Distressed M&A: what buyers and sellers need to know

Posted: 05/07/2023

Amid ongoing economic uncertainty, businesses face growing – and sometimes insurmountable – challenges to remain viable, leading to a marked increase in accelerated or ‘distressed’ sales.

Distressed M&A describes a sale of shares or assets where the business is in financial distress. This includes, for example, companies that are undergoing restructuring or facing insolvency. The sale can be led by the company itself or an officeholder if the company has entered into a formal insolvency process.

While these transactions can present opportunities for buyers (to make a strategic acquisition) and sellers (to focus on a restructure or exit altogether), they also involve heightened risks and tensions - typically compounded by expedited timings - that need to be carefully managed by experienced advisers.

This article highlights some of the key issues for parties dealing with distressed M&A.

Timing

The seller will usually want to sell the business and assets as soon as possible to avoid any negative impact to the company that would diminish its value, such as key employees leaving and loss of key contracts. Therefore, due diligence on the buyer-side will usually be conducted under time pressure.

Form of consideration

Sellers will generally ask for the purchase price of the business and assets to be paid in cash. In the case of insolvency proceedings, any conditional or deferred consideration goes against the seller’s interests to conduct the process quickly. However, it may be possible for the buyer to negotiate this in certain circumstances.

Directors’ duties

To avoid personal liability, the directors of a company facing distress should act with their statutory and fiduciary duties in mind. For a business incorporated in England and Wales, these duties are largely contained in the Companies Act 2006. To read more about dangers and tips for directors facing company insolvency, click here.

Stakeholder interests

A distressed seller will have to keep in mind the several stakeholders, such as lenders and commercial creditors, who will want to be updated during the sale process. The seller should be able to demonstrate that an appropriate value for the target is being realised.

Risk allocation

By contrast to conventional M&A deals, a distressed seller will typically be unwilling or unable to provide contractual comfort via warranties or indemnities. Proper due diligence will therefore be crucial for the buyer.

It may be possible for the buyer to mitigate some of the risks via warranty and indemnity (W&I) insurance – typically involving a more expensive ‘synthetic’ warranty package being negotiated directly with the insurer (as opposed to the seller). However, this may impact on timings and the extent of cover is likely to be rather limited unless brokers are engaged early in the process so as to address the insurer’s demands on the scope of due diligence.

Due diligence

The burden is on the buyer to conduct a thorough due diligence process, where the formal investigations into the target will be made by the buyer’s advisers. The aim of this will be to assess the risks of the purchase and potentially negotiate a downwards price adjustment.

In the context of distressed M&A, limited time will be made available for the due diligence process so it needs to be properly managed and focused on what is really important.

There are several key areas of concern for the buyer’s due diligence. Along with examining change of control provisions, financing arrangements, IT/IP infrastructure and tax matters, other key areas will include for example:

• Evidence and validity of appointment. If the company has entered a formal insolvency process, the buyer should request the appointment documents of the insolvency practitioner.
• Title to the insolvent company’s assets. Does the company have title to the business and assets being sold? Likewise, if any fixed assets are sold which contain interests in real property (eg land), further investigations will be required.
• Retention of title (ROT) claims. Some of the assets being sold may be delivered on conditional terms, such as where the seller retains title to the goods until full payment of the goods is received. The buyer should check if the asset being sold is still subject to ROT claims.
• Security over sale assets. Are any of the assets being sold subject to a fixed or floating charge? The buyer may need to check that certain court orders have been obtained or agreements with charge holders have been made to release security over the assets once the sale is completed.
• Data protection issues. The buyer and seller will need to comply with relevant data protection legislation where there is a transfer of personal data.
• Book debts. How will the book debts be distributed following the sale of the insolvent company? This will be a point of negotiation between the seller and buyer.
• Employee issues. Where there is a sale of a business, the buyer should consider the impact of ‘TUPE’ legislation that protects the rights of the insolvent company’s employees throughout a business transfer. 
• Pensions implications. What are the seller’s liabilities regarding its pension scheme and its details? Compliance with pensions legislation, including any notification requirements, will need to be factored in; otherwise, the Pensions Regulator may impose sizeable fines in certain situations.  
• Security concerns. The National Security and Investment Act 2021, in force since January 2022, establishes a statutory regime for government scrutiny of corporate acquisitions and investments to protect national security in the UK. Notably, it imposes a mandatory notification requirement for certain types of acquisitions before completion. If the transaction is not approved beforehand, it will be void. The buyer’s legal team should therefore raise due diligence enquiries to establish whether the proposed transaction is at risk of falling under the NSI regime and check if any of the trigger events for mandatory notification are met. To read more about the NSI regime, click here and here. Competition concerns may also apply.

Conclusion

To meet the shorter timescales while carrying the burden of due diligence and limited protections, a buyer will need to instruct a team of experienced advisers to help plan the distressed sale process and avoid future risks and liabilities.

Likewise, it is crucial that the seller(s) and the board of a distressed target obtain timely and trusted professional advice as to their legal duties and financial position, to mitigate the risk of any transaction subsequently being challenged (for instance, for being at an undervalue or creating a preference) or the directors incurring personal liability.

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