Winter 2014
Focus on Bankruptcy and Reorganization Financial Advisory Services
Editor for This Issue: C Ryan Stewart Bankruptcy Transaction and Structure InsightsBest Practices:
Investing in Distressed or Underperforming Companies: Recent Challenges to Favored Deal Structures
Nancy A Peterman, Esq, and Kevin P Ray, Esq
As the distressed deal market becomes more competitive, with more money and fewer
deals, a recent trend has developed. Losing bidders or creditors, who are attempting
to leverage a recovery (or a better recovery), are challenging acquisition structures
typically used by distressed investors in Chapter 11 cases. These challenges relate to
reorganization plans, claims that have been purchased for use as a credit bid in a
sale process, and Section 363 sales. This discussion focuses on some of these trends.
First, the discussion explores whether plans, in which management, equity holders
or insiders retain some interest, may need to be subject to competitive bidding.
Next, the discussion analyzes recent case law in the claims trading area and how
creditors or others may challenge purchased claims and attempt to limit use of the
purchased claim to credit bid for a debtor corporation’s assets. Finally, the discussion
explores recent challenges to Section 363 sales made by losing bidders in an effort
to re-open the auction process. To ensure that they win the deal, any participants in
the distressed marketplace should carefully structure any proposed acquisition and be
prepared for these challenges.
The Importance of Sellers’ Representations in M&A Transaction Purchase Agreements
John C Ramirez, Aaron M Rotkowski, and Irina V Borushko
It is virtually impossible for the corporate buyer to verify every detail about an acquisition
transaction target. For this reason, the corporate buyer typically demands representations
from the corporate seller in order to complete the acquisition transaction. Valuation analysts
and other transaction professionals should understand such sellers’ representations in order
to provide effective transaction-related consulting services. This discussion summarizes both
what a seller’s representation is and why a seller’s representation is an integral part of the
transaction purchase agreements.
Though Leadership
What Is “Investment Plus”? Understanding a Private Equity Fund’s Liability for a Portfolio Company’s
Pension Shortfall
John M Wirtshafter, Esq, Shawn M Riley, Esq, and John A Polinko, Esq
A recent federal court decision calls into question an assumption many private equity
firms make regarding their portfolio companies: that the liabilities of such companies are
not liabilities of the private equity firm. In Sun Capital Partners III, LP v. New England
Teamsters & Trucking Industry Pension Fund,1 the First Circuit turned that assumption
on its head. While the decision applies only in the First Circuit (federal courts in Maine,
Massachusetts, New Hampshire, Puerto Rico, and Rhode Island), the holding—that
any activity beyond mere investment in a portfolio company could trigger control group
liability—should be a concern to all private equity funds, particularly funds that invest
in financially distressed companies or participate in Bankruptcy Code Section 363 sales
transactions. With a better understanding and with reasoned expert guidance, private
equity funds can take steps to insulate themselves from the pitfalls of this type of liability
which could potentially include financial distress or bankruptcy of the private equity firm.
Recent Development in S Corporation and Qualified Subchapter S Subsidiary Tax Status in Bankruptcy: In re Majestic Star Casino
Brett Berlin, Esq.
This discussion reviews a recent judicial decision at the intersection of tax law and
bankruptcy law: The Majestic Star Casino, LLC, et al. v. Barden Development, Inc., et al.
The decision is the first federal appellate court case to examine whether S corporation and
qualified subchapter S subsidiary (Q subsidiary) tax status constitute property of a debtor
corporation’s bankruptcy estate. The United States Court of Appeals for the Third Circuit
concluded that taxable status is not property of the bankruptcy estate. Therefore, in courts
subject to Majestic Star Casino as controlling precedent, taxable status is not protected
by the “automatic stay,” and the debtor corporation or a bankruptcy trustee may not
use bankruptcy “avoidance powers” to undo a transaction that results in the revocation
or termination of S corporation or Q subsidiary tax status. Notably, the court reached the
opposite conclusion from several lower courts that previously considered the same issue.
Owners of S corporations presumably will welcome the holding. Professional advisers to,
and creditors of, financially distressed S corporations and their Q subsidiaries should take
a cautionary note from the decision. Legal counsel, tax planners, and financial advisers
should give due consideration to these issues during the pre-bankruptcy planning process, if
possible, to anticipate potential consequences.
Due Diligence and Analytical Procedures
for Fraudulent Conveyance Opinions
Katherine A. Gilbert and Kyle J. Wishing
The considerations related to fraudulent conveyance opinions can be complicated. Often,
fraudulent conveyance opinions are at the center of Bankruptcy Code Section 548 transfer
avoidance actions. A fraudulent conveyance analysis involves the following three tests: (1)
the balance sheet test (i.e., a solvency analysis), (2) the cash flow test, and (3) the capital
adequacy test. If the three tests are passed, then the transfer is generally not considered to
be a fraudulent conveyance. This discussion describes each of the tests and illustrates the
related analyses. This discussion also presents a procedural and due diligence checklist that
may be useful to valuation analysts, the debtor corporation management, creditors, legal
counsel, and other users of a fraudulent conveyance opinion.
