The acquisition of a company or one of its strategic assets can be challenging. It gets an additional layer of complexity when seller is under financial distress. Front and center, the parties need to consider the risks that seller’s creditors may seek to block or undo the transaction, or to hold buyer liable for seller’s debts.
Mergers and acquisitions of distressed assets are typically discussed from the perspective of buyer and seller. Those discussions may range from how each side can get greater protection from seller’s creditors (for instance, by agreeing on pro- or anti-sandbagging provisions, which regulate seller’s liability for contingencies known to buyet) and indemnity from the other side if such protection fails to ways of convincing antitrust authorities that the M&A deal will not adversely affect the market (the so-called “failing firm defense”).
Somewhat paradoxically, less attention is given to the perspective of creditors, which makes distressed M&A deals so complex. In most high-profile cases, creditors can see the writings on the wall, anticipate that debtor is about to become insolvent and prepare accordingly, but that is not necessarily always true, even for large and sophisticated parties.
Two recent examples come to mind. Few people in late 2022 predicted that leading retailer Americanas or Rio de Janeiro electricity provider Light would file for in-court reorganization (“recuperação judicial” – or “RJ”, similar to Chapter 11 proceedings under U.S. bankruptcy law). In 2023, both companies did, each of which under very peculiar circumstances: Americanas was dragged into a corporate and accounting fraud probe, while Light was legally forbidden from making an RJ filing and was preparing to request the renewal of its concession to the federal administration (the interaction with regulatory agencies and other authorities is per se a hot topic in the field of distressed M&A).
To begin with, creditor’s profile matters. Trade suppliers, banks and bondholders may have aligned or conflicting interests. Most claims are unsecured, but a handful of claimholders may have been granted a collateral, either over the asset which debtor intends to sell or another asset indirectly involved in the transaction. The type of collateral may also be consequential for creditor’s strategy: a contingent transfer of property rights as collateral (“alienação fiduciária em garantia” or “AFG”) will mean that the claim is not affected by debtor’s insolvency filing; an ordinary pledge will cause the claim to be ranked as a secured claim if the filing is made; a third-party personal guarantee will not suffice to upgrade the claim from unsecured into secured (although it may allow creditor to sue the guarantor if such guarantor has not filed for insolvency alongside the main debtor).
Additionally, three variables come into play when a creditor learns that its debtor is or will soon be insolvent and wants to pursue a distressed M&A deal: the nature of the asset (a controlling stake in debtor’s stock capital, control over a subsidiary, an asset, an organized set of assets); the structure of the transaction (a direct sale, subscription of new shares, a debt-for-equity swap); and, notably, the timing (prior to or over the course of an insolvency proceedings, such as an RJ).
After having appraised the broader context, creditor should make a crucial determination: whether to support or challenge the transaction envisaged by debtor, and to which extent bargain with either side of the transaction.
This context – factual background plus economic interest – is the starting point when devising creditor’s legal strategy and setting it into motion. Quite obviously, there is no one-size-fits-all approach to distressed M&A deals, but creditors should at least take note of some issues that they may need to face.
Upon an event of default, the holder of a claim secured by AFG will be able to elect to foreclose on the asset and therefore be fully or partially repaid, or refrain from foreclosing and voluntarily engage in the M&A discussions.
However, as comfortable (or less troubling) as this position may be vis-à-vis other secured and unsecured claims, there can still be pitfalls ahead. In the RJ of coffee producer Terra Forte, the São Paulo State Court of Appeals found that a claimholder whose claim was secured by AFG over shares issued by debtor is deemed a shareholder of debtor, and therefore may not vote its restructuring plan; the court also found that the contractual provision by which Terra Forte was required to seek one creditor’s prior consent to the restructuring plan is unenforceable.
A creditor who determines to support a transaction that is being carried out before any insolvency filing has been made should be careful not to seek to be paid ahead of the maturity date or in a manner that is different from the one originally agreed. These situations may be framed as preferential payments under the Business Insolvency Act and voided based on fraud if debtor goes bankrupt subsequently.
If creditor’s goal is to become a shareholder of debtor, it may want to submit a competing offer for the proposed M&A deal or lend money to debtor on a lend-to-own basis. This can take place before or during RJ proceedings. However, creditor’s position may be worsened by holding a minority stake in debtor. Not only does bankruptcy law prohibit shareholders from voting the RJ plan, the Superior Court of Justice has found that a creditor who is also a minority shareholder has no standing to appeal against the approval of the plan; that opinion was issued in the RJ of luxury brand retailer Daslu. In the RJ of sugarcane producer Renuka, the São Paulo State Court of Appeals went as far as to disregard the quorum set forth in the company’s by-laws and allow the restructuring to proceed as contemplated in the RJ plan against the will of a creditor who held 40% of the company’s stock.
If no insolvency filing has been made yet, creditors who wish to oppose the distressed M&A deal will usually argue that the transaction is fraudulent under the Civil Code. It is harder to build a fraud case under the Civil Code than under the Business Insolvency Act. Creditor will in principle need to prove that seller and buyer have colluded to intentionally harm third parties. If the underlying asset being transferred to buyer is shares issued by debtor, creditor may even have no direct recourse against debtor, as seller will likely be a shareholder and not debtor itself.
Even in such adverse conditions, creditors can find ways of disrupting the M&A deal or at least building a case for the longer term. If the claim is already being pursued in court, creditors may seek to pierce debtor’s corporate veil to reach seller’s (or its shareholders’ or officers’) assets. Alternatively, they may file a court application against the transaction (“protesto contra a alienação de bens”); this will not block the transaction but will notify buyer that the asset will be under threat in the future.
If debtor has filed for RJ, asset sales will need to be either contemplated in the restructuring plan to be voted by creditors or otherwise approved by the insolvency court on a case-by-case basis. In both cases, creditors who oppose the distressed M&A transaction have little leeway to act.
Should the transaction be contemplated in the restructuring plan, dissenting creditors can vote against it at the assembly and, if it is approved, seek to prevent or reverse its confirmation by the court. To that end, they should repeatedly state their position in clear and motivated fashion: once debtor has submitted the plan in court, they should file a written objection thereto; at the creditors’ general assembly, they should submit their dissenting vote in writing containing a detailed reasoning against the plan. These measures are important to mitigate the risk that the insolvency court later disregards the dissenting vote on the grounds that it is abusive (i.e., that its ultimate purpose is to undermine debtor’s chance of surviving the RJ).
In the case of a transaction submitted for court approval outside the RJ plan, creditors should seek to intervene before the court enters its decision. Once the court has allowed the transaction, creditors have limited ability to challenge it: in order to do so, they must amass claims representing at least 15% of debtor’s total indebtedness; they must post a security in an amount equal to the value of the sale and ask for a creditors’ assembly to vote the proposed transaction, as opposed to having the court undo it.
Creditors will be wise not to overlook key strategic decisions and hurdles in debtor’s distressed M&A deal, and to pay attention to details to better protect their interests in such a challenging context.
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