A difficult economic climate can be a good opportunity for strong market players to build and expand their businesses by way of strategic acquisition. Many companies in the tech sector are looking to consolidate, for instance in order to secure supply or distribution chains or extend their market share.
An astute buyer with cash in the bank (or that rare thing, a line of credit) may be able to find valuable business assets (including intellectual property) for sale at bargain prices out of insolvent companies. But acquiring businesses and assets out of insolvency situations presents its own particular risks. The following are our top ten tips:
1. Timing is key
When a company is trading normally, decisions are taken by its directors. When a liquidation, administration or administrative receivership order has been passed, decisions will be taken by a licensed insolvency practitioner.
There will be period when the company is in financial difficulties but the directors are either ignoring the problem or trying to trade their way back to financial health. If a buyer acquires assets during this period, there is a risk that the sale could later be attacked by a subsequently appointed insolvency practitioner. The buyer would need to show that a proper price was paid.
If in doubt, you should insist that an insolvency practitioner is appointed because an acquisition on this basis is extremely difficult to challenge.
2. One-sided agreements
Buyer beware – this is the watchword for acquisitions from an insolvent company. The insolvency practitioner will likely know relatively little about the business and will be loathe to take on any liabilities as a seller. Accordingly, he will not give the warranties which a solvent seller would and the terms of the sale agreement will generally be very one-sided.
Buyers should be aware of this and not waste effort on non-negotiable terms. Instead focus on getting the best possible price or securing other key commercial objectives.
3. Due diligence
Because of the severely limited warranty coverage, it is crucial to understand what you are buying. Your due diligence team (financial/tax advisers, lawyers, HR, industry specialists etc) should be lined up early and be prepared to carry out an extensive but accelerated due diligence exercise as quickly as possible.
The onus is very much on the buyer to gather as much information as possible in order to flesh out the marketing information given by the insolvency practitioner.
Ideally, you should commence due diligence before the insolvency situation arises, while there are still people in charge who know the business. For tech companies with innovative business models or difficult-to-understand technologies, you will need to get to grips with this at an early stage and keep key people on board.
4. Check which third party consents are required
Increasingly, contracts with key customers, suppliers and/or landlords will have an automatic termination right triggered by insolvency.
Similarly, if an intellectual property licence is a key asset being acquired, you will need to be comfortable that it will not be terminated as a result the insolvency.
If contracts/licences are key to the business you are acquiring, you should consider approaching third parties for their approval prior to the transfer. If approval cannot be obtained, the price should be reduced to reflect the increased risk which the buyer is taking on.
Before talking to third parties, though, you will need to make sure that this will not be in breach of any duty of confidentiality, for instance as a result of a non-disclosure agreement.
5. The bank’s position
In today’s heavily leveraged times, you will need to check the extent of any registered security over the assets you are buying. You will want to be sure that any charges over the assets will be released prior to the sale completing.
The insolvency practitioner will not usually have the authority to provide such a release. This must be approved by the charge-holder(s) – normally the company’s bankers – who will therefore need to be happy with the terms of any deal.
6. Be aware of retention of title issues
If the seller carried on business as say a manufacturer or supplier, the assets being sold may be subject to retention of title or other conditional terms. The administrator can only pass on the title which the seller has in such assets. This means that the assets may have to be returned to the supplier, if a valid retention of title claim can be proven.
You may want the insolvency practitioner to agree to deal with retention of title claims in the first instance. Many such clauses are poorly drafted or not supported by proper procedures and the insolvency practitioner will have experience of challenging them.
Consider acquiring such disputed assets on the condition that you are to be refunded all or part of the purchase price if a claim is successfully made against you.
7. Be prepared
The insolvency practitioner may be approaching a range of interested parties. A buyer who can move quickly will be at a great commercial advantage:
• incorporate a new entity in order to ring-fence the acquired assets;
• make sure you have cash funds. Deferred payment terms are obviously not popular with insolvent sellers; and
• if possible, negotiate a “pre-pack” sale (one negotiated before the insolvency practitioner is appointed). The sale (which is sometimes, though not always, made to the previous directors or managers of the insolvent business) is then rapidly executed without the business being offered on the open market or suffering the stigma of trading in administration.
8. Consider the employment position
Employment due diligence is particularly important. The appointment of an insolvency practitioner will not automatically terminate contracts of employment (save for compulsory liquidation). However, the insolvency practitioner will often dismiss some of the workforce, on or shortly after appointment, to make the business more attractive to a potential buyer or more commercially viable.
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) may apply in relation to the sale of assets of the insolvent company. This can have considerable consequences – TUPE provides, amongst other things, for the contracts of employment to transfer to the buyer without variation. This entails protection for employees against dismissal connected with the transfer and imposes duties on the buyer to inform, and possibly consult, with the trade unions or elected employee representatives.
It is extremely unusual to obtain an indemnity from the insolvency practitioner with regard to employee claims, so you need to understand the extent of the potential exposure and ensure that the purchase price reflects the risk.
9. Substantial property transactions – section 190 Companies Act 2006
This provision comes into play if a director of the insolvent company (or holding company) is seeking to purchase assets from the insolvency practitioner.
Section 190 of the Companies Act 2006 states that transactions above a given value will be voidable, unless the arrangement has been first approved by ordinary resolution of the sellers’ shareholders.
Consider the timing and structuring of the buyer’s board of directors.
10. Section 216 Insolvency Act 1986 – “Phoenix Trading”
Section 216 of the Insolvency Act 1986 sets out restrictions on the use of the failed company’s name or trading name. This is to prevent so called phoenix trading in which the directors of a failed enterprise start a new company with the same, or a similar name, to exploit the goodwill of the previous company, whilst escaping liability for the debts.
Directors of the company (any time in the twelve months prior to the insolvency) should not act as directors or be otherwise involved in the business of a company with the same or the similar name for five years following the insolvency unless certain conditions are satisfied. This will involve strict compliance with certain notification requirements.
In our experience, unless there is substantial value in the name, it can sometimes be an anchor around the neck of the fledgling business. You should therefore carefully consider the potential downsides of using the same name.
The reduced price of assets acquired in an insolvency sale reflects the increased risk assumed by the buyer. In order to set the right price and get what you bargained for, you need to understand what you are buying and, where possible, minimise the risk of nasty surprises. Due diligence is the key and a experienced and reactive legal team is essential.