Rehabilitation M&A: A Third Way for Financially Distressed Companies

When a company faces financial hardship, the traditional options have been to either attempt independent recovery or initiate closure. Still, a third path – merger and acquisition (M&A) within the rehabilitation process – is gaining prominence in recent court practices. This approach offers a viable alternative for companies struggling to survive in an increasingly complex economic landscape.

The Shift Towards Rehabilitation M&A

Historically, companies undergoing rehabilitation procedures often prioritized independent revival, believing it achievable with financial restructuring. However, as economic conditions become more challenging, an increasing number of businesses find independent survival difficult. Rehabilitation M&A is evolving from an exceptional option to a realistic alternative.

Five Key Drivers of Rehabilitation M&A

Several factors contribute to the growing trend of M&A during rehabilitation:

• Long-Term Industry Recession: When an industry is in prolonged decline, independent recovery without synergy from other businesses becomes unlikely.
• Need for New Funds: Revival may be uncertain even with operating funds alone, necessitating the injection of new capital.
• Creditor Consent Challenges: Securing the consent of a majority of creditors can be difficult using traditional 10-year installment repayment methods, even if the company’s outlook is positive.
• Going Concern Value vs. Liquidation Value: Investigations may reveal that the company’s value as an ongoing entity is lower than its liquidation value.
• Negotiation Deadlocks: Agreements with potential acquirers may stall due to unresolved contingent liabilities.

Benefits for All Stakeholders

Rehabilitation M&A offers advantages to both acquirers and creditors. Acquirers can achieve synergy with the debtor company’s business and expand into new markets. Creditors, in turn, can recover a portion of their debt more quickly and with greater certainty than through a prolonged installment repayment plan. The rehabilitation process confirms the existence of debt, reducing the risk of unexpected contingent liabilities.

Timing and Methods of Revival M&A

The timing of rehabilitation M&A varies. Negotiations can begin before formal rehabilitation proceedings, during the process before a plan is approved, or even after plan approval if business conditions change. Common methods include:

• Capital increases allocated to a third party
• Capital increases combined with new borrowing
• Business transfer

Procedural Fairness and Open Bidding

The process emphasizes procedural fairness, typically following an open bidding structure. This involves selecting a sales manager, conducting due diligence, announcing the sale, receiving letters of intent, performing preliminary due diligence, selecting a preferred bidder, signing a memorandum of understanding, finalizing the acquisition contract, preparing a rehabilitation plan, depositing the acquisition price, and holding a meeting of interested parties.

If open bidding fails, court permission may allow for limited competitive bidding or a private contract. The “Stalking Horse” method, where a preliminary agreement is reached with a potential acquirer before public bidding, is also utilized. This ensures a baseline offer and facilitates a competitive process.

Ensuring Consistency and Transparency

Given the multiple stakeholders involved, consistency of standards, fairness, and transparency are paramount in rehabilitation M&A. Rehabilitation courts establish practical rules to govern the process and ensure a structured framework.