Caveat Emptor: Bottom Fishing With No Regrets

The pros and cons of waiting for the seller to declare bankruptcy.

Sometimes a great opportunity is just too good to be true. Consider, for example, a purchase of distressed assets from one of the many energy companies now mired in well-publicized financial difficulties.

Many of these companies cannot raise capital in the public markets. Their debt securities are downgraded, some to junk status, and are trading at a fraction of their face values, with new financing perhaps unavailable. And their stock prices have fallen, making any new public offerings unattractive or even infeasible. Such companies may be forced to sell assets on the cheap, offering apparent deals for buyers who can lay claim to the necessary cash or credit.

This prospect puts the question to the buyer: Move quickly and buy now, while the getting is good, or wait until after the "target" has filed for bankruptcy under Chapter 11?

The first strategy gives a buyer a jump on the competition, but it may anger creditors. It may draw a fight from lienholders, and expose the buyer to unnecessary risk from potential litigation, such as that arising from successor liability or the rule against fraudulent conveyances, especially in the case of a leveraged buyout.

The second strategy puts most litigation risk to rest, yet it opens the buyer's offer to the light of day, through an open bidding process. That invites new offers from competitors, putting the buyer at risk for an overbid and possible loss of any investment sunk into the due diligence process.