Top ten tips for buyers of assets from insolvent companies

May 8, 2014

After almost half a decade of economic instability, recent signs indicate that the UK economy is now finally moving in the right direction. Despite this, there are still a large number of companies in the UK that are either continuing to struggle or have actually been forced into insolvency.

An astute buyer, blessed with cash in the bank, can find many assets and businesses at bargain prices from such companies. Those being sold by insolvent companies often present the best value. However, the acquisition process does not come without its risks.

Therefore, we have set out below our top ten tips for potential buyers of assets from insolvent companies:

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 a 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 acquisition could be attacked by a subsequently appointed practitioner. In such circumstances, the buyer would need to show that a proper price was paid.

If in doubt, a buyer should insist that an insolvency practitioner is appointed as an acquisition from an insolvency practitioner is extremely difficult to challenge.

2. Check the validity and extent of the appointment of any Insolvency Practitioner and check which third party consents are required

If you are indeed acquiring assets from an insolvency practitioner, you should satisfy yourself that their appointment is valid.

The requirements vary according to the different types of insolvency procedure. For example, an administrative receiver is appointed pursuant to powers in a debenture and the buyer will need to ensure, amongst other things, that the debenture was properly executed and registered at Companies House.

A buyer should also check which entities are selling the assets. Insolvency practitioners may be appointed in respect of some, but not all, of the subsidiary companies of an insolvent parent company.

Increasingly, contracts with key customers, suppliers and/or landlords will have an automatic termination clause. These allow such third parties to bring contracts to an end in the event of insolvency.

If contracts are key to the business/assets that the buyer is acquiring, the buyer 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.

3. The bank’s position

In addition to the searches in paragraph 2 above, a buyer should carry out a search against the seller to establish who has registered security over the company’s assets.

Often the company’s assets will be subject to either a fixed or floating charge. Under the Insolvency Act 1986, an insolvency practitioner can sell assets that are subject to a floating charge without the consent of the charge holder. Therefore, full legal title to the asset will pass to the buyer regardless if consent has been obtained or not.

However, for assets which are subject to a fixed charge, unless the consent of the charge holder is obtained, a court order will have to obtained by the insolvency practitioner before the asset in question is purchased. If neither is obtained, title to the asset cannot be purchased free of the fixed charge.

4. Be aware of retention of title issues

If the seller carried on a business as a manufacturer or supplier, the assets being sold may be subject to retention of title or other conditional terms. The insolvency practitioner 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.

A buyer should ask the insolvency practitioner to agree to deal with retention of title claims in the first instance. Many clauses are poorly drafted or not supported by proper procedures and the insolvency practitioner will have experience of challenging them.

The insolvency practitioner may face difficulty in ascertaining what, if any, assets are subject to retention of title clauses if he has not been appointed by the directors themselves. In such circumstances the directors may be less inclined to assist and provide details of which assets are subject to retention of title clauses. This is in addition to the limited time available for the insolvency practitioner to test whether assets are subject to such retentions. Therefore, a buyer should only consider acquiring such disputed assets if they are to be refunded all or part of the purchase price if a claim is successfully made against them.

Alternatively, a buyer can purchase the assets for a reduced price, on terms that they will deal personally with any supplier who claims the purchases assets were supplied subject to retention of title. A buyer will then have to deal with the supplier and try to negotiate a price for the assets.

5. 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 the funds are in place to pay the consideration. Deferred payment terms are obviously not popular with insolvent sellers;
  • if possible, negotiate a “pre-pack” sale (one negotiated before the insolvency practitioner is appointed, see paragraph 6 below). 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; and
  • be prepared to carry out an extensive but accelerated due diligence exercise. Due to the lack of warranties which are likely to be offered, due diligence will be all the more important.

The due diligence team (financial/tax advisers, lawyers, HR, industry specialists etc) should be appointed/in place as soon 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.

6. Pre-pack sale

A pre-packaged insolvency sale is a sale which is structured, negotiated and agreed on by an 'insolvency practitioner in waiting' and a buyer. This occurs before the proposed insolvency procedure begins and the insolvency practitioner is formally appointed. This means that the buyer must have its own structures and funding in place before the deal is completed. Once terms are agreed, the insolvency practitioner is appointed and the sale will normally be completed soon after - usually within minutes.

