How to Navigate Bankruptcy and Restructuring in M&A

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I'm Kisan Patel and you're listening to M&A Science where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A Deals. Hello M and A Scientist. Welcome to the M and A Science Podcast. This podcast is part of a mission to rethink how M and A is done. The old school seller led approach. It's dead. Buyer led. M and A is about strategy, alignment and efficiency. Putting value creation at the center of every deal. Let's freereal is not just about closing the deal, it's about making it successful.

We uncover what truly works in M.

And A by learning directly from the best. If you're ready to challenge the status quo, ditch your outdated methods and learn how to minimize risk while maximizing value, you're in the right place. For episodes, resources and tools to elevate your M and a game, visit mascience.com I'm your host Kisan Patel, founder and CEO at Dealroom and chief scientist at M and A Science. Joining me today is Ben Beller, partner at Sullivan and Cromwell. Sullivan Cromwell is a top tier global law firm known for its expertise in handling complex legal challenges across 7A finance, restructuring and litigation. With a legacy of advising industry leaders on high stakes transactions, the firm combines deep legal expertise with innovative solutions for clients worldwide. Today we're going to talk about how to navigate bankruptcy and restructuring in M and A. Ben, thanks for hosting live here. Sullivan Cromwell Headquarters, New York Headquarters.

That's right, headquarters.

Thank you for being here. Thanks for having me on. It's nice to have it be just down in a couple floors from my office. So this is great.

Try to make it convenient.

You did it.

Can we kick things off a little bit about your background?

Graduated law school in 2013. I went right into bankruptcy and restructuring work at my old law firm. I came over to Sullivan and Cromwell in 2020 right in the middle of the height of the pandemic, which was a really interesting time to change law firms. But of course to be in the bankruptcy and restructuring space, there was a lot going on and it's been a great run here for going on five years at S and C. Had the opportunity to work with just an amazing roster of clients. Debtor representations which we'll get into. Creditor side representations, really everything in between, the full gamut. We have a great practice here and I'm honored to be part of it.

This is great. I get your perspective from all sides of bankruptcies. I know you worked on some like really high profile deals.

Yeah.

Can you mention some of them?

Sure. Lots of people know that we represent the FTX debtors in their bankruptcy case, which filed in November of 2022, and that's been all over the news for two and a half years. That case confirmed a bankruptcy plan late last year and emerged from bankruptcy just this month. Earlier this month, which has been a great accomplishment for the team and for the company and for everybody involved. And it's a great outcome, we think, for creditors and for stakeholders. So that's probably the highest profile in the last few years. We've also worked on as debtor counsel in the Silicon Valley bank bankruptcy, which the filed shortly after the crypto wave and that had a successful emergence from bankruptcy last year. On the creditor side, which is an important part of our business, important in growing. We've been involved in the Mallinckrodt bankruptcy, both bankruptcies, another one that had a lot of attention on it, given the opioid exposure there. We represented one of our great private credit clients and we have a roster of private credit clients that we've been doing work for over the years in a lot of bankruptcies that we can get into. And of course, there are representations that aren't in Chapter 11 bankruptcy and are out of court restructurings, which don't always get as much attention for good reason. And that's part of the point. And those are also very challenging and rewarding cases to work on because of course, you're trying to keep the company out of bankruptcy for a reason.

And those don't hit the headlines.

Those hit the headlines when we want them to. As some of my partners like to say, that the best deals leave no fingerprints. The Chapter 11 always does. That's a fully public process. You're always in the spotlight on those. But it's a mixed bag for us since we do everything. We have a generalist model here. We do in court, out of court, all across the capital structure, company side, we get the full picture.

Let's start with the basics. When I think of bankruptcy, there's a lot of chapters. There's chapter seven, chapter 13, your primary focus. Chapter 11?

Yeah.

What's the difference?

Chapter 11 is our primary focus. It's the primary focus of all law firms like ours. Chapter 11 is the most fundamental reorganization, chapter or type of bankruptcy for companies. So a company that has a viable business and looking to restructure and reorganize through a bankruptcy is going to file for chapter 11. Chapter 11 can also be used for sales and liquidations of a type. But in chapter 11, the company stays in control the chapter 11 is run to preserve value and maximize value through some sort of process. Chapter seven on the other hand is a straight liquidation type of bankruptcy. That one is also for companies, but that's when the company has no viable operations to continue. And what's called a Chapter 7 trustee gets appointed and basically liquidates the business. Fire sale type asset sales, brings some litigation if there is any to be brought and trying to just eke some dollars out for creditors. Chapter 7 in some ways is always a specter when you're talking about chapter 11. Because a chapter 11 done wrong or chapter 11 that goes wrong can turn into a chapter 7. But chapter 7 should never be the goal. And chapter 13 is really for individuals. That's for individuals who typically have income and can use the bankruptcy process to pause all the maybe litigation, maybe collection actions that are from people that they owe money to and pause all of that come together, figure out payment plans and get their finances back on track.

Okay, so 13's personal between 7 11. Most of it's 11 7. If company's total fubar. You just do like a pure liquidation. That's what chapter seven is. But most of it's on a chapter 11 where you're trying to get the most value for it. The company can come out restructuring, come out of chapter 11, perform again or figure out the best solution to get the top dollar.

Our focus is on chapter 11 tend to be the most complex. Multiple stakeholders negotiating with organized groups across the capital structure. And that's when large firms like ours will get involved and can help figure out solutions.

What are the scenario differences between the reason why a company would go into chapter seven opposed 11 chapter seven is.

When the company basically can't has no operations to continue. Either they've lost all of their contract, their customer contracts or all of their employees are gone or there's really no future for the company. So there's not going to be a going concern sale. There's not going to be anything to reorganize around. You need value really to use chapter 11. Chapter seven is when you're just stripping it for parts. There's no real value to be left. You can think about Chapter seven is a little bit of a different context than we usually work in. But if you have some sort of construction general contractor, terribly capitalized business really has no inherent value other than the contracts that they have to do the work and get paid for it. And this happens all the time is that general contractors file for Chapter 7 bankruptcy. They're selling the van, they're selling the tools, maybe there's a little bit of litigation to be brought, but that's just an organized way to wind up and liquidate the company without paying creditors in full. In chapter 11, the company is typically relatively strong and it just needs to deal with its capital structure. Now, there's exceptions to those where the company, despite seeming like it has value, really can't sustain a Chapter 11 process. And that often is the case. For example, service providers, accountant firms, those kinds of companies can't really survive a chapter 11 because their customers aren't going to be around sticking out through the bankruptcy. But most companies can if they've done proper planning and if they have frankly engaged advisors who can help navigate these things early and figure out strategies, figure out what's the best value maximizing type of transaction, engage with creditors in a constructive way rather than a destructive way, there's a path through chapter 11 that can really reserve the company, preserve jobs very importantly and preserve value for stakeholders.

