Covid-19 provides opportunity for deals in distressed mergers & acquisitions: Torys

Nobody likes the idea of being an insolvent company dealing with the tough times of Covid-19. However, the Covid-19 pandemic has created a rise in opportunities to buy distressed assets, which could benefit both insolvent firms and potential acquirers, say members of the mergers and acquisitions team at Torys LLP.

“There still is a significant amount of money in the system,” says David Bish, head of Torys’ corporate restructuring and advisory practice. While potential buyers may be more cautious given the uncertainty caused by the pandemic, a low-interest-rate environment means those with capital are looking for ways to deploy that money.

“There’s not a shortage of those who have money to spend in the right circumstance for the right opportunity.”

At the same time, distressed companies looking for a lifeline may feel, like it or not, that their best option is to put themselves on the market, whether it’s inside or outside a court-sanctioned sale process.

Partner Konata Lake, whose practice focuses on M&A in general, not just distressed M&A, says in many cases, potential acquirers had been looking for opportunities even before the pandemic. However, they felt that the valuations were too high to make it a lucrative deal. Now, distressed assets offer a chance for these potential acquirers to “kick the tires and look at things that a year ago they felt they may not have had a shot at.”

Scott Bomhof, another partner in the corporate restructuring and advisory practice at Torys, says that quite often, distressed M&A is considered very specialized. Relatively few capital funds deal in this area because the distressed businesses often have underlying structural issues that need addressing.

However, given the economic climate caused by Covid-19, companies that never had underlying problems are also running the risk of becoming insolvent, either because of government restrictions on their businesses or changing consumer buying habits.  He noted that Torys is currently working on a couple of large retail insolvencies, including General Nutrition Centers and men’s clothier Brooks Brothers.

This situation can provide an attractive opportunity for new investors, not just those who specialize in distressed assets, as the assets potentially available don’t “need the high-level restructuring that often goes into distressed M&A.” These aren’t necessarily “bad” companies, Bomhof says.

All three lawyers agree that at this point, it’s hard to know whether what is happening to distressed companies these days is just the tip of the iceberg. And Bish notes that while some areas, such as retail, entertainment, and restaurants, have been hit hard by the pandemic, it is “certainly not sector specific.”

Bomhof says another factor at play is the amount of government money available — and not just in Canada — that is propping up affected businesses and consumers. “What will really be the tipping point is when markets don’t get back to normal in the three to six months,” he says, noting that government doesn’t have an infinite capacity to keep things afloat.  At that point, “if we’re in the same or similar conditions, there will be a much bigger wave of [insolvency] filings.”

Lake adds that while there have been more inquiries lately from potential buyers, there also is a “wait and see” attitude, especially as a second pandemic wave might come, and what does that mean. He also notes that timeframe and pressures are quite different in regular versus distressed M&A.

In a typical situation, the company owners decide it is time to sell, and they put themselves on the market. Or a potential acquirer makes an unsolicited offer because they like what the target company is doing.

In distressed situations, the target company is likely to have liquidity or structural problems threatening its viability. The scenario is also much more stressful, Lake says, and the timeframe is considerably shorter.  Bomhof agrees, saying that there typically is some trigger hanging over the company insolvency in distressed situations. “It’s a very compressed timeline,” he says, “with a lot of high-level decisions to be made quickly, within days, not months.”

Bish says that distressed M&A situations also offer an “extraordinary diversity of tools” that aren’t available in regular M&A cases. That is thanks to a court process that wields enormous power. Under the Companies Creditors’ Arrangement Act, a company can restructure its financial affairs deal with its debts and operations and emerge as a going concern. Or under court supervision, the company can sell some or all its assets to pay creditors.

“You can sell without shareholder approval, you can force the assignment of contract that would otherwise require consent to negotiate, you can reject parts of the business you don’t want, liabilities you don’t want to assume, employees you won’t need.”

Adds Bish: “The toolbox encourages incredible creativity because there’s so much more you can do that you would not be able to do outside of a court process in a regular M&A situation.” As well, the process ends with a court-granted vesting order that gives the purchaser “the cleanest form of title you can get, a title free and clear of liabilities you don’t want to encumbered with.”

Bomhof notes that CCAA filings are up 46 per cent in the last 12-month period compared to the previous 12-month period. “The effort to restructure businesses, or use a sale process through court supervision, has jumped quite a bit.”

As for who the potential buyers in distressed situations could be, Bomhof says there will almost always be some well-capitalized strategic players, “like the Apples and Googles of the world,” who will see the opportunity to expand business or grow their footprint. Any of these types of players will likely have beefed up their credit facilities in anticipation of an opportunity to buy.

Another, more likely, scenario, says Lake, is “that there are always pools of capital waiting for these opportunities.” They could be pension funds, hedge funds or private equity, all sitting on a lot of money who need to invest it to make a positive return.

“A zero-interest rate environment is not new, but Covid-19 has exacerbated the problem,” says Bish. “These pools of money need to find deals and transactions that offer meaningful returns,” and the potential to buy these assets at lower valuations is a big incentive.

As for how lawyers involved in distressed M & A should advise clients who are potential buyers, Bish says one of the most important things is making sure they understand that they need to “move much more quickly with faster decision making.”

There may also be a competitive sale process in an insolvency process that goes through the courts, such as a “stalking horse” bid in which a sale price is negotiated, but others are allowed into the process to increase that bid potentially, and there is no exclusivity preventing other offers.

Lake adds that the need for due diligence in a distressed M&A situation is crucial, as there may not be any recourse for protection once a deal is complete. “You need to be really comfortable with what you are buying, because the company you purchased from won’t be available to stand behind the promises they’ve made.”

No one wants to be a distressed business facing tough times, Bomhof says. And a potential buyer may be nervous, purchasing a distressed company, thinking there may be fundamental structural problems.

“But this is a different distressed market because many of these companies have all the fundamentals to do well. But they find themselves in distress because of these unusual circumstances, and which we all hope turn out to be temporary.”

Adds Bomhof: “But the main message is that one person’s distress is another’s opportunity.”