When a company or a business enters into a formal insolvency situation it can look like the end of the road. It does not need to be as the underlying business, or part of it can still be viable and worth saving. In this article, our insolvency solicitors look at how and when a business can be acquired out of insolvency, what the process is and what differences arise when buying an insolvent business compared to a solvent business.
If you are reading this guide because you are thinking about buying an insolvent business, our insolvency solicitors can help. Working alongside our corporate team, we’ll guide you through the risks, structure the deal to protect your interests, and flag issues early, before they become costly. We’re more than legal advisors; we’re commercial partners, giving you clear, practical advice you can act on with confidence.
Contents:
- The benefits of buying an insolvent business
- Why is the business insolvent?
- How is the insolvent business valued?
- What should I have in place before I buy an insolvent business?
- How do I purchase an insolvent business?
- Should I buy assets or shares?
- What are the key differences when buying an insolvent business?
- How can we help?
The benefits of buying an insolvent business
Correctly structured, the sale of a business out of insolvency can have benefits for the buyer, seller and third parties who have an interest in the business:
- For the insolvent business: the realisation of value to pay creditors and/or restructure its finances.
- For the buyer: certain legacy liabilities of the insolvent business can be left behind.
- For employees: the possibility that their employment transfers to the buyer, preserving jobs rather than leading to redundancies.
- For customers and other third parties dealing with the business: their commercial arrangements may continue where they otherwise would have ended.
Why is the business insolvent?
It is important for a buyer to understand the cause of the business’ insolvency. There may be one major factor which leads to insolvency (such as a change in industry regulations or market trends) or more typically, a series of events or circumstances which all contribute to the business no longer being viable. These may include poor management, litigation, bad debts or changes in the labour market.
The reason for the insolvency of the business is crucial to establish for a potential buyer as this will impact the valuation of the business and the risk profile of the purchase. It will help the buyer to assess how much will need to be invested in the business to be able to turn it around and which areas will need to be focused on and crucially whether the business can be turned around at all.
The valuation of the business will be impacted by the reason for the insolvency, for example, if the business has failed due to bad debts or poor management, then systems can be put in place to help prevent this reoccurring. In these cases, the valuation of the business would not be impacted as much as if the business had failed due to wider market or industry issues over which there is limited or no control.
How is the insolvent business valued?
Office holders have rules they must follow when selling an insolvent business, and these are stricter if selling to an existing director or directors of the company or business in insolvency, which is often the case. They must be independent, they must obtain an independent valuation of the business, and they must allow for a reasonable marketing period for the business before agreeing on a final sale price. This ensures that the best price is obtained for the business in the best interests of the creditors overall. This remains the case regardless of who brought about the office holder’s appointment.
It is often the case that a new company will be set up by the directors of the insolvent company or business to make an offer for sale of the business, and they may be vying with competitors in the market. Often, the only offer for the business will be from the former directors, who know the business and believe the viable parts can be saved. This inside knowledge can put the former directors in a strong bargaining position with the office holder.
What should I have in place before I buy an insolvent business?
When buying an insolvent business, you often have to move quickly as value can leak out of the business the longer the situation continues. You will need some basics in place before you are able to do this, as discussed in more detail below.
- Legal advice: engaging a team of insolvency lawyers early on is important as they can advise on the structure of the deal, negotiate and draft the sale and purchase agreement and ensure any assets bought are transferred and registered (if necessary) in the correct way. They will also check the validity of the office holder’s appointment to make sure this cannot be challenged later by creditors, which could result in the unpicking of the sale.
- Financial advice: a team of financial advisors will be needed to advise on the valuation of the business and assets, help with due diligence to understand the business’ tax and debt position and assist with any funding requirements.
- Funding: you will need to have funding arranged if this is required to purchase the business.
- Transition and turnaround plan: you will need a clear strategy and plan in place for the transition and potential integration of the business or assets and a proposition for the rehabilitation of the business.
- Permits or licences: any permits or licences which the business may need to continue operations should be organised (as far as possible) before the sale completes.
- Cherry picking: once you are satisfied with your due diligence on the business and its assets, you need to decide which parts of the business you would like to purchase and ensure that these are clearly and comprehensively identified in the sale and purchase agreement.
How do I purchase an insolvent business?
On a practical level, once the offer has been accepted by the office holder, the sale will go ahead as soon as possible. Delay can have a negative effect on the value of the business in many ways, so time is of the essence. Too much delay can see employees and customers and suppliers move on and goodwill diminish.