Many more, because I noticed that chapter 11 some go in and come back out and some don't come back out. What makes it a successful process for company to continue?

Well, often it's about planning, because what ends up happening is a company that doesn't plan in advance loses optionality. The more planning, the earlier you do it, the more you're strategizing with advisors, the more you can engage with stakeholders. And that's the name of the game. Chapter 11 is all about gathering as much stakeholder consensus as you possibly can while preserving the value play for those stakeholders who are either investing new money or compromising their claims, exchanging their debt for equity. A company that waits until they're basically out of money, you've lost a lot of all of your optionality. You're desperate for money, you don't have the ability to negotiate. You're just kind of dead in the water. But a company that says, look, we're going to have this upcoming maturity in 18 months, or right, going to have a liquidity issue in 18 months or 24 months, you can start planning even that early about how are we going to deal with this? Are we going to do some sort of liability management transaction? We can talk about that. That's a hot topic in the bankruptcy and restructuring space these days. But are we going to do some sort of liability management transaction out of court, see whether that can solve some of our problems? Are we going to look for new money? Are we going to do debt financing? Is there an opportunity for equity financing? How are we going to use the Toolbox. That's what it's all about, to preserve the company and maximize value. And sometimes those things don't work. And then you say, okay, what's our plan B? We call it contingency planning. The contingency planning is what happens if all of our plan A doesn't work out. We can't raise financing, we don't get to a deal with our existing creditors to do some sort of out of court restructuring. Then you start talking about chapter 11 and chapter 11 again. There are options. Are we, do we have an option for a prepackaged bankruptcy? Prepackaged bankruptcies are short, they cost less money, which is a huge problem in bankruptcy these days. The exorbitant cost of going through a bankruptcy process, chapter 11 process, can we do a pre pack? Prepackage is when you don't impair any unsecured creditors, meaning all of the unsecured creditors ride through the bankruptcy. It's as if they were the bankruptcy never happened for them. That's when you have relatively simple capital structure. You have a cooperative lender or set of lenders in your secured debt and you're doing some sort of transaction, usually equitizing their debt through the prepackaged bankruptcy and the company can just continue on. That can often be a great outcome for all of the stakeholders. But not all the cases are as easy as that. You have different types of bankruptcies where you can file with a lot of consensus. Still not quite a prepackaged level of consensus, but a lot of consensus. And you're running some three or four month process to impair unsecured creditors. Likely do some sort of exchange with your secured creditors, maybe have some fights along the way and then you emerge. So all of these are the options and you have to be thoughtful early about what the best route is and you have to be able to toggle. That's the other big thing. The earlier you start, the more the better situated you are to toggle when one route doesn't pan out. So the ones that end up in real trouble, poor planning, overly aggressive to start out with in some way, and working well with your stakeholders to garner consensus. And at the end of the day, some of these companies, when you say don't come out, they might have to toggle until a Chapter 7. That was the SmileDirectClub, for example, case that had to turn into a Chapter 7 even though it was filed as a Chapter 11. And there were issues with that case. And that might be interesting to some of your listeners, but most of the Time you see a chapter 11 filed by some of the typical players in this space, there's going to be a route out. It's not always the success that they hoped it would be when they filed. Sometimes it takes longer, sometimes it goes a different direction. But one of the most important things when a company is thinking About a Chapter 11 bankruptcy is how are we going to get out?

Okay, we got a lot of things to talk about. We have the planning process itself. I want to get more specifics there. You mentioned liability management transaction, doing some kind of debt or equity to raise. And then a prepackaged bankruptcy is also another one. Let's make up a scenario here. Let's say I raised the money, took on about $10 million of debt. Should we throw in like another secondary on there to make you want to.

See how complicated you want to make this?

We got a little secondary on there. Let's say what, $10 million of primary capital that we borrowed from a good institution and then we had some secondary line of credit. Is that like a common secondary?

Yeah, sure.

Let's say a couple million dollars.

Frankly, usually the numbers have another zero or two zeros on them from 10 and 2, but we'll work with 10. 10 and 2 is easier for my lawyer math anyway.

Exactly. It's easier for me of whatever encounter. So, okay, simple math here. So what is our payments on something like that $10 million loan? It's not that high. It's going to be maybe, let's say 150 a year or something.

I believe you.

Simple math, made up math. And then we're breaking even. Like we, we don't have money, we're losing money. We don't have money to pay off the debt, we don't have money to pay off the secondary. We just had a bad year, missed our growth targets, lost a key customer. It was a really rough year. And I want to click into the planning part because I'm trying to get a sense of that line of sight, because you say planning. But a lot of the stuff I realize in the real world tends to be easier said than done. So what are these things that you start sensing we should start planning it as early as, hey, this looks like it's going to be a rough year. Where does a planning process start?

Well, the company's planning process should be, from my perspective, an ongoing thing. Most of the management and the CFOs out there are constantly staying up at night because they're worried about liquidity and they're wondering about the next raise and all of that. So for those folks, they're probably always in planning and contingency planning mode. The more fundamental question is when do you start engaging with others outside of the C suite about these issues about what's going on at your company? From my perspective, as someone who often does a lot of creditor secured creditor work, we represent a lot of private credit lenders in mid sized, mid market companies, knowing your lenders, having a relationship with your lenders so that you can then go to them and say, look, here's the situation, here's why the situation is what it is and here's how we want to solve it. That goes a long way in getting your lenders to buy into, then what you want to do, showing that you are thoughtful about it, that you have a good reason for why this company is in the situation that it's in and that you're looking to work cooperatively with them to solve the collective problems. That goes a long way and it's going to smooth the road because you're going to need those secured lenders on board one way or the other for the most part. From my perspective, once you see the writings on the wall, you shouldn't wait.

