The main investment thesis of a private credit lender is simple: get the loan reimbursed when it matures. Private lenders do not provide loans to acquire the business of their borrower. In some circumstances, however, private lenders must be prepared to take possession of the money when the borrower is in difficulty and there is no realistic prospect of paying off the loan in the short term. Becoming a borrower’s business owner may very well be the last resort loan collection option.
There are different ways to implement a change in control or debt for a capital restructuring, including an out-of-court conversion, foreclosure sale under Section 9 of the Uniform Commercial Code (“Article 9 Sale“) and a sale under section 363 under Chapter 11 of the Bankruptcy Code (a”Bankruptcy Sale“). The strategic path to take depends on a multitude of factors, including cost, speed, degree of consensus, extent of operational difficulties, and the need to address other liabilities on the borrower’s balance sheet.
In the case of a Section 9 sale or a bankruptcy sale, secured lenders have the right to “make an offer of credit” for their collateral using the debt relief as the purchase price. to acquire the guarantee. Lenders offering credit can thus acquire the collateral constituting the business of a borrower without making major changes to the business and will assume the specific responsibilities necessary for the operation of the business. Lenders offering credit typically form a New Acquisition Vehicle (“NewCo”) that will look a lot like the borrower. NewCo is likely to conduct the same operations from the same locations, serving the same customers with the same employees. NewCo can even operate under the same name as the former borrower.
Outside of bankruptcy, a scenario like this can expose NewCo to unpaid debts from the borrower’s creditors based on so-called “successor liability” theories. Unpaid creditors of the borrower may argue that NewCo is a “mere continuation” of the borrower / seller and that NewCo should be liable for the debts of the seller. Lenders who are considering “out of court” strategies, including a Section 9 sale, will certainly prefer the speed and cost of this option. In some circumstances, however, the specter of potential successor liability may outweigh the benefits of a section 9 sale. The risk of successor liability is greater when the sale is marked by evidence. unlawful or unfair acts, for example when the buyer knows that the seller will transfer the proceeds of the sale to the seller’s shareholders and leave the seller’s creditors unpaid.
The Bankruptcy Code, under section 363 (f), authorizes real estate sales interests in these goods ”provided that certain conditions are met. However, the Bankruptcy Code does not define the term “interest”. As a result, the courts have had to determine what “interests” can be written off by a free and clear sale under section 363. Although the term certainly includes a proprietary interest in the asset itself (such as a lien or a mortgage), many courts (including the Second, Third and Fourth Circuit Courts of Appeal) have adopted a broad interpretation which considers “interest” to include obligations that are connected with or derive from the property sold. According to this view, “interest” includes the liability claims of the successor. Thus, in an acquisition of a credit supply through a bankruptcy sale, all creditors’ claims – even conditional and unliquidated debts – can be terminated by a court order. The practical value of this strategy was recently reinforced when the buyer of Sears assets in a bankruptcy sale sought to use the sell order to bar a product liability claimant from asserting successor liability claims. .
In 2019, substantially all of Sears’ assets were purchased under Section 363 of the Bankruptcy Code. A year later, a consumer allegedly injured in a tumble dryer accident brought a product liability action in Illinois state court against the manufacturer (Electrolux), the seller (a debtor of Sears) and a subsidiary of the purchaser, Transform SR Brands LLC. The state court cleared the disclosure against Transform, who then asked the bankruptcy court to bar such claims based on the order approving the sale of 363. Transform, he argued, did not could not be a defendant because the 2019 Court’s sale order expressly provided that Sears assets were sold free from any liability action. Indeed, the sale order specifically stipulated that the sale would not subject the buyer to the responsibility of the successor, considering that the buyer was not the successor of the debtors and that the buyer would not have bought the active without this repair. The sale order enforcement petition is currently pending in the Southern District of New York Bankruptcy Court.
Proskauer’s private credit restructuring team works with clients to formulate and execute simple and complex loan collection strategies, both in court and out of court. Maximizing speed and minimizing costs are priorities for every lender-side debt restructuring, but there is no one-size-fits-all solution, especially for change of control transactions involving a complex business. Potential and unliquidated exposure to product defects, environmental contamination, labor and employment issues, and long-term contractual commitments may make an out-of-court solution impossible. As illustrated by the recent skirmish at Sears, a carefully structured and well-executed acquisition via a bankruptcy credit offer may be the best way to ensure that the acquisition vehicle will be protected against all claims and liabilities, including responsibility of the successor. We will continue to monitor developments at Sears and keep our customers informed as the situation evolves.
 Whether an entity is considered a “mere continuation” of the seller is a question of state law. The court in Call Ctr. Techs., Inc. v Grand Adventures Tour & Travel Pub. Corp., 635 F.3d 48, 53 (2d Cir. 2011) (“Interline”), applying Connecticut law, examined two theories for determining whether a buyer is a “mere continuation” of the seller: “continuity of ownership “And” business continuity. Under the “continuity of ownership” theory, courts assess whether there is an identity of “shares, shareholders and directors between” the buyer and the seller. See Chamlink Corp. vs. Meritt Extruder Corp., 899 A.2d 90 (Conn. App. Ct. 2006). Under the “business continuity” theory, courts assess whether the “successor maintains the same business, with the same employees doing the same jobs, under the same supervisors, working conditions and production processes, and manufactures the same products for the same customers. ‘” Line spacing, 635 F.3d at 53 (citing Kendall vs. Amsterdam, 948 F.2d 1041, 1051 (Conn. App. Ct. 2008)).
 See, for example, Regarding Chrysler LLC, 576 F.3d 108, 119–27 (2d Cir. 2009), left vacant as a sub-name not applicable. Ind. State Police Pension Trust v. Chrysler llc, 558 United States 1087 (2009), appeal dismissed as not applicable In re Chrysler LLC, 592 F.3d 370 (2d Cir. 2010) (confirming the sale of assets to a newly formed acquiring entity exempt from debtor liability for certain vehicle defects); Regarding Trans World Airlines, Inc., 322 F.3d 283 (3d Cir. 2003) (affirming the sale of assets exempt and exempt from complaints of discrimination in employment); UMWA 1992 Benefit Plan v. Leckie Smokeless Coal Co. (In re Leckie Smokless Coal Co.), 99 F.3d 573 (4th Cir. 1996) (asserting sale of assets free and released from successor liability under the Coal Industry Retiree Health Benefit Act of 1992). Although it does not directly address the scope of “interests” under Section 363 (f), the Seventh Circuit arguably took a narrower approach when it allowed a successor liability action in under ERISA to sue the newly incorporated acquiring entity of a secured creditor after obtaining a stay of suspension from seizing its collateral in bankruptcy. Chicago Truck Drivers, Helpers & Warehouse Workers Union (Indep.) Pension Fund v. Tasemkin, Inc., 59 F.3d 48, 51 (7th Cir. 1995) (a “second chance [of recovery] is precisely the point of successor liability, and it is not clear why an intermediary bankruptcy proceeding, in particular, should have a in itself exclusive effect on the chances of the creditor. “). The United States Supreme Court has yet to rule on this issue.
© 2021 Proskauer Rose srl. Revue nationale de droit, volume XI, number 237