Explore the legal consequences of aggressive M&A tactics in this insightful blog post. Learn how a competitor’s move led a struggling glove manufacturer into bankruptcy and the ensuing legal disputes.
M&A Stories
March 25, 2019
Introduction:
Purchasing a struggling competitor can be a strategic move in business. However, the methods used in such acquisitions can lead to legal consequences.
The Acquisition:
This case revolves around a Texas-based glove manufacturer that was once a public company. A competitor had been in talks with the company since 2007 or 2008 but without any success.
In late 2014, the company secured a revolving credit facility from its lender, backed by most of its assets. Between November 2016 and April 2017, the lender waived defaults when the company breached the loan agreement’s debt service coverage ratio covenant. On April 11, 2017, this covenant was replaced with a 12-month trailing adjusted EBITDA covenant. In May 2017, the lender extended the loan’s maturity date to July 2018, demonstrating its willingness to work with the company during financial difficulties.
On July 6, 2017, the company disclosed accounting irregularities, including inflated revenue figures, in a Form 8-K Report to the Securities and Exchange Commission. The company’s CEO and CFO were terminated, and new individuals were appointed to these positions.
On July 10, 2017, the competitor increased its offer price and bought the company’s loan from the lender on July 25, 2017, despite having no prior experience as a commercial lender.
On July 26, 2017, the competitor declared the company in default due to the previously disclosed financial misstatements, accelerated the loan, and demanded immediate payment of the $3.7 million outstanding balance.
The competitor knew the company couldn’t repay the loan, as its last SEC financial statements showed a cash balance of less than $300,000. Over the next four weeks, the company sought prospective lenders to replace or supplement the existing debt, but the competitor did not allow this. Instead, it agreed to two one-week forbearances, one signed on August 1 and the other on August 14, even though the company requested two to three weeks to secure financing. The competitor continued to make offers to purchase the company.
On August 24, 2017, the competitor began sweeping cash from the company’s bank accounts. Unable to operate without cash, the company filed for Chapter 11 bankruptcy protection in a California bankruptcy court on September 8, 2017.
In bankruptcy, the company entered into a stalking horse asset purchase agreement with the competitor for its assets, but eventually, a higher bidder acquired the company’s assets.
Legal Dispute:
Shareholders of the company sued the competitor in bankruptcy court, alleging that it forced the company into bankruptcy to prevent a better deal.
The competitor defended its actions, claiming they were legal. The court agreed but allowed the shareholders to amend their complaint.
The court stated that Texas law might prohibit threatening to accelerate the note in bad faith, though the competitor had not made such a threat; it merely declared the note as in default (which it was) and exercised its right to be paid off under the loan agreement’s acceleration provision.
However, the court suggested that the company could amend its claims to argue that the notice of acceleration implied a threat to sweep the company’s cash, which might be illegal under Texas law if not done in good faith. Good faith would be established if the action aimed to protect the competitor’s legitimate interest as a creditor, but not if it aimed to force the company to sell to the competitor. Whether good faith is required under Texas law when threatening a cash sweep would be a matter for the California bankruptcy court to decide if the shareholders amend their complaint.
Comment:
While it’s a familiar plot in film and television for a ruthless businessperson to buy a struggling enterprise’s debt to compel a sale, this case demonstrates the legal risks involved in such tactics.
Case Reference:
In Re ICPW Liquidation Corporation, Lead Case No. 1:17-bk-12408-MB, Jointly Administered With 1:17-bk-12409-MB, Adv. Proc. No. 1:17-ap-01101-MB, United States Bankruptcy Court, C.D. California, San Fernando Valley Division, (March 11, 2019).
By John McCauley: I help businesses minimize risk when buying or selling a company.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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