You may be looking to expand your portfolio, secure a strategic asset at a reduced price, acquire a distressed rival to consolidate market share or buy a distressed supplier to secure your supply chain.
Buying a distressed business is a complex and risky process which must be navigated quickly to achieve the best results for both buyer and seller. A successful sale will require careful consideration of various legal and financial factors and will need teams which can adapt to the challenges of rapidly changing circumstances. It is vital that you have a legal team on-board early in the process to avoid mistakes which may lead to additional time and costs being incurred and ultimately, the potential failure of the sale.
This article sets out the key legal issues to be aware of when buying a distressed business and is for those entrepreneurs, founders and SME owners who may be considering growing their business at a lower cost by acquiring distressed assets.
Contents:
How does a distressed business sale work?
As mentioned above, a distressed business sale needs to happen quickly due to the worsening position of the business. Sales are normally completed within weeks rather than the months it takes for a standard business sale to sign.
Distressed businesses sales can happen both before and after insolvency processes and a different approach and model will be needed in each case. In this article, we will focus on post-insolvency sales by administrators or liquidators who are looking to get the best price possible for creditors and will be heavily involved in the structuring and negotiation of the sale.
Because of the involvement of the administrators and the need for a quick turnaround, due diligence is often limited to the bare minimum and no protection is offered to the buyer in terms of warranties and indemnities. The administrators will also look to the buyer to indemnify them and the insolvent company against any liabilities arising from the sale.
The buyer therefore needs to reflect this increased risk in the purchase price which should be significantly lower than that offered in a standard business sale.
How does a distressed business sale differ from a standard business sale?
Broadly, distressed business sales are similar to standard business sales, with the buying process and due diligence following the same steps. For more information on standard business sales, please see this article on the M&A process and this article on due diligence. There are, however, fundamental differences which we will explore in more detail below.
Sale of assets not shares
The structure of the 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.
Very 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.
No warranty protection
Unlike in a standard business sale where the seller will provide warranties (statements of fact) about the business and assets (which if untrue, give rise to a claim against them by the buyer), a distressed business is sold on an ‘as seen’ basis with limited or no warranties at all.
In a distressed sale, you will be negotiating with the administrator or liquidator appointed to the company who will not be willing to provide any warranties for various reasons. These include a lack of knowledge about the business and assets being sold, the need to avoid any continuing liability for the company or themselves and the need to distribute the sale proceeds to creditors promptly.
Buyers in distressed sales will have very little recourse against a seller and even if they did, the seller is likely to be insolvent and unable to pay any claims brought against it in any event.
There may be a possibility of obtaining warranty and indemnity insurance against the risks but this is not always practical in the short timeframes for the sales and is likely to be expensive.
Due Diligence
As the buyer will not have the benefit of any warranty or indemnity protections, due diligence is very important as the onus is on the buyer to ensure it understands exactly what it is purchasing.
On the other hand, there is usually very little time to conduct a thorough due diligence exercise as would be seen on a standard business sale and the information available to the buyer may be very limited if dealing with the administrators. Buyers therefore need to limit their investigations to the most fundamental areas of the business to them, for example, information on the key assets or employees.
Need for speed
In a distressed sale, time is of the essence. You need to engage a legal team early on that has experience in navigating the challenges of buying a distressed business. For more information on the potential challenges of an M&A transaction, please see this article. If there was a possibility that the company had been trading when insolvent, you will also need input from a legal insolvency team.
Deals can often be finalised within weeks, unlike the months typically required for a standard sale. There is a small window of time to complete the sale as the longer the business is in distress, the more likely it is to run out of cash. Key contracts may be terminated, key employees may resign and debtors may become less inclined to make payments.
Buyer Beware
Buying assets from an insolvent company is a risky business and it is important that you are aware of the potential pitfalls which could leave you seriously out of pocket.
Due diligence on the assets being purchased is key as you are unlikely to receive any warranty protection in the sale agreement but access to information about the business and assets is also likely to be limited. The title to the assets being bought needs to be checked thoroughly to make sure they are not subject to any financial charges or hire purchase agreements or owned by a different group company which could all mean that you will not own the asset outright after the sale.
Different types of assets (for example, intellectual property, real estate, contracts) need to be transferred and registered in different ways in order to effect a legally binding transfer. Applications for licences or permits which the business needs to continue trading after the sale may need to be arranged in advance.
Assistance with buying a distressed business
We have specialist teams of lawyers who have years of experience in the sale and purchase of distressed assets and businesses. We can guide you through the necessary steps, including due diligence exercises, drafting and negotiating the sale documentation and advising on title and transfer of assets. We can also help with the more practical ‘day one’ questions and tidying up and integrating the business once acquired.
