Private Credit Lenders ' Navigating Successor Liability Issues

• Published date: 26 August 2021
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, M&A/Private Equity, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Proskauer Rose LLP
• Author: Charles A. Dale, David Hillman and Matthew A. Skrzynski

The primary investment thesis of a private credit lender is simple ' get the loan repaid at maturity. Private credit lenders do not make loans as a means to acquire their borrower's business. There are circumstances, however, where private credit lenders must be prepared to take ownership when the borrower is distressed and there is no realistic prospect of near-term loan repayment. Becoming the owner of a borrower's business may very well be the loan recovery option of last resort.

There are different ways to implement a change of control or debt for equity restructuring, including an out-of-court conversion, a foreclosure sale under article 9 of the Uniform Commercial Code ("Article 9 Sale") and a Section 363 sale under chapter 11 of the Bankruptcy Code (a "Bankruptcy Sale"). Which strategic path to pursue depends on a host of factors, including cost, speed, degree of consensus, extent of operational distress and need to address other liabilities on the borrower's balance sheet.

In either an Article 9 Sale or Bankruptcy Sale, secured lenders are entitled to "credit bid" for their collateral using debt forgiveness as the purchase price to acquire the collateral. Credit bidding lenders can thus acquire the collateral comprising a borrower's business without making major changes to the enterprise and will assume those specific liabilities that are necessary to operate the business. Credit bidding lenders typically form a new acquisition vehicle ("NewCo") that will look very similar to the borrower. NewCo is likely to conduct the same operations from the same locations, serving the same customers with the same employees. NewCo may even conduct its business using the same name as the former borrower.

Outside of bankruptcy, a scenario like this may expose NewCo to unpaid claims from the borrower's creditors based upon so-called "successor liability" theories. The borrower's unpaid creditors may contend that NewCo is a "mere continuation" of the borrower/seller and that NewCo should be liable for the debts of the seller.¹ Lenders considering "out-of-court" strategies, including an Article 9 Sale, will certainly prefer the speed and cost of this option. In certain circumstances, however, the specter of potential successor liability can outweigh the advantages of an Article 9 Sale. The risk of successor liability is greater when the sale is marked by evidence of wrongful or unfair acts, such as when the buyer knows that the seller will transfer the sale...