Get ahead of it.

You should be getting your advisors, whoever the advisors are, up to speed and you should be proactively managing the situation. Because the other thing that has a huge impact on all of that is your employees and your customers. You lose one key customer, that happens, but you start having more fundamental issues. You start having employees worry about what's going on. You can have employees start leaving. Other customers can hear that there's serious problems. They can start pulling their contracts. Vendors can start saying, okay, instead of having you on 30 days or 60 days payment, I'm going to make you put up cash on delivery. All of those little things are straws. And the straws can break the camel's back and it can be a cascade. You got to get ahead of that cascade.

Lenders can be different when you borrow money. Some could be like cold hearted loan sharks and they want their money. Might not send somebody to break your knees, but they sort of are pretty tough on where they stand. And then others may be more relaxed and flexible. Where do you see that? Like what types of lenders fall in what category?

This is the point. You have to know your lenders and you got to know your lenders when you're taking their money to begin with.

How do I know that?

Like right, right now I'm shopping for some debt and I'm not even thinking about this. I'm just thinking about pure interest number, getting the best terms possible. But this is a good point is, hey, when you need the help, do you have a friend in your corner or do you gonna sort of have somebody else that's gonna be after you? How do you get a sense of that early?

It depends on where you are in the market. If you're a huge company, the lenders that are able to write significant checks, they're pretty much known in the industry. And any debt finance lawyer, my debt finance lawyer, you know, partners can tell you left, right and center about how all of the lenders in the market behave. And if you're talking about, are you talking about banks, are you talking about private credit? The rise of private credit over the last 10 years has changed the face of this a little bit. Private credit lenders on the one hand can.

When we say private credit, we're talking about like these actual structured funds that are essentially doing these type of debt placing debt and they're cash based or.

Oh yeah, yeah, yeah. It's just as a comparison to large syndicated bank loans basically and where the regulation is a little bit different and the underwriting standards are different and how they deal with their investments are different. But of course there's differentiation between the private credit lenders. You gotta know your lenders, that's why engagement with them, even in non distressed times is an important step for any company that you know that when push comes to shove, you have a sense of where they're gonna be at the end of the day. All these lenders are economic animals. They have made an investment, they have underwritten that investment with diligence, and they wanna see that investment play out the way that they intended it to. Different lenders may take a different approach to achieving that goal. But for the most part, lenders are not in the business of foreclosing on assets. That's not what they want to do. That's their remedy at the end of the day. And one of the things that we counsel our lender clients about is you got to remember at the end of the day, that is your remedy is taking the assets. And it can be very difficult in certain kinds of industries. Regulated industries like pharmaceuticals. We've had a number of cases here. You can't just go take someone's pharmaceutical inventory and put it in your garage and then sell it. There's a ton of regulation about how it has to be stored. So that's a difficult position for a lender to be in having facing foreclosing on pharmaceutical drugs, that's not a great position to be in. Most of the time lenders don't want to foreclose. That's the total nuclear option. Now different lenders will take different approaches in how they engage in the negotiations about how to avoid that foreclosure. Some will be more aggressive, some will be willing to take equity, some won't be. You got to know whether your debt is held by clos who really can't hold equity. Equitization for them is not that great an option. And that's why debt trades. Debt trades from banks, trades from clos. It trades to people who are a little bit more agile and able to come up with creative solutions that can take equity, that can take warrants, and are happy to do that if the value is right. But at the end of the day, these, all of these lenders are economic animals who want to get paid back. And the earlier you are engaging with them about ways to do that, the.

More again, optionality options and you'll get a sense of their appetite and how they want to negotiate.

Exactly. So many first conversations that we are involved in, whether we're on the company side or on the lender side, is saying to the other side, what are you looking for here? What do you want? Because maybe you want something that I want too. Maybe we can figure out how to get to yes. That's the element of the, of a restructuring is getting to yes. Can't always do it. If you're the company and your lender wants to take your company for cheap so it can merge your company into some other portfolio company of its to benefit that company, maybe there's no deal to be made there. But for the most part, if the lender says, look, I want to figure out a way to get my money back, the company is saying, well, let's do that. And I'm not going to give up the ghost to do that for you. I'm not going to give you all the value. I'm not going to give you $200 million worth of equity when your loan is only 100 million. But maybe I need to give you something that really could have a lot of upside. If all things go well, we align our incentives and we can move forward into a different kind of chapter. So everybody has to be a little bit more open minded. They have to be willing to accept outcomes that maybe they didn't foresee two years ago, five years ago. If you're dealing with a founder of a company, that can be very challenging but the name of the game in restructuring is figuring out how to benefit everybody in a way that works.

Is there a strategy of dragging things out so be more aggressive to negotiate where the bank lender doesn't want to go through a bankruptcy process because it's headache for everybody. Wait till it's sort of a like, I need you to cut down this debt or sort of use as leverage to reduce the debt.

Definitely timing is a huge element of this. Again, this is part of planning is when do we go? It's not just I'll go as early as possible, it's when do we go and approach them and what is the situation that what is the proposal that we approach them with? Companies tend to wait too long because they are usually unfamiliar with bankruptcy, are concerned about the impact of the business. Often the people, the decision makers frankly have equity at stake and want to preserve equity, which is sometimes a challenge to do in bankruptcy. They're often waiting. They want to drag things out as long as possible. But what we see is sometimes lenders jump the gun and lenders will go too early and they will put the company into a. The company doesn't have to do a transaction. Maybe they would in six, 12, 18 months. But going too early can actually harm the process and make it more difficult. If the company says, you don't have any leverage over me right now, there's no default.

Chapter 13, the lender. Yeah, they can. No.

Well, I don't mean to initiate the Chapter 11 case, but to initiate restructuring discussions. What often happens is these kinds of situations. The company's doing fine. The debt is trading publicly at a fine price, not distressed, not stressed. And then something happens. The prices come down, the debt trades, it trades. The people who are practiced in the world of distressed investing, they buy the debt up at a relatively cheap price and then they're ready to act. They're ready to engage with the company to then turn their 50 cent paper into 75 cent paper.

