M&A — CCAA: Has the Stalking Horse Left the Barn?
February 28, 2008
With the recent turmoil in credit markets cutting off access to acquisition financing, the sustained wave of M&A activity may be reaching an end. Further, with the US economy in difficulty and the strong Canadian dollar impacting Canadian exporters, 2008 looks likely to be a year that will challenge many businesses financially. Say "goodbye" to leveraged buyouts and "hello" to distressed company work-outs.
However, restructuring an insolvent company in court proceedings, typically under the Companies’ Creditors Arrangement Act (CCAA), is not always the best way to maximize value for stakeholders and preserve a viable business. Further, there are times when the complex compromises necessary to restructure successfully cannot be reached, or are unlikely to be reached within the available time. As a result, we may see a dramatic increase in the number of companies in Canada looking to sell their businesses within CCAA proceedings. If this occurs, there will be new M&A opportunities. For that reason, the nature of the CCAA sale process will be of interest to M&A players.
In CCAA sale situations, courts are asked to supervise the sale conducted by the CCAA debtor, typically under the guidance of a court-appointed monitor, and to approve the ultimate sale. The challenge in each case is to develop a sale process that will produce a purchaser who will carry on the operations, thereby preserving the business, and who will offer the best terms, thereby maximizing value for stakeholders in the circumstances.
Until a few years ago, Canadian court-supervised sales of insolvent businesses, whether in CCAA proceedings or in a court receivership context, followed a consistent ‘Canadian’ pattern. There was no formal auction. The seller (either the CCAA debtor or the receiver) conducted a process that approximated a private sale of the business. The process would include wide marketing of the opportunity, due diligence by interested bidders, submissions of expressions of interest, the selection of front runners and the final negotiation of a binding agreement for recommendation to the court. The courts supported this process by refusing to consider late over-bids. The Canadian view was that consideration of late bids made outside the process run by the CCAA debtor or receiver would undermine the seller’s credibility in the negotiation process.
In contrast, sales in US bankruptcy proceedings follow a very different process, one that often has two phases. The first phase resembles, in many ways, a condensed ‘Canadian’ process directed at a preliminary group of prospective bidders. Its objectives are to negotiate a form of ‘stalking horse’ agreement with a selected bidder and to obtain court approval of bid protections for that bidder, including a break-up fee and cost indemnity. In the second phase, the debtor company shops the stalking horse bid by soliciting competing offers, with the process culminating in a formal auction if one or more over-bids materialize.
Adherence to the traditional Canadian approach has led to a number of distinguishing features when compared to a US sales process. Because over-bids were not considered as a matter of principle, Canadian receivers/debtors were able to resist requests for bid protections and cost indemnities. Bidders paid their own advisor and other costs. Additionally, successful bidders were prepared to forego break fees because they were confident they would not be over-bid if they negotiated a deal that the receiver or debtor company and monitor were prepared to recommend to the court. However, the past few years have seen the introduction to Canada of the US stalking horse sale approach. There are two principal reasons for this.
First, with the increased frequency of Canada-US cross-border insolvency cases, participants and the courts have been challenged in sale situations to develop a process suitable for both sides of the border. Rather than insisting on a traditional Canadian process, courts in Canada have been showing considerable flexibility in approving stalking horse bid processes for use in Canada.
Second, the Canadian-style sale process has been substantially undermined since the recent British Columbia case of A&B Sound, a now-defunct record store chain. Prior to its formal insolvency, the company had attempted to attract a buyer. It became apparent that a formal filing would be necessary to complete a transaction. In the course of the process, A&B Sound negotiated with two interested buyers and came to terms with one of them. It then applied for approval of that agreement, but was met with creditor opposition despite the recommendation of the trustee and a new bid by the other bidder.
In the face of the opposition and the new offer, the court reopened the bidding process, and ultimately the new topping bid was accepted, much to the disappointment of the first bidder.
A number of facts about the A&B Sound case could distinguish it from a typical sale process. Nevertheless, it has become something of a watershed case. Because of the court’s decision, more and more potential bidders will require bid protections similar to those usually available in a US-style sale process.
As a result of these developments, it appears that the stalking horse sale process is here to stay, to be utilized in appropriate situations as an alternative to the traditional Canadian approach. Familiarity with CCAA proceedings generally, and with stalking horse sale processes in particular, will significantly benefit those seeking to participate in what looks likely to be the next wave of M&A activity — acquiring distressed companies.