There are generally three methods of sale for an insolvent business: by way of a private sale and purchase agreement, an auction process or sealed bids. The usual method is a sale and purchase agreement once the office holder has chosen the preferred buyer. The office holder will arrange for a sale and purchase agreement to be drafted by their solicitor, and the buyer will instruct their own solicitor to act for them on the sale.
Auction processes are more usual for the sale of smaller assets or larger assets in a bigger market and sealed bids is a process generally used where there is strong competition for an asset, allowing the office holder to obtain the best price.
Often, a sale of assets of a distressed business will be structured as a pre-packaged sale, commonly known as a ‘pre-pack’, where the terms of the sale are agreed before the appointment of an administrator and the sale completes upon the appointment of the administrator who then sells the assets. This method of sale helps to preserve the continuity of the business and protects it from reputational damage. For more information on this topic, read our guide on pre-pack administration.
Should I buy assets or shares?
The sale of a company may be structured as a sale of its shares or its assets. The key difference is that on a share sale, the entire business (including debts and liabilities) will be transferred to the buyer. An asset sale allows the buyer to choose which assets it would like to buy without inheriting the liabilities of the business.
The structure of an insolvent business sale will typically be a sale of assets of the business rather than the shares. This allows the buyer to ‘cherry pick’ the assets it wishes to buy while leaving behind the less desirable assets and (subject to a few exceptions) the liabilities and debts of the company.
As a result of this limitation of liability and risk, an asset purchase is usually safer in an insolvency situation, particularly as office holders don’t typically provide warranties and indemnities in the sale agreement which exposes the buyer to greater risk. Also, in an asset sale, a buyer may not have to take on the existing employees of the business which they would in a share sale.
An asset sale can typically be negotiated quicker than a share sale which is important in an insolvency situation and also allows the buyer a ‘cleaner’ purchase as they have more control over the selection of assets which they really want and/or need rather than having to inherit all of the business, warts and all.
There may be situations where the purchase of the shares of an insolvent business makes more sense, although these tend to be few and far between as the shares will be worthless at this point. The purchase could be structured as a share purchase for tax reasons or where there is a potential to acquire the company itself and restructure it as part of a wider group. Acquiring shares may also be an easier way of purchasing and transferring the assets of the business where there are a large number of assets.
There will be differing tax implications for the buyer which arise from the purchase of shares versus assets, for example VAT may be payable on individual assets if the business is not transferred as a going concern. Specialist tax advice would need to be sought early on to ensure the deal is structured in the most tax efficient way.
What are the key differences when buying an insolvent business?
There are quite significant differences when buying an insolvent business from an office holder compared to a solvent business. The main one being the seller of the business. In an insolvency situation, the seller will be the office holder, rather than the shareholders and their day to day knowledge of the business is necessarily sparse and they won’t be willing to give warranties or indemnities about the business. .
It is also the case that an office holder is under a duty to deal with an insolvent business without unnecessary delay. For that reason, they are less likely to agree a deferred purchase price unless this is very limited, and they will not give the usual warranties and indemnities. The business will be ‘sold as seen’ with very little, if any, recourse.
There is a very limited opportunity for a potential purchaser to complete any due diligence, but this is inevitably reflected in the price. Equally, there is little room for negotiation of the terms of sale.
Aside from price and risk, the main key differences are:
- The officer holder will not accept any personal liability under the contract save for reasons of negligence or similar.
- The standard protection of the purchaser under the Unfair Contract Terms Act 1977 will usually be explicitly excluded in the sale contract.
- The buyer will usually be expected to indemnify the office holder in respect of all future claims concerning the business and assets after the sale. This is because once the sale has gone through, the company or business itself is not likely to continue in existence for more than a few months, and so the buyer will not have the opportunity to make financial claims against the business further down the line.
- Due to the speed of the transaction, the sale will often complete before consents or new contracts are obtained, even if these are sold under the contract. So, for example, while a licence may be granted for the buyer to remain in the business premises for a limited time, a lease assignment will need to be agreed and negotiated separately with the landlord following sale. Similarly with any equipment on a hire purchase agreement.
- The sale agreement may include customer or supplier lists but novation of contracts will inevitably take place following sale, and are therefore ultimately subject to the agreement of the customers or suppliers. This is a risk that is taken by the buyer, and the sale price should reflect this.
A buyer will usually accept these risks as they are often overridden by the discount applied to the sale, and if the buyer was a director of the company or business in insolvency, they will be able to make an educated decision on the level of these risks.
How can we help?
Buying a viable business from an office holder can be both a risk and an opportunity for a buyer. At Harper James our corporate and insolvency solicitors have many years of experience in advising buyers of insolvent businesses and acting for office holders on selling them and can work for you to reduce the risk of purchase and address all relevant issues.