That's a whole other element. Somebody could actually sell this debt for cents on the dollar. Now you got to deal with somebody that's more ROI driven.

Right. And debt trading is a whole topic that is very important. That's been a really interesting. And it's been pretty well covered in the FTX case where this wasn't financial debt that was trading, but there's just regular claims trade. Customers are able to sell their customer claims in the open market and there's a lot of funds that very early on in the case went and bought up a ton of Customer claims on the public market, on the open market, and have turned that into a very successful return on investment. But yeah, all of the publicly traded debt for these, for large companies gets bought and sold and traded, and it usually makes its way into the hands of people who are familiar with restructuring, familiar with the bankruptcy process. Not necessarily vultures, not necessarily lenders who are want to do wrong by the company, but people who know their way around the system and can use the system to their advantage. They might come in and say, okay, I'm ready to engage with the company about what a restructuring looks like. Because the debt is trading low, the company has serious problems. The company needs to face these problems and we're here to help, but we're not going to be here to help forever. So the company needs to engage with us now. And then the company has to say, okay, what are we going to do? What are our options? What kind of leverage do we have? Are we willing to engage with them right now? Do we feel like we need to wait until something that's on the horizon has happened and then we're ready to engage? So again, this is all the strategy and each case is different and each situation is different. You gotta know who you're dealing with, you gotta know how you're gonna do it, and you gotta start thinking about it early.

Okay, Timing is gonna be a big thing, early planning. But even with that, there's still element of timing. Going back to our private debt case over here, example that we still try to get a sense of early, of what we can do. We probably strategize, even get some outside perspectives and what are different things that we could propose, hopefully try to clear things off early. But if that doesn't happen, one of the elements too that you mentioned, maturity. So here's a debt that sort of has an end date that needs to pay out, basically, yeah. And then that sort of, you can get a sense of planning, then that, hey, here's something that's going to come up and we need to act on it. It's like not natural just to try to refinance that debt.

And it is. The problem becomes when you can't refinance.

It because your overall picture doesn't look as good.

Exactly.

So they said, hey, nobody wants to refinance this debt. We got a problem.

Either nobody wants to refinance it or the price is not right and for whatever reason you can't refinance it, then you have to say, okay, what are we going to do?

Now when you said liability management Transaction. Tell me more about that.

This is something that it's become a phenomenon a little bit in this business and in the restructuring tabloids or whatever you want to call them. There's a ton of focus on all of this and it started to make its way into the more other financial press. I don't know if it's familiar to you and your listeners from the M and A side, but basically it's when typically a private equity sponsor, although it's not only for private companies, it's also for public companies, but the owners of the business engage in some sort of transaction to manage their liabilities as the name suggests. And you can have liability management transactions that are plain vanilla. You would just call restructuring or exchanges of debt. But what people really mean when they talk about liability management transaction is some sort of either coercive transaction with a subset of your lenders that favors those lenders over other lenders, involves amendments to the debt documents, involves super senior issuances, drop down transactions, up tier transactions, double dip transactions. These are all the words that have come into the vernacular in the restructuring space over the last 10 years, which you can probably have a whole nother podcast on, frankly.

Can you tell me what some of those mean? I never heard any of them. Drop down.

People love catchphrases and that's what these are.

I love learning these catchphrases.

Under a typical debt document there's all these negative covenants about what you can and can't do as a company and your company group. And it's can't just go dividend all the money. We give you up to your equity owner and it's you can't go out and raise $1 billion of debt. Senior to US or even Perry Passu with us, or maybe even junior to us.

Perry Passu equal in ranking, equal rank. Okay.

This is a whole negotiation that happens when you're entering into this debt. And the negotiations are different again whether you're in the private credit market, whether you're in the syndicated loan market. These are all the S and C capital markets, finance, leverage finance folks like my partner Ari Blaut and Neil McKnight, they're the ones that are typically negotiating all of these things when the debt is issued and it's a whole negotiation between the lenders and the company about what you can do. Years go by and the company is maybe facing some distress or stress and people start thinking my debt, even though it's senior secured, is trading at 60 cents on the dollar. If I exchange my debt and Somehow get senior on some assets that get moved. And even if I exchange that into a smaller amount of principal, I can turn my 60 cents on $100 million into 80 cents on $90 million. The question is, how do I do that? Within the restrictions of the debt documents, dropdown transaction is moving assets in the collateral package for your existing debt into typically a newly formed subsidiary that itself then issues debt to a subset of your current lenders. Where the lenders are exchanging their current debt, they're getting the new debt. Usually there's a new money component which makes it worthwhile for the company because they're getting some incremental financing that they probably wouldn't otherwise have been able to get in the public market. And the lenders themselves have benefited because they've just on paper increased the value of their debt. And there's all these different iterations. That's a drop down. Up tier is, let's say you have unsecured debt, unsecured convertible debt, and let's say there's $500 million of it and I own $100 million. I take my $100 million of unsecured debt, I exchange it for secured debt in a lower amount, $75 million, $65 million, I give some new financing that's also in that secured debt piece. And all of a sudden I've gone from unsecured to secured. So I've uptiered my debt. The company again has gotten some liquidity and those parties maybe are perfectly happy. Of course the people who are left behind might say, what's this all about? These liability management transactions, when they're super aggressive, have brought a lot of litigation. So the Certa Simmons case, which was a liability management transaction, went into bankruptcy as often the aggressive liability management transactions do, by the way. And then there were, there was litigation in the bankruptcy case. It went up to the 5th Circuit. This was a case that got a lot of attention in the industry because the fifth Circuit basically said that the transaction was not permitted. And that's just contract law. This is just interpreting the terms of the debt documents and whether what was done was permitted or not. And so this is again why, having leveraged finance and restructuring lawyers at S and C, we have a generalist model both at the firm, but also in the finance and restructuring group. The finance and restructuring lawyers are doing both the liability management transactions and the out of court restructuring and the in court restructuring. A one stop shop being able to navigate the debt documents in creative ways, but in ways that are going to work. This Goes to your point about a chapter 11 can't just do a transaction and say, well maybe it works, it's got to work. Being able to structure these transactions has become very important to companies who are looking for ways to avoid chapter 11. Bring in some liquidity. But of course there's always a risk of litigation and that has its, has its own. You got to make the cost benefit analysis.