Often a pre-pack sale is made to a company owned by the former directors/shareholders of the old company. This is a reason behind why pre-pack sales have a bad reputation, as the sale is to those who were originally responsible for the old company’s financial problems. However, pre-pack sales result in a purchaser being in a position straight away to continue the business as a going concern, meaning that its assets continue to have value. This is far more preferable than the appointment of an administrator and the business being closed down as it will result in the assets being worth next to nothing.

There are a large number of requirements that an insolvency practitioner has to comply with and include in his report to the creditors when he has been party to a pre-pack. These include (i) setting out how he was introduced to the company; (ii) whether the purchase is connected in any way to the directors of the company; and (iii) details of any prior attempted to market the business more widely to other potential buyers prior to the pre-pack sale.

These requirements are in place in order to provide information on the circumstances leading up to the company’s pre-pack sale to the creditors of the company. Creditors can then hold the insolvency practitioner to account should it look like the pre-pack sale of the company was not the only viable option for the company.

7. One-sided agreements

Generally the terms of the sale agreement for the business/assets will be in favour of the seller. Even the least contentious standard provisions will often not be drafted on a reciprocal basis. Nevertheless, the sale agreement should be scrutinised to check what is included and excluded.

It is very much buyer beware and the insolvency practitioner will not give the warranties which a solvent seller would. In fact a big part of the agreement will be excluding the insolvency practitioner's personnel liability, especially in respect of the disposal of assets which may be subject to retention of title clauses. This will be sought as the sale of such assets will likely be inconsistent with the rights of the actual owner and therefore be liable to a claim of ‘conversion’ from the actual owner. Buyers should be aware of this and not waste effort on non-negotiable terms. Instead, they should focus on getting the best possible price or other key commercial objectives.

8. Consider the employee position

Employment due diligence is particularly important. The appointment of an insolvency practitioner will not automatically terminate the contracts of employment of the insolvent company (save for compulsory liquidation). The Transfer of Undertakings (Protection of Employment) Regulations 2006 ("TUPE") may apply in relation to the sale of assets of the insolvent company, if the sale amounts to a transfer of a qualifying business unit.

This will be important as TUPE provides, amongst other things, for the contracts of employment to transfer to the buyer without variation; protection for employees against dismissal connected with the transfer and also sets out duties on the buyer to inform, and possibly consult, with the trade unions or elected employee representatives.

Further, an insolvency practitioner will often dismiss some of the workforce on, or shortly after, their appointment to make the business more attractive to a potential buyer or more commercially viable. This means that any buyer who wants to purchase the business/assets but does not want to take on any/all of the employees, may become liable in relation to any employees who are dismissed by the insolvency practitioner. This is because such dismissals will be deemed “automatically unfair” under TUPE as they are in connection with the transfer to the buyer.

Due diligence must therefore be carried out to find out the number of employees the company had on the date it went into administration and the extent of the reduction in employees. The only circumstance a buyer will not be liable for previous employee dismissals by the insolvency practitioner shall be when the reason for the dismissals was due to a lack of funds to pay wages, rather than in an attempt to make the business more appealing to a potential buyer.

It is extremely unusual to obtain an indemnity from the insolvency practitioner with regard to employee claims. Therefore, the purchase price should reflect such a risk.

The position on pensions should also be considered. A buyer can either takeover an existing scheme, provide a new scheme or negotiate a bulk transfer.

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.

Under section 190 of the Companies Act 2006, such transactions (in respect of a certain minimum value) will be voidable unless the arrangement has been first approved by ordinary resolution of the sellers' shareholders.

Therefore, the timing and structuring of the buyer's board of directors must be considered so that section 190 is complied with.

10. "Phoenix Trading"

Section 216 of the Insolvency Act 1986 sets out restrictions on the further use of the failed company’s name in the future. 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.

People who were directors, or shadow directors, of the company 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.

There are exemptions (involving the notification of all creditors) but the use of a different name should be considered.

Summary

When purchasing assets from an insolvent company, the reduced price paid for those assets must be set in context with the increased risk that is being taken on. It is important to try and minimise this risk wherever possible and due diligence is key. An experienced and reactive legal team is essential.


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Paul Taylor
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