Legal pitfalls in buying a distressed company part I – the perfect timing for a takeover

published on September 25, 2018
If a company is in distress, this is a welcome opportunity for investors or competitors with strong liquidity to acquire the business of or shares in such a company. Buying a company out of insolvency holds dangerous pitfalls, though, that need to be avoided. This kind of acquisition is the way for buyers to expand their business and retain important contractors. 

Nevertheless, to avoid making hasty decisions and not fall into a debt trap, it is advisable to carefully weigh the risks and rewards. Also valuations of ailing companies often turn out to be very difficult. Forward-looking forecasts must be very carefully prepared. 

An ailing company can be acquired in three points in time: before an insolvency petition is filed, after an insolvency petition is filed, or after insolvency proceedings are opened. 

Buying a company before insolvency petition is filed

The decisive upside of buying a company before the insolvency petition is filed is that it helps avoid the negative image of a failed company that is otherwise projected to the market. Special attention should be paid to the possibility of the insolvency practitioner to challenge legal transactions and legal acts that were performed within various time frames before the insolvency petition was filed. In individual cases, measures taken by the company up to 10 years before filing for insolvency can be challenged. But what matters most in practice is the time frame of three months before filing for insolvency because the insolvency practitioner can challenge the company acquisition agreement if it is followed by the petition for declaring insolvency of the acquired company within this time period. If the buyer already paid the purchase price or made an advance, a risk exists that the insolvency practitioner will not transfer ownership of the assets, or requests their return, while retaining the amount of the price paid for those assets. If this happens, the buyer can register its claim in the schedule of creditors' claims.

Another risk arises from the fact that the next insolvency practitioner has the option to decide whether to terminate or continue contracts that were signed before the opening of insolvency proceedings but not carried out yet in full. If the insolvency practitioner opts to withdraw from the company acquisition contract, the buyer will have to suffer serious harm:  if the buyer already paid part of the price, this advance remains in economic terms a part of the debtor's assets involved in the insolvency proceeding, the buyer can no longer enforce the transfer of ownership, and the claim for damages has almost no economic value.  

Acquisition after insolvency petition is filed

If the insolvency petition was filed and an interim receiver was appointed, the procedure is basically the same as before the insolvency petition is filed. Furthermore, the interim receiver is not yet authorised to dispose of the assets. In practice, companies are practically never bought out of insolvency in this time period. But the role of an interim receiver is important because they are usually used for negotiating requisite contracts.

Acquisition after opening insolvency proceedings

The main argument for buying a company after insolvency proceedings are opened is that the business of such company can be acquired with the highest degree of legal security possible and the buyer does not assume liabilities on the takeover. In addition, with the support from the insolvency practitioner, it is easier, quicker, and more cost-effective to take measures under labour law.

In addition to classical restructuring called 'asset deal', also the share deal under an insolvency plan is said to grow in importance in the future. After the ESUG amendment, there has been a significant rise in the number of insolvency proceedings carried out by companies who appoint their own administrators in a bid to finalize the insolvency plan. Advantages offered by a share deal are the same as in the case of an asset deal. In addition, on transferring shares in the legal entity also all (desired) contractual relationships are passed on to the transferee, but the insolvency practitioner, or the director appointed by the company to serve as administrator, or board of directors, can usually quickly cancel unwanted contracts. 

However, buying a company after insolvency proceedings are opened can tarnish the image of the failed company, which is not the case for acquisitions before opening insolvency proceedings.

In sum: Buying a company after insolvency proceedings are opened carries fewer risks. The bottom line is that buying a company after insolvency proceedings are opened is usually the safer way to acquire a business. If the buyer buys a company in distress and has to file for insolvency immediately after the asset deal is finalized, he will be under threat of suffering high losses. The same applies to share deals under an insolvency plan when the target company has to file for insolvency after the deal is completed.


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Nadine Schug

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