Yeah. Quite creative. Between this example of a drop down, up tier.

Well, I wish I had invented all of this. People have been doing these transactions for quite some time. The another famous, you know, you hear the names. J Crude was a very famous one of these that had a litigation over it. A lot of retail cases frankly. But it's not just retail. This has become part of the industry and frankly it's become a huge part of the industry. And one of the reasons that people say bankruptcies over the last couple years have actually not being as high as historically they tend to be is because of the rise of the frequency of liability management transactions and those largely deferring bankruptcies. Because as I said, the aggressive liability management transactions almost always end up in bankruptcy anyway, even though they're intended to avoid it. Those cases still file for bankruptcy. But it smoothed out the waves that we were used to seeing post financial crisis in 2000, call it 2014-2019 with oil and gas wave retail waves. Those are kind of in some ways been smoothed out by these liability management transactions.

You mentioned earlier, prepackaged bankruptcy.

The way we think About a chapter 11 is you have three types. You have a prepackaged bankruptcy, again we love jargon. Prepackaged bankruptcy, prearranged bankruptcy and a free fall bankruptcy. Free fall bankruptcy is in some ways the easiest to understand. That's when you basically have none of your stakeholders on board with what you're using the chapter 11 for. Often those are filed in an emergency situation. Lehman is a classic free fall bankruptcy. FTX classic free fall bankruptcy. Because those were filed under circumstances where the most important thing was to get the company into chapter 11. And then you figure things out from there. Prepackaged bankruptcy is something that everybody should be thinking about when both on the company side and the lender side, when you're evaluating restructuring options. Because the prepackaged bankruptcy is the least expensive chapter 11. And as I said earlier, bankruptcy has become very expensive. And we can talk about why. But part of it is that the company is paying not only for its advisors, lawyers, bankers, often financial consultants, independent directors and all of that. It's also paying the fees of the official committee of unsecured creditors, which is a statutory body that gets formed usually early in the case to represent unsecured creditors. They have lawyers, they have bankers, they have financial advisors. Typically the company's secured creditors are also having their lawyers and sometimes a banker's fees paid. The company is taking on a huge professional fee cost to do the bankruptcy. So the juice has to be worth the squeeze. It has to be worthwhile to pay $20 million, $30 million in at least in our world, chapter 11, professional fees to do the transaction. And that's a question for the stakeholders, the creditors, the lenders who might be equitizing their debt through the bankruptcy may say it's not worth all of that. And maybe they just do some sort of out of court transaction. Or maybe they say we want to do a chapter 11 because we can't get everybody's consent. There's the secured debt is too widely held, it's going to be too hard to get 100% lender consent. But we have to exchange all this debt. So we want to do a prepackaged bankruptcy. In a prepackaged bankruptcy, there's no unsecured creditors committee formed because unsecured creditors are just totally unaffected, unimpaired 100% recovery, where either they're getting paid in cash in the ordinary course, they're being reinstated and assumed on the back end of the case. And all that's happening is up top at the financial debt and what we call a balance sheet restructuring those cases. There was a time when I was a younger lawyer when people were filing one day prepackaged bankruptcies. That meant you were in bankruptcy for less than one day. You'd file the bankruptcy, you would then go to court later that day, the court would approve the plan of reorganization and you would have a moment in time of bankruptcy. That's great when you can do that and when you're, you know, because there's minimizing disruption to the business. Again, worried about employees, worried about customers, worried about all of that. That trend, one day bankruptcy, seven day bankruptcy, that trend has gone away for a variety of reasons. But now we think about prepackaged bankruptcies as taking somewhere between 20 and 30 days at best, which is a relatively short amount of time for a company to be in bankruptcy. And it gives the most certainty to the market, it gives the most certainty to vendors, to customers, to employees. But at the end of the day, it has to be make sense economically because you're not impairing any of the.

Unsecured Debt can't be a terrible situation. It's one that likely going to be the business.

From there the business has to be strong. Otherwise it just has to be that there's too much financial debt on the company, the interest cost is too high and the lenders have to agree with that. And they have to say, look, we're willing to give unsecured creditors 100% recovery even though we secured creditors who are senior on the assets are taking less than 100% recovery because we're taking, we're turning our debt into equity. They have to be willing to say this is the best way path forward. This is the best way to preserve value, this is the best way to return investment on our investment. This is the best way to pursue the interests of our investors and RLP's because at the end of the day the lenders, they have their own obligations to their investors that they have to pursue. That's a prepackaged bankruptcy. We try to get in and out as quickly as possible, do the least amount of time in to minimize disruption to the business. Not always viable. Not always viable. Prearranged is I would say the vast majority of bankruptcies. That's when the company has done adequate planning, has engaged with their typically secured creditors, but doesn't have to be secured creditors about a transaction in bankruptcy. And you come into the bankruptcy with that support, typically through a restructuring support agreement that lays out the basic terms and timeline of the case. Is it going to be a sale or is the company going to run a sale process in bankruptcy? Are the creditors going to credit bid? That's when you use your your debt as consideration for buying the assets. Maybe you have to throw in some cash too, but it's mainly going to be debt. Is it going to instead be a plan case where there's an equitization of some sort? Is there going to be a rights offering? Is there going to be new money coming in? What's the exit financing going to look like? Those are the negotiations with the supporting creditors, and often your equity owner too about what that bankruptcy is going to look like. And the idea there is, if you can, you try to make it three, four month case, which gives sufficient time to go through the due process considerations that are required to get the benefit of bankruptcy, usually sufficient to market the transaction. Because one of the important things in bankruptcy is to make sure that there is an adequate process to make sure that the transaction that the company is trying to do is value maximizing. Can't just come in and say don't worry, Judge. Don't worry, everyone. We've decided there's still business judgment. There's a huge amount of business judgment deference. But you have to be able to prove that as a matter of evidence in court.

So there's somebody to come in, just put an offer to buy the company.

Oh yeah.

Just cause it's in bankruptcy.

Oh, yeah. Usually what happens if there's going to be a sale process? There's an organized process. People have to sign NDAs, people get access to the data room. We'll put in bids by a certain date, maybe there's an auction. One of the interesting things for your listeners who are more in the M and A space is a little bit of unfamiliarity with the M and A process in bankruptcy. And we represent a number of potential bidders, we'll say, who don't know the process as well. And it's actually one of the things I really like is educating them about it because it's not that different. Bankruptcy is really a tool for implementing a transaction, whether it's an M and.

