Buying the business and assets of an insolvent company:

What is a pre-pack?

The term “pre-pack” is used, in the context of administration, to describe the process through which a company is put into administration and its business or assets (or both) immediately sold by the administrator under a sale that was arranged before the administrator was appointed.

The benefits of a pre-pack strategy can include:

1. The quick and relatively smooth transfer of a business to a new owner, compared to a sale negotiated at length after the insolvent owner goes into administration; minimising the erosion of the confidence of a business’ stakeholders including customers and employees inevitably caused by insolvency proceedings.
2. Saving more jobs than an administration that attempts to continue to trade the business pending a later sale.
3. Often there is little other choice if there is no funding available to fund administrators trading a business pre-sale transaction.

Criticisms of pre-packs:

• A lack of transparency.
• A lack of accountability.
• Pre-packs do not necessarily maximise returns for unsecured creditors; pre-packs are similar to the outlawed practice of creating “phoenix” companies.
• The proposed administrator has a potential conflict of interest (the proposed administrator may be approached by the directors of a company planning a pre-pack deal and may only secure the appointment if the proposed administrator agrees to executing the pre-pack).
• Writing off liabilities using a pre-pack may only be a short-term fix.
• Where the entity is a regulated entity, it can require certain stakeholders, particularly regulators, to respond quickly to proposals when there may be less information available to them than they would prefer given the timescales involved.

What are the pre-pack guidelines for administrators?

Administrators are subject to professional guidelines that relate specifically to pre-packs. These guidelines were introduced in response to creditor concerns about pre-packs and aim to make the process more transparent. Although the guidelines are not legally binding, failure to comply could result in an administrator facing regulatory or disciplinary action. In addition, new regulations have been introduced to require scrutiny of pre-pack sales to connected parties (usually where management of a distressed business buys it back via a newly set up purchaser entity), which prohibit an administrator from disposing of property of a company to a person connected with the company within the first 8 weeks of the administration without either the approval of creditors or an independent written report by an evaluator.

1. Time is of the essence

• Sellers in distress will be looking for a quick sale in order to realise liquidity to settle debts and avoid defaults. Often the extent of the seller’s distress will dictate the speed of the transaction.
• When the target is in the hands of an insolvency practitioner (e.g. an administrator or liquidator), the longer the process, the greater the risk of its deterioration (debtors become disinclined to pay, creditors may refuse further credit, key employees may leave).
• Distressed M&A buyers therefore need to ensure they can move quickly, with advisors on standby and funds readily available.
• Early engagement with management and key customers/suppliers in an appropriate and orderly fashion is key.

2. Limited and focussed due diligence

• Given that the seller will be keen for a quick transaction, the buyer will not have time to diligence the target as thoroughly as it would under a solvent M&A process. A data room may not be prepared, or may be limited and not up-to-date.
• Focussed due diligence is key. A buyer must satisfy itself on the key areas of risk and upside only, price the risk and adjust the price accordingly.

3. Buyer beware

• The sale will be on the basis that the seller/insolvency practitioner will only sell whatever right, title and interest (if any) the seller has to the business and assets. Doing diligence in the limited time available is key in light of this term of the sale and there being no warranties from the seller/insolvency practitioner.
• Onerous indemnities from the buyer: Sellers/insolvency practitioners will look to avoid any continuing liability either for themselves or the insolvent company, after completion of the sale. They will therefore take indemnities from the buyer.
• No warranties from seller/administrators: Administrators will not want to wait for a warranty period to expire after the sale, as they will need to distribute the sale proceeds to creditors. In addition, they will not know more about the business than the buyer could find out through its own investigations.
• Traditional M&A consideration structures, such as earn outs, will be unworkable when dealing with an insolvency practitioner.

4. Deal dynamics when insolvency practitioners have been appointed

• No personal liability of insolvency practitioners: The law in this area provides that insolvency practitioners act as agents of the insolvent company. The sale agreement will reflect that the insolvency practitioner will avoid personal liability whilst also incorporating appropriate disclaimers.

• Insolvency practitioners must obtain best price obtainable: An insolvency practitioner is under a duty to take reasonable steps, including delaying a sale if appropriate, to obtain the best price that circumstances permit.

5. Method and structure of sale

• Business sale agreement: This is an agreement to sell the business and assets of the insolvent company (rather than the shares in it), which is the main transaction document in distressed M&A deals. It will identify all the assets that the buyer seeks to acquire, together with any liabilities to be transferred, leaving other assets and liabilities which do not transfer under the agreement or by law behind.
• Leasehold properties: If the premises in which the buyer acquires an interest are essential to the conduct of the business, then, pending the receipt of any landlord’s consent, the buyer will want to be able to use those premises under licence. It is common for insolvency practitioners to grant a licence to the buyer even though the insolvent tenant has no right to do so under the lease.

6. Commercial considerations in distressed situations

• Retention of title (ROT): The assets to be sold may comprise assets delivered to the insolvent company on conditional terms that title to the assets did not pass to it until those assets have been paid for. It is always possible that assets are sold by the seller/insolvency practitioner that are subject to ROT claims.
• Employees: In a business and assets sale the contracts of employment of the employees in the undertaking being sold are deemed to be transferred automatically from seller to buyer without variation, together with liability for certain debts owed by the seller to those employees, under TUPE.
• Pensions: Past service pension liabilities will remain liabilities of the insolvent seller, however there will likely need to be consultation in advance with the Pension Protection Fund in respect of defined benefit pension scheme deficits.
• Transitional services: In sales out of an insolvency process, a transitional services agreement is less likely to be available so the buyer should be prepared to stand alone or acquire services from third party providers.

7. All of this goes to price

Because the circumstances in which the business is sold are exceptional, a buyer can expect to negotiate a lower price than if the seller was solvent. On the basis of its own investigations and factoring in the risks noted above, the buyer will calculate the price it is prepared to pay for the assets and business offered for sale.

Funding

Clear evidence that an offer is fully funded with funding being quickly available. Lenders’ credit processes can take time and increase diligence requirements. An option may therefore be to fund the acquisition from equity initially and then refinance post completion.

Ability to transact quickly

Including if possible a confirmation that all necessary approvals are in place and that this will not be subject to further authorisation.

Clarity

A clear indication of which assets the buyer is looking to acquire and which assets the buyer will not acquire.

Appreciation of key principles

Comfort that the buyer (via their lawyers) has a sophisticated approach to transaction documents and understands market practice, appreciating that standard terms and conditions with exclusions and limitations will feature in the business sale agreement and that these are fair and reasonable having regard to the sale being by an insolvent company in circumstances where the administrators' knowledge of the business and assets is limited.

Specialist advisers on standby

That the buyer’s legal team and other professional advisers are experienced in this area and are instructed and ready to commence work immediately.

No conditionality

That the buyer is offering to buy the business and assets and complete one single, clean transaction without requiring any conditions subsequent to be fulfilled.

Best offer

That the buyer’s offer is better than any other bids, taking into account the price, the timeframe for the transaction, the price that would be received by way of a break up sale of the assets, amongst other factors. Therefore, it is worth engaging with the seller/insolvency practitioner early to understand any objectives beyond value.