Distressed M&A on the rise: How to use deal structuring, stakeholder management and market standards to ensure a successful deal

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Sarah Wared
Wolf Theiss, Vienna
sarah.wared@wolftheiss.com

As could be expected, Austria's M&A market has been impacted by the Covid-19 crisis. Transactions that were already in advanced stages are either now finalised or are on track to being finalised. This is mainly because the targets were not significantly exposed to the crisis-driven downturn (eg, technology, healthcare and pharmaceuticals, and food). However, in the months to come, we expect an increase in distressed M&A. As we have learned from past crises, distressed deals have saved many companies that have since become successful. In reality, distressed M&A offers opportunities for buyers as well as for sellers, if they are prepared and know how to act swiftly.

In particular, experienced investors and crisis-proof strategic buyers with cash-reserves or an intact stock price are utilising high-profile collapses, as they are eager to purchase distressed targets at favourable valuations. Furthermore, the sale of non-core business reduces costs and simultaneously increases much-needed liquidity in times of crisis.

On 2 April 2020, the Austrian government issued a legislative motion announcing further amendments to the Austrian insolvency and restructuring regime. The motion, inter alia, regulates that the duty to file in Austria for insolvency resulting from over-indebtedness is suspended until 30 June 2020 if the over-indebtedness occurred after 1 March 2020.

However, directors are under the obligation to file for insolvency within 60 days from 30 June 2020 if the company is (still) over-indebted by the end of June 2020 or within 120 days from the date of the occurrence of over-indebtedness, whichever period ends later. This means the number of distressed M&A transactions may further increase after 30 June 2020.

Structuring is paramount

According to Austrian standards, a company is in crisis when it is:

• illiquid (unable to pay all debts when they fall due);

• over-indebted (the status of the assets of the company in a liquidation scenario and its future forecast on its continued existence are both negative; typically, over-indebtedness is easy to determine by comparing the assets and the liabilities of the company, whereas the forecast assessment on continued existence is a challenging task and must be based on a realistic restructuring plan); and

• facing the need for reorganisation (this need is assumed when the company's equity capital is below eight per cent and the (expected) term for the debt repayment exceeds 15 years).

Typically, the duty to file is triggered when a company is illiquid or over-indebted (material insolvency). Distressed M&A encompasses all transactions before or during the insolvency of a company in crisis. Depending on the phase of the crisis that the company is in when the distressed asset will be acquired, different rules apply.

The careful structuring of distressed M&A transactions is essential in order to reduce risks and increase deal security. The relevant party will need to assess whether the acquisition of the distressed assets before insolvency or the acquisition from insolvency is favourable for the relevant party. The buyer may have restructuring privileges to the extent insolvency proceedings have not yet been opened. For example, loans granted in the course of the acquisition of a stake in a company in crisis for the purpose of overcoming the crisis within the framework of a reorganisation plan may not be equity replacing.

It also needs to be determined to what extent an asset deal or share deal in a distressed scenario makes sense. In the course of an asset deal, the buyer acquires only the assets required, whereas in the course of a share deal, the buyer acquires the company with its entire balance sheet (including liabilities). Generally, a buyer of assets in a distressed M&A transaction will be interested in avoiding taking over any liabilities associated with the company it purchases. This is one of the main advantages of an asset deal over a share deal.

Managing stakeholder interests

The number of stakeholders in distressed M&A transactions is often higher than in other M&A transactions that are negotiated between the seller and the buyer. Distressed M&A is characterised by the need to find a resolution among the different interests represented by shareholders, creditors (banks), management, suppliers, customers and employees. Therefore, the success of a distressed M&A transaction depends to a large extent on the roles and actions of the parties involved and how these elements impact one another.

Dealing with time constraints

Companies in crisis must often be sold under extremely tight time constraints. Transaction documents are sometimes negotiated overnight; due diligence is limited to weeks or even days instead of what otherwise would have been months. Despite these tight time constraints, it is of critical importance to assess the risks and focus on and negotiate the issues in line with market standards applicable to distressed M&A transactions.

For example, the insolvency administrator is often unwilling to agree on extensive representations and warranties except for ownership and non-encumbrance of the assets sold, which applies to pre-packaged deals as well as to the ordinary sales process in the course of insolvency proceedings. Therefore, it is easier to handle time constraints and ensure deal security if all involved parties have the same understanding of the market standards.

In distressed M&A transactions, time is often short. The more prepared the buyer is, the quicker it can act to secure a successful deal.