Many investors, including PE firms, are waiting with bated breath to see how the UK economy, currently dependent on COVID-19-related government support, will respond once that stimulus is withdrawn. An increase in UK company insolvencies is expected, creating opportunities for savvy investors to acquire businesses at bargain prices, while at the same time appearing to be white knights swooping in to save a beloved high street brand or large regional employer.
Buying from an insolvency officeholder, such as an administrator or liquidator, is significantly different from a solvent sale. Here we highlight the top ten things investors should look out for in a distressed sale.
PE investors are familiar with typical M&A sales, where representations and warranties shift commercial risk to the seller. However, in an insolvent sale, the insolvency officeholder will not generally provide any representations, warranties, title guarantees, or covenants of title. This means that a buyer will not have recourse to the insolvency officeholder for damages where representations or warranties are found to be untrue or where there is any defect in title. The commercial risk lies squarely with the buyer and ultimately, its LPs.
Due to the limited protections available in the SPA, due diligence becomes even more important in an insolvency context. An accelerated sale timetable, lack of resources, and/or disorganised company records can make thorough due diligence impossible. Despite the limitation on due diligence, buyers should always ensure they are comfortable that the insolvent company owns the assets that it is purporting to sell or that are vital to its business.
Finality of any insolvency sale is paramount to the insolvency officeholder and consequently deferred consideration or other complex methods for paying consideration, which might be options in a solvent sale (such as earn outs, retentions or escrows), will not be favoured by the officeholder. Cash is king, and sponsors will need to have readily available funds or risk losing out to cash bidders.
In some circumstances, an insolvency officeholder may permit creditors to credit bid (using their secured claim as collateral in the process) in order to acquire assets, but this comes with strings attached. An insolvency officeholder may require their costs and expenses paid in cash (as well as funds to meet preferential creditors and the prescribed part payable to unsecured creditors out of floating charge realisations), particularly where there would be no assets to pay for these following the sale. A credit bid acquisition is, therefore, not completely cash free.
Where key assets include contracts, such as customer or supplier agreements, those may require third-party consent to be assigned or novated to the buyer. The acquiring PE House may wish to take the lead to ensure that they can control the communication, assure, and salvage relations with the relevant counterparties. Further assurance wording should be included in any SPA to ensure the insolvency officeholder provides reasonable assistance to support transfers and will terminate those contracts that cannot be assigned or novated.
Insolvency officeholders will be at pains to exclude personal liability and stress their status as agents, thereby absolving themselves, their firm, and their employees of any liability relating to the SPA. Again, the buyer should be aware that this language means it will not be able to pursue the insolvency officeholders for claims relating to the sale. It is essentially a “no returns” policy.
Where the entire business and assets are sold, including the books and records of the insolvent entity, the SPA will include obligations on the buyer to retain such books and records and allow the insolvency officeholders access to the same to complete tax and other filings during the insolvency. This is to be expected, but worth noting that it is often at the cost of the buyer.
Buyers should pay particular attention to how employment matters have been managed by the insolvency officeholder, particularly where the officeholder has undertaken a redundancy process to reduce staff. In such circumstances, the buyer will want to ensure liabilities relating to redundancy payments or other severance pay do not transfer to the buyer on any sale of the business.
While anti-embarrassment clauses, often structured as an anti-flip clause, afford protection to the insolvency officeholder, they create risk and uncertainty for buyers. PE Houses and their LPs will naturally want to minimise any uncertainty and price this risk. They could push back on the inclusion of anti-embarrassment provisions altogether. Ultimately, where the insolvency officeholder is not comfortable with the valuation of the business and the consideration received they should, arguably, not be selling the business at all.
New UK pre-pack regulations now require creditor approval or a report from an independent evaluator prior to any substantial disposal to a connected party by an administrator within eight weeks of the start of an administration. Investors, particularly those that are shareholders, directors, or other parties with a significant connection to the insolvent company and could be deemed connected parties, need to be mindful of the timing and cost of obtaining an independent evaluator report. While it is possible to shop around for a favourable evaluator and report, and to obtain more than one report, this is discouraged.
With those ten top tips in mind, for a sponsor looking for a bargain, a disposal by an insolvent company can certainly fit the bill, but PE buyers should be aware of the risks and differences between contracting with a solvent versus insolvent entity in the UK as there will be little recourse and no refunds (or, at least, no price protection) in the case of the latter.