In addition to providing a much-needed cash injection, a fresh perspective on the challenges faced by a troubled company can sometimes be all it takes to turn the business around. The appeal to the buyer, of course, is the opportunity to take over valuable assets at a heavily discounted price.
In the case of the Co-operative Bank, these assets include its branch network and current account holders. However, a buyer must be aware that a purchase of a troubled company, or more likely its assets, can be messy. The company will not be neatly organised and ready for sale. The buyer will have to deal with concerned employees, dissatisfied customers and impatient creditors.
It can be difficult to obtain reliable information and yet the buyer must be prepared to move quickly and have funding in place as the timescale for completing such a transaction will be tight to avoid further business deterioration.
The buyer should therefore consider the following issues prior to purchasing a troubled company. First, it needs to decide the structure of the deal. A buyer usually prefers to buy assets rather than the share capital of a distressed company to avoid inheriting historic liabilities. An asset deal, however, is not as straight forward as a share deal given that every asset needs to be transferred individually and some assets may not be transferable or need third party consent to transfer.
Also, certain employment-related regulations known as “TUPE” may apply and, if so, the seller’s employees, together with all their existing rights, automatically transfer to the buyer.
In some cases, the buyer can be required to make contributions to the seller’s pension scheme for the transferring employees and it may have to assume additional liabilities in relation to the employees’ entitlements under the scheme. This can lead to significant costs for the buyer, as it is not unusual for a distressed company’s pension scheme to be underfunded.
Second, the buyer must carry out a comprehensive due diligence investigation that goes beyond standard legal and financial due diligence and looks at issues such as why the company became distressed. Third, when it comes to negotiating the purchase agreement, the buyer should insist that the time between signing and completion is as short as possible to reduce the risk of a trustee in bankruptcy setting aside the transaction if the seller commences insolvency proceedings prior to completion.
Ideally, there should be a simultaneous exchange and completion. Likewise, the buyer must ensure that the true value of each asset is established before it is transferred to the buyer. Otherwise, a creditor or a trustee in bankruptcy could bring a claim for a transaction at an undervalue, and challenge the validity of the sale.
Fourth, the buyer should insist that a portion of the purchase price should be placed into an escrow account. A seller is likely to give only limited warranties and no indemnities and even these will have little value in the light of its financial situation.
Warranty insurance will also not be available in such circumstances. An escrow account may therefore be the only protection for a buyer if issues arise following completion. An escrow account can also be useful if a completion accounts mechanism is adopted, as it allows the buyer easy access to any repayment due to it as a result of a downward adjustment to the purchase price following the agreement of completion accounts.
If the potential buyer of a distressed business bears these issues in mind and acts prudently, it may well snap up a bargain. However, there is no guarantee in these circumstances and such a buyer needs to be careful to ensure that the risks do not outweigh any potential benefit.
Jeannette Meyer is an associate at Faegre Baker Daniels