A. I have a competitor that I know is in bankruptcy. I call you. I said, ben, I think there's an opportunity here. I don't know anything about how we can leverage it, but teach me what are we gonna do here to seize the opportunity?

No, exactly right. And one of the hugely important roles that a bankruptcy lawyer plays is educating the business folks about process because the process is a little opaque, it's complicated, there's a lot of jargon again being used. It does take some investment to learn the process, to learn the leverage points in the process. And it can take longer time sometimes than buyers or bidders are interested in taking. And it's all public. That's another thing. But at the end of the day, Chapter 11 is a tool for implementing a transaction, whether it's M and a debt financing, equity finance or a combination of these things. In any event, these prearranged cases, whether it's going sale route or a plan route, take strategy takes discussions with your lenders. There's pros and cons to each. And it's all dependent on the status of the business. And one of the things that again, hugely important for our clients is S&C's ability, our group's ability to bring in our elite M and a colleague, to bring in our elite capital markets colleagues. Whoever it is, the restructuring folks sit at the center of it to do all of those transactions, regardless of what it is. And we're there to be Swiss Army Knife Type lawyers. We're there to implement a transaction. At the end of the day, do we.

Do you want to give the example of how you would brief like this example of the competitors. Hey, I found out that they're going to bankruptcy. How do I get in there and actually buy that company?

Oh, sure, yeah.

Is it just it's going bankruptcy, there's definitely a chance we can go buy it, or is it sort of waiting for a certain flag to get lifted to say, okay, now they're taking bids on it?

Yeah, there's a process. So the company files for bankruptcy usually right away. There's a sense of whether they're going to run some sort of organized M and a process or whether they're going a different route, like just filing a plan of reorganization to hand the keys over lender.

So they have a plan and they could do that or there is an alternative like it goes for sale. So an insider like you could figure that out.

Oh yeah. The great thing about bankruptcy for someone who is looking to be involved in buying or providing financing is almost everything is public. Maybe it's not public today, but it will be public soon enough. You can't hide in bankruptcy. No matter what. The transaction has to be public. The terms have to be public. It has to be explained to the court why this is in the best interest of the company and the company's stakeholders. Part of it is diving into the process and saying, yeah, let's see what we can do. And knowing that maybe it's not going to work out. Especially a competitor. There's. There can be issues about selling to a competitor. The company might say, if I have a bid from a competitor worth $100 million and I have a bid from a non competitor worth $95 million, I might prefer to sell for 95, even though the number is less because it's not a competitor. But at the end of the day, the company, the debtor's advisors are obligated to find the highest or otherwise best. Is the phrase transaction. Usually money talks. If you're a competitor and you see an opportunity, you gotta deal with regulatory issues and whatever else is gonna come from that. But corporates in particular have great opportunity in the distressed M and A space to do relatively below market purchases. We've seen a lot of companies do that in the life sciences space. And the life sciences industry has some particularities that make more sense for corporates to do it than for strategic financials. But being able to look for purchasing opportunities In a chapter 11 context is something that is Worth looking at for companies and buying because again, it's a great opportunity. You're going to buy the assets free and clear of all liens and interests and all of that. You get a clean slate. Clean assets. And companies often have very strong assets, even if it's just the IP that's being sold.

Have you seen it like where the company still can still operate it and turn it around?

Oh, yeah.

If I give this better example, they're in bankruptcy. Put an offer there. What is it? Is, am I the stalking horse?

You can be. We can talk about stalking horse versus non stalking horse. That's an interesting area.

Does that make sense? Am I just talking. Let's break that down. I'm just trying to throw the buzzwords out there.

Yeah, yeah, yeah. No, I like it. You're picking up on the jargon.

Yeah, you got to teach it to me. Yeah.

The thing about the jargon is usually it's not that creative. It's not. It's not cool jargon, but it's jargon nonetheless. The stalking horse is the company says, I'm going to designate this buyer, this bidder as the lead and they're going to set the floor for this sale process. And it can be a third party buyer. Sometimes stalking horses are actually the lenders credit bidding, but it's. This is the floor for the sale. Anybody who wants to come in and bid, you should know that absent something significant, we're not taking less than this. Usually the bidding procedures that get filed and approved by the court that say, here's how this whole process is going to run, they'll say when you get to an auction, they say you're only going to be a qualified bid if you are determined to be higher than the stalking horse bid or if the company otherwise determines. And then you get to an auction and the one before the auction starts, maybe the stalking horse bidder is the lead bid for the auction, maybe not. But there's then a lead bid for the auction and every bid after that has to increase over that lead bid by some determined increment, depending on the case. But the stalking horse bidder, if it's a third party, usually is going to be given court approved stalking horse protections. And that can come in the form of a breakup fee. So you're doing a service to the company by creating a floor for the auction. You got to get paid for that. So 3% breakup fee of the purchase price. You're going to maybe have your advisor's fees paid by the company, by the way, adding to the cost of a chapter 11. Usually there's a cap, but stalking horse legal fees are paid for, and that's designed again to give structure to the sale process, set a floor. It's designed to give certainty to your customers, to your vendors, to your employees that there is some path forward.

How often do you see the stocking.

Horse bid be the winning bid? Is it a situation where there's no competition when that typically happens, or does it turn into a real auction that's competitive?

It varies. And things have changed over time. In the slightly previous generation, stalking horse bid was often going to be the winner. And that was either because it almost chilled the bidding because nobody wanted to compete, or because the stalking horse really wanted the asset and was willing to come into an auction, increase its bid, keep bidding up until it got what it wanted. These days, the trends probably are a little bit different. The likelihood of the stalking horse winning the bid has gone down. Part of that is because sometimes the stalking horse bidder are the lenders, and the lenders are credit bidding. And the credit bid can have a lot of hair on. It can have challenges to the debt because there's not cash coming in. You can have objections. Someone, a third party who really wants the asset, can come in and put cash on the table, sometimes even less than the amount of the credit bid, and still get the asset. When there is a stalking horse bid, it can sometimes create a more lively bidding dynamic. But I also think the frequency of stalking horse bidders has gone down. Something we've seen a lot over the last 18 months in our cases has been companies deciding that the stalking horse just isn't worthwhile, it's not worth paying the bidding protections, and it's not worth the risk that having the stalking horse actually chills the bidding. As I mentioned, sometimes the company says, if you came up $50 million or whatever it is, maybe we would make you the stalking horse. But when your bid is at this price level, it's just not worth it. We'd rather have a naked 363, as we call it, go into an auction and see what kind of bidding dynamic we can have. And that's also when it's really important to have good advisors on all sides, including good bankers, who can really have a finger on the pulse of the market. And to say, look, this bid is okay, but I think if we go out, there's going to be enough bidding interest to have a bidding environment at auction without it.

