about today.


Inheritance Law and Investment in Family Firms

This post comes from Fausto Panunzi of Bocconi University.

In my paper Inheritance Law and Investment in Family Firms (co-written with Andrew Ellul and Marco Pagano) which I recently presented at the Law, Economics and Organizations Seminar at Harvard Law School, my co-authors and I investigate whether inheritance laws reduce investment and growth in family firms. Inheritance laws may constrain entrepreneurs to bequeath a minimal stake to non-controlling heirs. The larger the portion of the founder’s assets to be assigned to non-controlling heirs, the lower the fraction left to the heir designated to remain at the helm of the firm. Absent any friction in capital markets, a lower wealth of the controlling heir would not affect the family firm’ ability to borrow and invest. But in the presence of capital market imperfections, it may hinder the firm’s investment.

In the context of a stylized model of succession in a family firm, we show that larger legal claims by non-controlling heirs on the founder’s estate lead to lower investment by family firms, as they reduce the firm’s ability to pledge future income streams to external financiers. To perform empirical tests, we collect data on inheritance law for 62 countries, mainly via questionnaires sent to law firms that are part of the Lex Mundi project. We measure the “permissiveness of the inheritance law” of each country as the maximum share of a testator’s estate that can be bequeathed to a single child, depending on the presence or absence of a spouse and the total number of children. We then merge this indicator with measures of investor protection and with data for 10,245 firms from 32 countries for the period 1990-2006.

We find that indeed the strictness of inheritance law is associated with lower investment and growth in family firms, while it leaves investment unaffected in non-family firms. Moreover, the negative effect of strict inheritance law on family firms’ investment is exacerbated by poor investor protection, which is also in accordance with the model. We also find that the results are mostly driven by family firms that experience succession in our sample period. It is precisely around and after succession that the effects of inheritance laws are mostly felt, because it is at this time that the decision on who is appointed as the controlling heir and his/her stake is determined. Indeed we find that during and after succession family firms experience a decrease in investment that is more severe for firms located in countries with stricter inheritance law. Also in this case, poor investor protection is found to exacerbate the effect of strict inheritance law, as well as having a direct negative effect on investment. Our results are robust to the use of different specifications of the investment equation, to the inclusion of inheritance taxes (which have no statistically significant effect on family firms’ investments), to different definitions of family firms and different measures of financial dependence.

The full paper is available for download here.

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