M & A 2016 CONFERENCE INDIANAPOLIS JUNE 9

M & A 2016 CONFERENCE INDIANAPOLIS JUNE 9 1 Acquiring Distressed Assets 2016 M&A CONFERENCE Bob Leasure, President LS Associates LLC Thomas van der Meulen, Operating Partner Source Capital LLC Jeff Schneiders, Managing Director The Chicago Corporation Moderator: Wendy Ponader, Partner Faegre Baker Daniels 2 Distressed Asset Purchases: Transaction Constituencies and Competing Interests Debtor / Owner / Management Buyer Secured Party Maximize price Avoid liability under guaranties Avoid tax liability Minimize liability for breach of fiduciary duty claims arising out of decisions made while the company is insolvent or in the zone of insolvency Avoid personal liability under applicable law on creditor / employee claims Minimize price paid and transaction costs Minimize successor liability Avoid competitive bidding Access to management and documents for due diligence Close sale quickly Acquire assets free and clear Nurture relationship with key personnel to be retained and other key constitutents Maximize price / Maximize recovery Quick resolution to remove bad loan from books and minimize any write off Avoid potential liability for Debtor s employee and tax obligations Minimize the risk of accusation of failure to act in a commercially reasonable manner Avoid lender liability for controlling the Debtor Hedging against good $ after bad when is the optimal time for writing off loan? Establish ongoing relationship with newco 3 Acquiring Distressed Assets 1

Distressed Asset Purchases: Buyer Considerations Relevant to Selecting the Acquisition Platform (when possible) Desire to cherry-pick favorable contracts and unexpired leases? As buyer, which liabilities will you assume? Which are required to assure goals of acquisition met? Are there successor liability concerns? Could a court order insulate buyer from specific identified exposures? What is the landscape of pending litigation? Who are claimants? Are there hostile shareholders or creditors? Are there critical vendors whose claims will have to be satisfied? What sale process does the least damage to seller s business? Will Buyer need assistance from debtor to negotiate key retention arguments with desired employers? How urgently does Buyer want to avoid a sale requiring an auction? Are the assets in multiple states? 4 Distressed Asset Purchase: Potential Post- Transaction Risks Fraudulent transfer What is it? Either (i) a transfer of a debtor assets intended to delay, hinder or defraud any creditor or debtor or (ii) a transfer made for less than reasonably equivalent value and the debtor was insolvent at the time or become insolvent as a result of the transfer Statute of limitations: generally 4 or 6 years Mitigation? Secured creditor not paid in full by a meaningful margin Avoid permitting insider to participate as Buyer / if inclusion of insider as Buyer desirable, best if sale public Obtain credible valuation of assets; pay what they are worth 5 Distressed Asset Purchase: Potential Post- Transaction Risks Successor liability What is it? General rule: a successor entity is not liable for debts, acts or liabilities of predecessor. Exceptions: (i) express assumption of liabilities, (ii) transaction is a de facto merger, (iii) Buyer operates assets post-close as a mere continuation of Seller, and (iv) transaction is an effort to fraudulently avoid liability. Also exposure can arise where (i) substantial identity between operations of Seller and Buyer and (ii) product line continuation Mitigation? Complete changes in organization/management Change in company name Change in location or operations Avoidance of buyer functioning publicly as continuation of Seller Buyer relationship and negotiations with Seller/Debtor pre-close; arm s length 6 Acquiring Distressed Assets 2

Distressed Asset Purchase: Potential Post- Transaction Risks Involuntary bankruptcy by disgruntled creditors What is it? Unpaid, unsecured creditors of debtor (typically 3 required, owned in total at least $15,325), file a bankruptcy petition seeking to place debtor into bankruptcy If successful ( order for relief entered), bankruptcy case look back period of two years permits an analysis of pre-petition transfers; focus on avoidance of alleged fraudulent transfers. 7 Distressed Asset Purchases: Article 9 Sale under Uniform Commercial Code Basic Information: Debtor must be in default; secured creditor must repossess collateral No judicial proceedings required Secured party forecloses lien and sells assets through agreement (Bill of Sale, Foreclosure Sale Agreement) Note: Buyer can buy secured creditor position then foreclose Title of assets transferred Sale free and clear of foreclosing & junior liens, not senior liens No customary seller reps or warranties Typically lower transactions costs than alternatives Contracts and leases cannot be assumed and assigned Option: Private or Public Sale 8 Header: Distressed Asset Purchases: Article 9 Sale under Uniform Commercial Code Private Sales Specified Buyer; no auction or overbid process Secured Party may not bid at private sale Limited exception: collateral customarily sold on a recognized market (essentially for publicly traded securities) or subject to widely distributed price quotations Notice requirements: Safe-harbor at least 10 days; Check for federal tax liens and state tax liens -- other specific, longer notice requirements may apply Review UCC search what are the other secured positions No public disclosure of identity of Buyer or terms of sale No risk to Buyer of being outbid 9 Acquiring Distressed Assets 3