Interesting.

Do you see it?

It's like nowadays there's more visibility and that's why you see more likeliness of credit bids, third parties getting involved.

Yeah, I think that's an interesting idea. That there's more visibility and more sophistication, more willingness to come into the process and participate in a Chapter 11 sale process. I also think that the dynamics of being a stalking horse, people have psychologically changed a little bit about it. Where they're worried about overpaying, that bidders are less willing to put forward their best price as stalking horse because they're worried that best price they're not actually going to have to pay it. They're saying, okay, I'd rather put my best price forward at auction than then when the company is filing, there's that disconnect between what the company is looking for in a stalking horse and what maybe the best bidder is actually willing to do at that time.

When these auction processes happen, how do you assure that you're getting the most value on these deals? Because like I'd expect this to be a great opportunity. But then you're mentioning it's auction process. I know how things can get competitive and sounds like a big variable. If it's competitive versus not, how is that going to get played out in terms of maximizing value?

In some ways it's no different in bankruptcy than it is outside of the bankruptcy context. There's a lot of uncertainty about how the market is going to respond to buying some assets. And so really important to have good advisors, really good bankers marketing the asset, who understand the Dynamics in chapter 11. And there are a lot of great bankers out there who specialize in this kind of thing and who know the assets and know the buyers. But at the end of the day, I think the best way to create a dynamic auction is as much as possible start pitting people's pride and arrogance and emotions against themselves and against each other. The best way to do that is you get two, maybe more, but really two people in the auction and get both of them feeling like they have to have that asset.

They're in the same room.

So yes, different auctions are structured different ways. You usually have breakout rooms so that parties have spaces where they can discuss by themselves. And usually what happens is there's a lot of back channeling where the company and the company's advisors are going room to room, having side conversations. And then there's an auction room that's just a conference room, but everybody comes into that and that's where everything happens that's on the record. Cause all these auctions are public record. You get two people in the auction and you say, look, you better buy this. If you're not going to buy it, then they're going to get it and you don't want to let them get it. You start to play up those psychological elements. That's a big part of it. And being thoughtful and strategic in how the company responds to bids. Because bids can take different forms. That's the other thing about bankruptcy, is that these bids aren't always just dollar increasing dollar by x amount. There's different ways to structure these things. You can structure it by assuming more liabilities that can give more value. You can structure it by giving different forms of consideration. So being strategic and agile in meeting the bidders where they are and then creating that psychological element I think is the way to do it. And we saw that happen exactly in the nano string bankruptcy from last year where you had two bidders in the room, both really wanted the asset. The auction went on for just about 18 hours and the bidding price doubled from something like 200 million to 400 million over the course of those 18 hours. So it was a little bit drifting.

They had a stocking horse bid so there was like a floor set and then.

And then we had an auction and.

Heat of the moment, some egos.

That's exactly right. I don't know if it was heat of the moment. It was heat of the 18 hours but, but over those 18 hours we got there and it was a great outcome.

Is this some fatigue and delirious happening or some after our cocktails? Like I don't know about after our.

Cocktails but there were some shake shack burgers that were brought in late night. It was an impressive auction and well done by all the, by the company and all the advisors and it was a great outcome for creditors. And that's a little bit of an unusual situation, but it can happen. It's all about trying to find the right path forward for the case.

Very interesting. Anything else around like structuring considerations when you're buying like a bankruptcy or business out of bankruptcy, this is really important.

For your regular way M and A listeners to, to think about because even when the company is nowhere near bankruptcy, if you're buying a company and you're trying to bring it into the, to the rest of your company, you gotta think about what happens in a downside scenario. It's really important to be thinking about that from a structuring perspective. Is this a company that has a lot more risk than the rest of your business? Do you want to try to figure out ways to keep that business a little bit separate in case there are some liability issues. Is this a business that selling football helmets where you could end up with all these lawsuits about how your football helmets were not safe. You don't want that to infect your business manufacturing microphones, which pretty low risk. I hope. We work very closely with our M and A colleagues, with our M and A bankers to advise buyers hand in hand about how to maximize the benefits from the transaction, but also be thinking about what happens in a downside.

Strong point having a holistic view on the structure post transaction.

Yeah.

Naked363 another cool bankruptcy term. 363 asset sale. Same thing as a Naked363.

Naked363 is basically is a 363 asset sale without a stocking course bidder. So going to ultimately the case sale.

Is the 363 in the chapter.

Fundamentally we call it a 363 sale because section 363 of the Bankruptcy Code is what authorizes the sale of assets in a bankruptcy proceeding and sets out what you have to do, what the requirements are, what protections are for creditors, secured creditors, all of that. So we call it 363sale. But it's just an asset sale.

And if you do it without a stalking horse, that's what we call.

That's what. That's the terminology we use. My partner Ari Blaut and I actually wrote an article with the heading Naked 363 about this trend, especially in life sciences cases, which is something we've had a lot of experience in. And I insisted on using that word naked because I figured it would get a lot of attention. When you send it out in people's emails, they'll at least look at it and wonder what that is.

They're going to listen to this and start googling.

Exactly. Exactly.

Let's talk about common mistakes. I'm curious because you mentioned earlier the biggest thing is planning. I get that you got to get early, get a sense of this plan early, have more options. Besides that, are there any other common mistakes that you make going through a bankruptcy process?

