Distressed acquisitions – opportunities and risks

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The measures to contain the coronavirus pandemic are plunging many companies into crisis. However, the current economic situation also offers opportunities for financial investors and expanding companies. These involve buying companies out of the crisis, gaining easy access to know-how, personnel capacities, new customer bases and markets. Only recently have the sale of Wirecard's core business to the Spanish bank Santander and the sale of a Wirecard subsidiary to a US group spectacularly demonstrated how businesses or business units can be restructured and their operations continued as a going concern by buying a company out of insolvency.


Investors buying businesses out of insolvency have various acquisition options. Depending on how serious the financial distress of a company is, these options may involve different legal and economic opportunities and risks.


Share Deal

Acquiring shares in a company which is at risk of becoming insolvent entails financial risk for the buyer because the buyer is acquiring the company along with all of its liabilities. Close attention should be paid to the company's financial situation in order to determine whether the company already has a reason for filing for insolvency or whether it is at risk of insolvency, and how much capital injection the company will need in the future. If the company has a high level of liabilities and a poor liquidity situation, a share deal may turn out to be financially unattractive. Furthermore, the root causes of the financial distress of the company should also be examined to determine whether further restructuring measures will be necessary. This requires extensive investigations as part of due diligence, possibly also a restructuring concept, and all this requires a certain amount of time. However, if insolvency is imminent in short time, there is often not enough time for such investigations with regard to the duties to file for insolvency.


Such a transaction in the run-up to insolvency is therefore only feasible for both parties if bridging measures can be agreed with banks and creditors.


Asset Deal prior to insolvency

In an Asset Deal, assets of the company are usually transferred to a newly created target company of the buyer. After transfer of the assets, the selling company retains mainly the liabilities, but often has no significant share in the assets recoverable by creditors other than the proceeds from the sale of the company. There is a risk of prejudice to creditors. An Asset Deal is thus often very risky for the transaction parties if the company to be sold is on the brink of bankruptcy.


If the seller files for insolvency after the agreement on the sale of the company is concluded but before the transaction has been closed, the execution of the entire agreement is at stake. In addition, the buyer may be exposed to the risk of insolvency by contestation of the seller’s legal actions at a later date.


In certain scenarios, this may carry serious implications arising from liability as a result of existential interference and/or committing of or participating in insolvency offences, such as delay in filing for insolvency or specific bankruptcy offences such as favouring debtors or creditors. The risk that the transaction will be harmful to the company's creditors or will further aggravate the damage suffered by the creditors is high.


In addition, there are other types of liability, such as the civil law liability of the buyer for liabilities in the event of continuation of the company’s operations as a going-concern (§ 25 of the German Commercial Code [HGB]) or the tax law liability of the buyer in the event of a business takeover (§ 75 of the German Tax Code [AO]).


Given this background, in the case of an Asset Deal in the run-up to insolvency, increased caution and care should be exercised by both parties when verifying whether and on what conditions such a transaction may still be executed.


Business acquisition out of insolvency

As regards severely distressed companies, an option that is less risky for the buyer is the acquisition of assets from a company where insolvency proceedings are already pending.


Such "reorganisation through transfer" is carried out through an asset deal by selling either the business as a whole or business units to an investor for continuation. The remaining assets of the insolvent company are transferred to another company, whilst liabilities remain with the insolvent company and are repaid at the end of the proceedings by proportionately allocating the insolvency estate to creditors. In contrast to this, it is inadmissible to satisfy creditors only partially outside insolvency proceedings , since such practices are subject to sanctions on the grounds of liability. Therefore, the takeover only of assets without liabilities from the insolvency administrator can be a financially attractive option.
Furthermore, in "reorganisations through transfer" the buyer is not liable for old debts of the acquired company as described above and the risk of insolvency contestation is also eliminated through the involvement of the insolvency administrator.


Conclusion

When taking over distressed or insolvent companies, high attention should be paid to aspects of liability of the parties involved. It should be thoroughly analysed what type of the transaction (Share Deal or Asset Deal) is more suitable given the actual stage of the company’s financial distress and liability exposure. The acquisition out of pending insolvency can be a reasonable alternative in financial and liability related terms.

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