When closing a leveraged buyout, if the buyer makes its payments to the company’s shareholders through a financial institution – even in an acquisition of a privately held company – those payments may be protected from being clawed back in a bankruptcy.
The Quality Stores Case
A recent federal case involving Quality Stores Inc. was decided in favor of the shareholders on appeal, permitting them to keep the payments they received for their shares when the company was acquired. This has long been the case for public company acquisitions, but now the rule has been extended to private companies as well.
The sale price for the Quality Stores acquisition was paid to the shareholders through a financial intermediary, who distributed the cash to the shareholders in exchange for their shares. The court found that use of the financial intermediary for payment and settlement was sufficient to entitle the shareholders to the protections of Section 546(e) of the Bankruptcy Code. This means that the payments cannot be unwound, and the cash cannot be pulled back into the company to be accessed by the company’s creditors.
What This Means For Financial Institutions
On one hand, it seems odd that the mere use of an intermediary would create such a result, when there is nothing else different about this transaction from most others. Steve Bobo, who is one of my bankruptcy partners here at Reed Smith, has been watching this case for some time. He recently explained that the exemption exists to protect financial institutions (i.e., the intermediaries) from instability and risk. But, as Steve also points out, this particular transaction had no economic or substantive difference from any other private LBO. The shareholders got paid for their stock just like in any other acquisition.
For financial institutions that act as intermediaries in settlements like these, this is good news. There is additional certainty that once you’ve transferred the funds to the shareholders, they can stay there. However, for financial institutions that act as senior creditors, the fact that these funds cannot be brought back into the bankruptcy estate means there may be less cash from which you can have your loan repaid, and you have less likelihood of recovery. Whether you cheer or decry this decision depends which side of the table you’re on in any particular deal.