Contingent Liabilities and Disputed Claims in the Context of a Bankruptcy Solvency Analysis
C. Ryan Stewart
Valuation is an integral part of the bankruptcy solvency or insolvency analysis. As part
of the solvency analysis, all of the debtor’s assets and liabilities, including off-balancesheet
liabilities are analyzed and valued. As a debtor becomes financially distressed on its
journey toward bankruptcy, it may become involved in financing schemes or become the
target of lawsuits that ultimately contribute to its bankruptcy. These types of contingent
liabilities and disputed claims that exist prior to the petition date can play a significant role
in the determination of a debtor’s solvency in the context of a bankruptcy proceeding. This
discussion focuses on the differences between disputed claims and contingent liabilities and
how to estimate their values. In addition, this discussion illustrates an erroneous valuation
of debtor liabilities. That example highlights the implications of that error.
Valuation Analyses and the Commercial Bankruptcy
Robert F. Reilly, CPA
There are valuation issues involved in most commercial bankruptcy matters. These
valuation issues are often important to the debtor in possession, the various classes of
creditors, the various contract counterparties and other interested parties, and the legal
counsel for all of the above. First, this discussion summarizes many of the reasons to
conduct a valuation within a bankruptcy environment. Second, this discussion considers
many of the issues the valuation analyst typically encounters within a bankruptcy context.
And, third, this discussion presents numerous caveats for the analyst who is performing a
bankruptcy-related valuation.
U.S. Bank National Association v. Verizon
Communications, Inc.: What Was the Value of Idearc?
Irina V. Borushko
The focus of this discussion is the U.S. Bank National Association v. Verizon
Communications, Inc., decision as it relates to the spin-off of the Verizon
Communications, Inc. (“Verizon”) directories business, Idearc, Inc., (“Idearc”).
Idearc filed for bankruptcy 28 months following its spin-off from Verizon. Amidst
reorganization, Idearc filed an action against Verizon, contending that Idearc was
loaded with so much debt in the spin-off that it was insolvent and destined to collapse.
The Verizon decision highlights various factors a valuation analyst should consider in
the application of (1) the guideline publicly traded company method, (2) the guideline
merged and acquired company method, and (3) the discounted cash flow method.
The Verizon decision also highlights factors and procedures a valuation analyst should
consider when reconciling the values estimated using the selected valuation methods.
Income Tax Consequences to the Troubled Debtor’s Property Abandonment, Foreclosure, or Repossession
Robert F. Reilly, CPA
When a debtor (whether a business or an individual) cannot pay its secured obligations, the
debtor has a number of options. However, all of those options generally involve the debtor
losing the collateral property (through either abandonment, foreclosure, or repossession).
In addition, the debtor may have to recognize taxable income related to the cancellation
of the debt related to any of these options. This discussion summarizes the income tax
considerations related to the secured debtor’s property abandonment.
Trends in ESOP Litigation from 1990–2013: Special Focus on Recent Valuation and Bankruptcy Cases
Corey Rosen
Since 1990, there have been two large waves of “stock drop” litigation, the first
following the accounting scandals of the early 2000s and the second following the
financial crisis of 2008. The large majority of this litigation involved public company
401(k) plans where employer stock was an optional investment and/or the company
matched employee deferrals in employee shares. In cases where there was an employee
stock ownership plan (ESOP), it was almost always used as a match to the employer
corporation 401(k) plan, and it usually owned relatively little sponsor company
stock. These kinds of plans are noticeably different from private company ESOPs.
Approximately 97 percent of ESOPs are in closely held sponsor companies. Most of
these ESOPs own 30 percent or more of the employer corporation stock, with perhaps
40 percent of these ESOPs owning or planning to own 100 percent of the employer
corporation stock.1 Public companies with ESOPs or 401(k) plans with employer
corporation stock rarely have more than five percent of their shares in these plans. Due
to the readily determinable nature of the publicly traded employer corporation share
prices, they are not required to have independent appraisals performed. The lack of
readily available closely held employer corporation share price data creates the need for
independent valuations and also creates the circumstances that give rise to issues such
as breaches of fiduciary duty, disputes the over fair market value of sponsor company
shares, disputes over transaction fairness and other points of disagreement that result
in litigation. This discussion focuses on the trends in ESOP litigation over the last 23
years, with a special focus on valuation and bankruptcy issues.
Defending Fraudulent-Transfer Avoidance Actions in Ponzi-Scheme Cases
Michael F Holbein, Esq, and Sean C Kulka, Esq
It is generally not a good way to start off the week by tearing into an envelope holding a
demand letter (or, even worse, a complaint) from a bankruptcy trustee claiming that over
three years ago, some unfamiliar company paid the hundreds of thousands of dollars in
debt accumulated by its affiliate, a name you only remember because of the big bill you
thought would not get paid. To make matters worse, you learn that the trustee is claiming
that the unfamiliar company was part of a Ponzi-scheme and that you may be on the hook
for decades of actual fraud and perhaps millions of dollars in potentially avoidable transfers.
This discussion focuses on the reach-back period applicable to avoidance of actual and
constructive fraudulent transfers under the Uniform Fraudulent Transfer Act (the “UFTA”)
versus the U. S. Bankruptcy Code, including the possibility of an indefinite reach-back
period for actual-fraud claims under the UFTA. This discussion also highlights strategies for
defending an actual-fraud Ponzi-scheme lawsuit.