Distressed M&A in Canada – Top 10 things a buyer needs to know

In the wake of the economic stress created by COVID-19, we have seen increased opportunities for buyers looking to acquire distressed companies and assets in Canada.  Increased deal flow in industry sectors that have been hit hardest by COVID-19, including retail, hospitality, travel, cannabis, and oil and gas has occurred, and with the passage of time other sectors will be affected. Distressed M&A transactions can be structured in a variety of different ways - a sale of shares, assets or debt or a combination thereof, and potentially through a formal insolvency process overseen by a court. This article addresses ten common questions buyers have when considering distressed M&A transactions.

1. Where do you source distressed deals? Someone interested in acquiring distressed assets will need to understand: (a) who the potential vendors are; (b) how to get access to these deals; (c) when to get involved in a transaction; and (d) how to successfully navigate the process. There is often low supply and high demand for "good" distressed assets, resulting in a highly competitive market for the best deals. Most distressed deals circulate within a small network of restructuring professionals including licensed insolvency professionals, investment bankers, private equity funds, special accounts units at banks, lawyers, chief restructuring officers and accountants. This network can be an invaluable source for buyers to gain access to distressed opportunities.
    
2. How do distressed deals differ from traditional M&A? Three key differences separate traditional M&A from distressed M&A: timetable, risk profile, and potential involvement of a court. 
   • Timetable - Distressed M&A often happens quickly over an accelerated timetable, which means buyers need to be well-organized and prepared to make key decisions rapidly – often over the course of days.
   • Risk Profile - Buyers frequently close transactions with the increased risks associated with limited due diligence, incomplete information, weak financial performance of the target and limited or no representations and warranties.
   • Court Involvement - Although many distressed M&A transactions are conducted through a formal insolvency proceeding overseen by a court, a large number of deals close outside of a court process as part of an informal or consensual workout.
      
3. What does a typical distressed M&A transaction look like? There is no "one-size-fits-all" acquisition structure in distressed M&A. Because each transaction is unique, prospective buyers of distressed assets need to look creatively at each transaction. A traditional path of purchasing assets might be appropriate in some cases, but creative approaches could put the buyer in a similar position while significantly increasing the chances of success. Potential transaction structures include purchasing assets, acquiring debt (either in respect of debt previously held by the purchaser or acquired by the purchaser immediately before the transaction), a "pre-pack" consummated through a formal insolvency proceeding, a hive-down transaction, or completing an amalgamation with the target.
    
4. What are the most common types of formal insolvency proceedings? The most common types of formal insolvency proceedings for corporations in Canada are proceedings under the Companies' Creditors Arrangement Act (the "CCAA"), Division I proposal proceedings and bankruptcies under the Bankruptcy and Insolvency Act (the "BIA"), and receivership proceedings under the BIA and certain related provincial legislation. CCAA proceedings and Division I proposal proceedings are in most cases "debtor-in-possession proceedings" where the company and its management remain in control of the company's assets during the proceedings up to and during the sale of its assets. In receivership proceedings and bankruptcy proceedings, the company's assets, on commencement of the proceedings, will vest in a third party receiver or trustee, as applicable, who will in turn negotiate and conclude any transaction as seller on behalf of the company's creditors and other stakeholders.
    
5. What are the benefits of completing a transaction inside a formal insolvency proceeding? In a transaction completed through a formal insolvency proceeding, the court overseeing the proceeding will have the power to issue an order (commonly referred to as an "approval and vesting order"), vesting out (i.e. discharging) all pre-existing interests in the assets being acquired including the interests of any secured and unsecured creditors of the seller. This allows a buyer to acquire assets free and clear of any third party interests, irrespective of whether or not the proceeds from the transaction are sufficient to pay out the seller's existing's creditors. A buyer and seller may additionally be able to use a formal insolvency proceeding to: (i) force the assignment of a contract of the seller to the buyer over the objections of the counter-party to the assigned contract; and / or (ii) right size the business by using certain statutory powers to terminate / disclaim unprofitable contracts of the seller notwithstanding that the seller may not otherwise have the contractual right to do so.
    
6. Are transactions outside a formal insolvency proceeding more risky? Under the BIA and certain supplementary provincial legislation (commonly referred to as fraudulent preference and conveyance legislation), a transaction completed outside of a formal insolvency proceeding can subsequently be voided or deemed void by a court at a later date if it is determined to have met the criteria of a fraudulent preference or fraudulent conveyance. This legislation, which is designed to prevent an insolvent seller from consummating a transaction that is prejudicial to its creditors, will have to be carefully considered in a transaction completed outside of a formal insolvency proceeding in order to properly understand, and where possible limit, the risks associated with this legislation.
    
7. What are the drawbacks of a formal insolvency proceeding? The potential rewards associated with a distressed deal come with an increased level of risk. Buyers, especially in the context of a sale in a formal insolvency proceeding, will not be able to conduct comprehensive due diligence on the target's assets. Due diligence will have to be conducted quickly and be limited to key aspects of the transaction. If a transaction is being consummated through a formal insolvency proceeding it is standard for buyers to receive limited to no representations and warranties from the seller (i.e. transactions are completed on an "as is where is basis"). It is important to note that a transaction in a formal insolvency proceeding will be on the public record regardless of whether or not the buyer or the seller is a public company. The court does retain and often exercises its power to seal certain deal terms from the public until closing, however the identity of the buyer is unlikely to be sealed. A transaction in a formal insolvency proceeding may be heavily scrutinized and, in certain circumstances, opposed by the seller's creditors and other stakeholders. A court will generally not approve a sale in a formal insolvency proceeding unless it has comfort that the assets being sold have been properly and thoroughly marketed and the transaction being proposed is in the best interests of the seller's creditors.
    
8. What kind of due diligence can a buyer do? Financial due diligence will be critical to assess the pricing and structure of the deal, as well as whether there are any potential deal breakers. However, legal diligence is also important and buyers should retain experienced advisors who can quickly identify and focus on the most material issues. In addition to the typical legal diligence requests, it is useful in distressed M&A to:
   • Identify, as fully as possible, the assets that come with the purchase;
   • Review key contracts and licenses;
   • Meet the management team (provided a trustee or receiver has not been appointed);
   • Consider third party consents; and
   • Examine other areas of risk exposure including environmental, employee and other common liabilities.

   For some buyers, transaction certainty and an ability to close quickly may be more important than completing fulsome due diligence.

9. What is a sales and investor solicitation process? In both formal insolvency proceedings and informal workouts, a seller may, as part of its restructuring process, undertake a compressive sales and investor solicitation process ("SISP") to solicit offers from potential investors and / or purchasers for all or part of the assets of the seller. In a formal insolvency proceeding this will often be done in accordance with an order approved by a court setting out the guidelines of the SISP. A SISP may or may not include a stalking horse bidder, whose offer to acquire certain or all of the assets sets a minimum bid threshold for the market, in consideration for certain accommodations provided to the stalking horse bidder including, in many circumstances, a break fee.
    
10. What is a buyer's first step? A good first step when considering a transaction with a distressed company is to hire legal counsel that are familiar with the insolvency process and are connected to the network of insolvency professionals in the target's jurisdiction. Gowling WLG has strong relationships with insolvency advisors, licensed insolvency professionals at the major accounting firms, investment banks and turnaround specialists, which can be drawn on where required.