Distressed Asset Purchases: Article 9 Sale under Uniform Commercial Code Commercial Reasonableness All sales must be commercially reasonable concept chiefly dependent on type of assets Definition essentially a matter of judgment: in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition Price obtained is not dispositive of commercially reasonable Commercial reasonableness important to deficiency, but also in minimizing fraudulent transfer and successor liability risks Notice of public sale widely circulated Develop evidence of value Market the collateral 10 Distressed Asset Purchases: Article 9 Sale under Uniform Commercial Code Possible detractions Involuntary Bankruptcy, Voluntary Bankruptcy or Injunctive Relief No cleansing court order No third party exercising independent judgment for transaction Subsequent challenges raised after the fact, e.g. fraudulent transfer claim 11 Distressed Asset Purchases: Assignment for the Benefit of Creditors Basic Information: Commonly used to effectuate distressed asset sales; Debtor assigns all of its assets to a third party assignee; Third party assignee liquidates assets for Debtor s creditors Proceeds of liquidation are distributed according to priority Assignee may be able to pursue preferences (state law determined) Because ABC sales occur without court involvement and notice, challenges may occur post-closing ABC s popularity as an asset disposition option varies widely among states 12 Acquiring Distressed Assets 4

Distressed Asset Purchases: Assignment for the Benefit of Creditors Advantages Faster than Bankruptcy 363 Sale sale can occur a matter of days (10 or fewer) after assignment; less expensive Best when secured party is cooperative and appreciably undersecured Assignee might not require marketing and auction if active marketing occurred in advance of assignment Can be done in conjunction with UCC Sale to wipe out junior liens 13 Distressed Asset Purchases: Assignment for the Benefit of Creditors Disadvantages Less protection from successor liability Assets cannot be sold free and clear of liens without consent of lienholders, including secured party Exception for combined UCC Sale Buyer closes before knowing whether there will be challenges to sale Contracts and leases cannot be assumed without third parties consent Breach of fiduciary duty risk to Board Mitigate risk by D&O policy Involuntary Bankruptcy risk May not be feasible (or permitted) if Debtor s assets are in multiple states 14 Distressed Asset Purchases: Receivership Basic Information: Typically, secured party files lawsuit seeking appointment of receiver, then Court appoints neutral third party as receiver (can be secured party designee) Receiver s duties are subject to statute and court order can include operating the business, selling property Receivers can be appointed in federal or state court Receiver must account to the Court 15 Acquiring Distressed Assets 5

Distressed Asset Purchases: Receivership Advantages Receiver is appointed at request of secured party and often selected by secured party; helpful if Debtor consents Receivership allows business to operate to preserve enterprise value Successor liability risk is reduced per receivership court order Neutral court-appointed officer makes decisions, which protects secured party and Debtor Check applicable state law for scope of receiver authority and transaction processes / terms, e.g. can receiver sell personal property; can secured party can credit bid; can liens junior to secured party and all state tax liens (irrespective of priority) be extinguished upon sale? Unlike ABCs, national remedy under federal receiverships 16 Distressed Asset Purchases: Receivership Disadvantages Expensive, slow, risk of being outbid, terms of sale public record, loss of control to court and receiver Operational issues receiver may not be able to operate Debtor efficiently Cannot force non-debtor parties to assume contracts Secured party (or another creditor) must be willing to seek appointment of receiver Involuntary Bankruptcy risk 17 Distressed Asset Purchases: Sales In Bankruptcy Bankruptcy Code 363 Sale Process Steps: 1. Debtor / trustee markets assets 2. Prospective Buyer(s) submit LOIs 3. Debtor selects stalking horse Buyer 4. Debtor and stalking horse negotiate: asset purchase agreement deal protections bid procedures 5. Debtor/trustee files motion to approve sale and bid procedures 6. Bankruptcy Court approves bid procedures 7. Debtor/ trustee conducts auction (though terms can provide for private sale) 8. Bankruptcy Court enters order to approve sale - highest and best offer 9. Unless sale order provides otherwise, sale order becomes final and nonappealable 14 days after entry 10. Closing 18 Acquiring Distressed Assets 6

Distressed Asset Purchases: Sales In Bankruptcy Buyer may choose contracts and leases to include in acquisition not obligated to accept any or all as part of sale except as identified Anti-assignment clauses otherwise enforceable may not be enforceable in bankruptcy ALERT: anti-assignment clauses, special protections for intellectual property licenses, partnership agreements, government contracts, franchise agreements, personal service contracts Debtor/ trustee must assume and assign cure defaults (Buyer) Provide adequate assurance of future performance (Buyer) Risk of successor liability materially eliminated, but order may be overridden by certain liabilities e.g., environmental 19 Distressed Asset Purchases: Sales In Bankruptcy Benefits / Protections to Stalking Horse Stalking horse bidder sets the floor sale price and is entitled to certain protections at auction Break up fee of 2 to 4% of purchase price (compensates stalking horse for due diligence expense if not the successful bidder at auction) Overbid protections (requirements of amount of the initial and subsequent overbid increments) Closing deadline requirements and procedures negotiated as part of the asset purchase agreement can diminish debtor s opportunities to meaningfully market and auction its assets, strengthening stalking horse position. 20 Panelists Bob Leasure President LS Associates LLC bleasure@lsassociatesllc.com Jeff Schneiders Managing Director The Chicago Corporation Jeff.Schneiders@thechicagocorp.com Thomas van der Meulen Operating Partner Source Capital LLC tvandermeulen@backyardproducts.com Moderator: Wendy Ponader Partner Faegre Baker Daniels wendy.ponader@faegrebd.com 21 Acquiring Distressed Assets 7