Acquisitions of businesses in financial difficulties
Corporate update January 2009

Updated January 2009

The current economic climate presents opportunities for acquiring businesses. As well as competitive prices, acquisitions in these situations present different commercial and legal considerations that should also be taken into account. As timing and quick commercial decisions are crucial our experienced lawyers are on hand to assist and provide detailed advice on these and other issues that are common in the current market.

Agree the right structure
Typically a buyer will only be interested in acquiring certain assets and excluding the unconnected liabilities of a business in financial difficulty. This means that the acquirer is unlikely to set out to acquire the shares in the company that owns the target business, and will instead aim to acquire its business and assets only. The buyer should also consider using a newly incorporated company for the purchase to 'ring-fence' the acquired business.

Prior to acquisition the business and assets to be acquired could be 'hived-down' into a newly incorporated subsidiary of the selling company, enabling a buyer to purchase the shares in the newly incorporated subsidiary. The hive-down approach can suit a buyer since it may be possible for the tax benefit of trading losses of the target business to be transferred, provided that certain anti-avoidance tests are satisfied. The amount of losses which can be transferred will be limited to the extent that liabilities are left in the parent company. Our lawyers can provide specialist tax advice for buyers interested in this approach.

Timing is everything
Time is of the essence when the business and assets of a company in financial difficultly are being sold. The longer the process takes, the greater the risk of deterioration of the goodwill in the target business. Debtors become disinclined to pay and creditors may refuse to extend credit any further. Flash points are particularly common at the end of a month when a business has to pay its staff or when rent for premises is due.

Warranties?
It is not always possible for a buyer to obtain adequate protection from warranties and representations in a sale contract when purchasing a business in financial difficulty, whether insolvent or not. An insolvency practitioner will usually not be in a position to give any warranties and if the sale is being carried out outside a formal insolvency process, warranties from a company in financial difficulty with few remaining assets are worth very little. Any alternative sources of comfort should be explored with advisers and discussed at an early stage.

A buyer also needs to protect itself by carrying out as much due diligence as possible on the target business in the time frame available. Areas that should be concentrated on include ownership of the assets to be acquired, particularly in relation to premises, stock, intellectual property and retention of title. Increased risk that a buyer is taking when buying such a business should also be reflected in the price paid.

Employees
The Transfer of Undertakings (Protection of Employment) Regulations 2006 ('TUPE') are a key issue on the sale of a business and assets. Their impact includes (subject to the exceptions set-out below):

• contracts of employment of the employees of the target business automatically transferring to the buyer from their original commencement date;
• all outstanding employee liabilities of the seller passing to the buyer;
• protection for employees against dismissal; and
• the buyer and seller having duties to inform and consult with trade unions or employee representatives. If this is not done liability to employees can be a maximum of 13 weeks' pay per employee.

The effect of TUPE is modified on a transfer of an insolvent business. If the seller is in insolvency proceedings which have been opened not with a view to liquidation (such as administration in most cases, administrative receivership and voluntary arrangements) then pre-existing debts such as statutory redundancy payments, arrears of pay and holiday that the seller owes to its employees may not be automatically transferred. Instead, a certain maximum amount will be paid by the State through the National Insurance Fund. This eases the financial burden on the buyer, but there is a cap on the amount payable by the State and the buyer will be liable for all debt in excess of the cap. Permitted variations to transferring contracts of employment may also be possible.

If the seller is in insolvency proceedings which have been instituted with a view to liquidation (such as creditors' voluntary liquidation), the employees will not automatically transfer to the buyer together with the employee liabilities, and protection for employees against dismissal is reduced.

Advice will need to be taken on the effect of any insolvency proceedings in each case. If a business is in insolvency proceedings and employees have been dismissed it will be vital for any proposed buyer to investigate whether liability from the dismissal could be transferred under TUPE. In a decision of the Court of Appeal last year, an employee of an insolvent business dismissed by an insolvency practitioner (who was unaware of an intention to transfer the business to a new company), was not dismissed for a reason associated with the transfer. Therefore the sacked employees' claims were left in the insolvent company.

This is an important limitation on TUPE and can have valuable benefit to the business for a potential buyer. Conversely a business burdened with a loss making contract and significant potential redundancy costs may be able to trigger a transfer that avoids redundancy liability.

TUPE is complex and requires careful consideration with experienced advice at an early stage to decide the best practical course of action to take.

Real estate
If a buyer wants to purchase real estate when buying the target business it may not be able to obtain the usual full searches if the acquisition has to occur on a short timetable. Some search results can be carried out on an expedited basis, but a buyer will have to consider the cost/benefit of what should be carried out in the time available.

If a site is leasehold the assignment of the lease is likely to require landlord's consent. This process is often lengthy, so a buyer may need to consider taking an informal licence to occupy the property from the seller until landlord's consent can be gained. It will be key to check the terms of the lease as early as possible to understand the risks involved. There may be a risk of termination of the lease by a landlord when an informal licence is granted.

Price
When buying a business in financial difficulty where no insolvency practitioner has been appointed a buyer needs to assess whether any subsequent insolvency could unwind the sale, such as due to the sale being a transaction at an undervalue.

Summary
It is key for a buyer to assemble a team of experienced advisers when acquiring businesses in difficulty to ensure that they get the best deal in the timeframe available. This will enable a buyer to take full advantage of the opportunities in the current financial conditions.

Contributors: Alice Gardner and Andrew Webber.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2009. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.