M&A in distressed assets on the rise, and appealing
Amidst the enduring aftermath of Covid-19 and the recent economic turmoil, distressed assets have become abundant in Vietnam. Thus, M&A in distressed assets is rising in Vietnam, especially for those assets developed with heavy debts such as real estate and hospitality sectors.
Acquiring distressed assets offers buyers appealing chances to secure assets at fire-sale price, yet it also comes along with inherent legal risks. The key to navigate distressed M&A substantially relies upon striking a balance between the potentially high commercial gains and the special legal risks peculiar to distressed assets. This article sheds lights on what buyers should be mindful of and how they can manage the key legal risks for the best possible desirable outcome.
What make M&A in distressed assets challenging professionally?
Generally, distressed assets are assets or companies that are in financial trouble that the owners need to sell or to seek financing for recovery or survival.
The key features that make M&A in distressed assets challenging include
(i) the need to get the transaction concluded and performed very fast;
(ii) difficulty in assessing the target’s chances for recovery, and accordingly its valuation;
(iii) the unlikelihood of relying on contractual, post-closing protections such as warranties and indemnities; and
(iv) sophisticated negotiation, due to the complexities of the involved parties e.g. lenders, creditors, contract parties/ suppliers, and in case of bankruptcy, courts and trustee.
The special difficulties demand special approach, structures, and skills. In this article, we will touch on the key points to help effectively navigate M&A deals of distressed assets.
Structuring: Asset deal or share deal?
Distressed M&A deals typically require completion within a truncated timeframe to reduce deterioration in the target’s value. As a result, buyers usually can only afford the opportunity to conduct a limited due diligence. In a share deal, limited due diligence may not encompass all aspects of company’s operation. Therefore, buyers may potentially face a broader spectrum of risks. That said, choosing to sell shares in a company, as opposed to its assets, usually accelerates the process, reducing the complexity of documentation requirements, and potentially leading to more favourable tax treatment for the sellers.
Meanwhile, in asset deal, buyers can more readily cherry-pick asset of their interest. Since the focus of the deal is confined to specific selected assets, the burden of due diligence is reduced. However, when compared to share deal, asset deal is more susceptible to “claw-back risk”, wherein undervalued asset transfer occurring within a specific period before bankruptcy initiation can be declared invalid by the Court.
Mitigating risks by way of due diligence: fast but not furious
One common characteristic of distressed M&A transaction is to transact on “as-is, where is” basis. As a result, when compared to a standard, ordinary M&A transaction, the safeguards and other contractual protections available to the buyer in acquiring distressed assets are very limited. When buyers cannot expect to rely on post-closing contractual protection, it is better to identify the risk before closing – Thus due diligence can help.
However, the challenge is time. Given the needs of many stakeholders involved in distressed assets, there is very little to time to investigate the target. Due diligence needs to be conducted skillfully i.e. focused rightly, and performed promptly.
To manage risks within a constrained timeline, legal due diligence should be conducted on an exceptions-only basis, focusing on specific areas that are likely to trigger material risks or could potentially derail the transaction. One of the options is to employ a risk-based approach. For example, for a share deal, legal due diligence should aim to identify material risks falling within the following groups (and by this order of priority):
Risks potentially derailing the intended acquisition or necessitating significant adjustments to the deal structure (e.g., foreign ownership limits, legal title and status of the shares, target insolvency status, and third-party rights triggered by the intended acquisition)
Risks potentially resulting in business suspension or termination of the target (e.g., material non-compliance that could lead to key license revocation or suspension)
Risks potentially resulting in substantial administrative fines (e.g., non-compliance that could result in fines surpassing a pre-identified acceptable threshold)
Risks potentially causing a substantial decline in the target’s value (e.g., adverse or unfavourable contractual clauses or incidents that could result in premature termination of key property leases, employment of key personnel, business relationship with key supplier and customer)
Mitigating risks by using professional valuation and competitive bidding
In the context of an asset deal, claw-back risk can be somewhat mitigated by way of (1) obtaining professional valuation from a recognised appraiser for asset; or (2) the seller implementing a competitive bidding process to determine the highest and best offer for the asset. Both approaches can provide a robust evidence should the Court question the legitimacy of the transfer. However, these strategies can only help mitigate the risk, not eliminate it. Additionally, from a commercial standpoint, these approaches may be not advantageous for buyers, as they often prevent buyers from acquiring assets at a favourable price.
Mitigating risks by using bridging loans
Another approach is to minimise the risk that the seller becomes insolvent within a period during which claw-back risk may arise. This could involve using bridging loan, mandating debt restructuring as a pre-condition for the sale or a combination of the both. Particularly, under Vietnamese laws, a company is considered insolvent, and may face possible bankruptcy filing, if it fails to meet any of its payment obligations within 3 months from the due date . Meanwhile, any asset transfer within 6 months before the initiation of bankruptcy proceedings by the Court may be subject scrutiny for potential claw-back risk.
In light of this, the buyer may opt to facilitate a bridging loan for the sellers to cover liabilities that are about to become overdue by more than 3 months. The proceeds from the loan could be set off against the consideration for the asset transfer. Alternatively to, or in conjunction with bridging loan, the buyer may require the seller to implement debt restructuring to reschedule the debt. This approach should aim to mitigate the risk, at least for 6 months following closing, that the seller is unable to settle any debt within 3 months from its due date.
Mitigating risks by using locked-box mechanism
When it comes to determining the consideration for the transaction, the locked-box mechanism tends to be adopted more frequently than the closing account mechanism. This preference is primarily rooted in the time sensitivity of distressed M&A deals. The locked-box mechanism expedites the consideration determination process, enabling the seller to promptly access cash to address debt settlements with creditors.
Mitigating risks by managing consideration, closing conditions and warranty insurance
When selling their assets on “as-is, where is” basis, typically the seller does not offer warranties and indemnities. In this case, the buyer often needs to rely heavily on valuation assessment and the ability to walk-away from the deal. These aspects are often integrated into the definitive agreements as considerations and closing conditions.
Closing conditions play a pivotal role in these transactions. Given the urgency in deal execution, most, if not all, closing conditions should be achievable by the sellers within a short timeframe. Conditions that require extended implementation periods are often factored into the valuation considerations. A material adverse change (MAC) clause is also often included as a closing condition. MAC grants buyers a degree of flexibility, allowing them to respond to unforeseen adverse developments that could significantly affect the transaction. As negotiations progress, sellers tend to seek the minimisation of closing conditions and might even aim to eliminate MAC-related termination rights. This strategic approach aims to maximise deal certainty, considering that a failed deal might leave the seller with limited time to explore alternatives, potentially pushing them toward the brink of insolvency.
Furthermore, warranties and indemnities insurance may help. Particularly, while buyers typically cannot secure indemnities directly from sellers, buyers may still be compensated for breach of warranties if warranties and indemnities insurance have been obtained from reputable insurers.
In short, while distressed situations present opportunities for buyers to acquire assets at highly appealing price, they also give rise to particular risks associated with opportunistic acquisitions. To manage these risks, it requires appropriate approaches, suitable strategies, and skillfully conducted actions, to beat the tight deadlines and seizing the opportunities.
*Disclaimer: This Briefing is for information purposes only. Its contents do not constitute legal advice and should not be regarded as detailed advice in individual cases. For legal advice, please contact our Partners.