Planning for sure and not ignoring problems, thinking that problems are going to solve themselves. That's bucket number one. Bucket number two that people struggle with is bankruptcy is a means to do a transaction. And that process requires litigation. And sometimes you luck out and the deal is structured in a way that there's enough value that you can get by without too much litigation. That's an example in a prepackaged bankruptcy you're minimizing the litigation by giving value to unsecured creditors and trying to keep the litigation costs, the overall time in bankruptcy down. But bankruptcy is inherently a litigation exercise. Every transaction needs to be court approved. Anything that needs to be court approved, people have an opportunity to object to. And anybody who doesn't like what's going on or has their own interests, they might come in and object. And then you have to the debtors and the other proponents of whatever transaction it is, they have to carry their evidentiary burden. It's just a litigation exercise. When you're going into a bankruptcy, you got to understand that there's going to be litigation, there's going to be challenges, and you got to be able to fight through all of that. And again, this goes hand in hand with having the right advisors who are able to bring you both the litigation expertise and the transactional expertise. And of course, at S and C, we pride ourselves on being able to provide the best of the best across the board.

Right people, right time. Embrace yourself.

I'm gonna put that on a bumper sticker.

And how about on the buy side? What are common mistakes companies make when they're buying a business out of bankruptcy?

One of them is thinking the process is gonna go totally smoothly. No challenges, no issues. And again, it's understanding the process, that there's gonna be bumps in the road. There's gonna be some issues to deal with. And that's all part and parcel of the process. I also think that sometimes buyers overestimate the transaction costs associated with all of that. They get scared by the process, and part of it is unfamiliarity, but they just get turned off by the idea of having to do everything out in the open. That's a little bit of the pay to play. You have to pay some cost in order to get all the benefits of bankruptcy. And it's the same when you're a buyer. You have to do things out in the open. Bids have to be subjected to higher and better in order to be able to buy assets free and clear of liabilities and to be able to pick and choose which contracts you want to take with you. And that's a huge advantage for a buyer coming out of bankruptcy. And not only it's that you get to pick and choose, but you can use that leverage to renegotiate contracts, even if you're going to take it no matter what contract. Counterparties, they don't want to be left behind. They want to go with the new. With the new business because there's a future There they're going to be willing to make concessions to you as the buyer, making sure that you're thinking through, okay, how much leverage do I have? How do I use this leverage to really set the business up on a go forward basis on the best foot that it possibly can come out of?

Adds a lot more dynamics and complicates things in terms of how you negotiate, put an offer together.

Oh yeah, it's a hugely important piece of it is what contracts you're going to take and thinking creatively about what that business looks like and what you want it to look like. Because at the root you're buying assets and you're picking and choosing what comes along with it and being strategic about that. Having again, advisors who can help you think through the process for, for implementing the business decisions. That's a hugely important piece of it. And you got to be thinking about that anytime you're in a 363 process.

How about trends? How is the trends in distress lending and debt trading affect corporate restructuring?

So we've talked about liability management transactions and that is the trend du jour demo and much more. The last few years has been an explosion of this liability management transaction activity and that will continue. It's a little bit of a nascent industry or area. You're getting court decisions that really affect how people are thinking about those kinds of transactions. And then you have advisors and smart investors and smart private equity sponsors and smart companies saying, okay, now that we have this information now what are we going to do? How are we going to change the way documents are written to be able to do transactions that we want to do? How are we going to take advantage of the way the documents are written when we need to do some sort of exchange to take advantage of a discount, to get more liquidity, whatever it is, that is a continuing trend and it's morphed over time and for good reason. The courts have an impact on how all of that is done. That is certainly a huge trend that.

Will continue getting more complicated earlier drop down and up tiers and oh yeah.

I'm sure there's more to come, more jargon for you as everybody tries to get more and more creative.

Do you see any upcoming changes or reforms in bankruptcy laws that could affect corporate restructuring?

It's always hard to predict what reforms there will actually be, including, given sometimes some paralysis in making law and changing laws. But two areas that get a lot of attention when you think about reforms are the cost of bankruptcy. And we've talked about that a bit when Venue has been often on people's radars at different times over the last 10 years in bankruptcy. There was a lot of attention put on it during the Purdue bankruptcy for reasons that are probably too wonky for your listenership. But then you will continue to be an issue where companies file and why they're allowed to file, where they file and differences in different jurisdictions in the law and how the law is applied can have a big impact on how a bankruptcy is going to go and then on the costs. The costs are big for a bankruptcy, and there have been some good developments, including making bankruptcy streamlined for smaller businesses. And that's a very important development. And I personally hope that there are more changes like that to distinguish between a bankruptcy for a company that has $10 million in revenue versus $100 million in revenue versus $1 billion in revenue. Those Chapter 11 cases really shouldn't be the same. It shouldn't be a one size fits all. There's more case discrimination in a good way between those cases that could be improved on. But even in the large cases, the costs are unfortunately out of control. And it's a. I don't know how to solve it, but I anticipate that people will continue to talk about ways to do so and considerations about that.

I'm glad you're on top of it, so I don't have to be.

I don't know if I'm on top of it. I would say more. I'm in the middle of it.

Ben, I got to ask. What's the craziest thing you've seen in M and A?

So I don't know if it's an M and A situation, but the craziest thing I've seen in bankruptcy and M and A is there was once a situation when I was a clerk in the bankruptcy court where a party had to be arrested on site for reasons that we won't get into. But having a party in interest in a bankruptcy court, getting arrested real time as a young clerk starting my law career was something I'll never forget.

Someone lost their shit, didn't they?

It happens. It happens. You know, people's money and lives sometimes are at stake here and people get emotional and I understand it, but this one crossed the line for sure.

I remember I had like a business litigation in court is next to divorce and you would hear like these screams.

Oh, yeah, yeah.

That could happen here in bankruptcy, too.

Yeah.

This has been a great conversation. I appreciate you taking the time, helping me become a better M and A scientist. Those of you still listening. Thank you. You have more questions about bankruptcy, don't send them to me. Go track down Ben, send it to him.

Mention M and A Science.

He gives you a fee discount.

So friends and family discount for M and A Science.

Mention M and A Science listeners. Beyond that, I appreciate you getting this far in the interview. You are true M and A scientist. Value your feedback. Connect me on LinkedIn love to hear your thoughts, opinions on the content we're creating here. Ideas on topics or just a criticism. That's how I get better at doing this. So till next time, here's to the deal.

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