The Vanishing Earn-Out Reorganization Plan; Corporate Bankruptcy as an Extension of the Mergers and Acquisitions System

           In the recent history of corporate bankruptcy, a distressed company would file bankruptcy with the goal of  making business adjustments, confirming a plan of reorganization, and emerging from bankruptcy.  In recent years, however, the trend in has been for the case  to be an extension of  the merger and acquisition world.  More and more firms which file chapter 11 are sold outright, or merged into other firms.  This is a departure from proposing the traditional “earn out” plan in which the debtor pays its pre-repetition claims from post-confirmation operations.

            Bankruptcy as a forum for merger and acquisition activity has taken two forms.  First, the friendly form, in which the target company and its suitor already have a transaction in principal.  Concerns about the target company being able to survive even until the closing, or the acquirer’s concerns regarding fraudulent transfer liability if it negotiates too good a deal for itself, result in the parties looking to the bankruptcy system.  The case is filed, and a motion for approval of the sale is then noticed for approval, subject to overbids, overbid protection, and break-up fees.   The goal is a “squeaky-clean” bankruptcy court order approving the sale free and clear of leans and claims, and insulating it from attack at a later date. 

             The other form is not so friendly.  The target company’s very presence in chapter 11 puts it “in play”, and hostile suitors form alliances with the unsecured creditors’ committee, or the debtor’s lenders, in order to force a sale of the company.  A sale of the business will often appeal to unsecured creditors if the terms involve a substantial cash component.  The promise of cash now through a sale, as compared to an extended payout through a plan proposed by the debtor, is more attractive to unsecured creditors.

            In conclusion, the stated purpose of business bankruptcy in chapter 11, to provide a method for troubled companies to earn their way out of their difficulties, and at the same time preserve jobs and going concern value, has changed. 
There is, of course, no [above]  proof that a hostile purchaser will preserve jobs, which is one of the social benefits for which chapter 11 is extolled.