Navigating Distressed M&A – Corporate and Company Law

Investors and advisers have been poised for a flood of
distressed M&A transactions since the early days of the
pandemic. To date, deal flow has been more of a trickle but with
companies now firefighting a perfect storm of economic (inflation,
interest rates) and logistical (supply chain, labour) issues in a
generally volatile geopolitical context, 2023 is likely to see that
trickle become a flood.

Whilst each business under pressure will have its own set of
challenges, there are certain considerations common to almost all
distressed M&A transactions – the most important being
that they are often run on a limited timeframe, on the basis of
limited information and with limited contractual protections. This
article provides a short introduction to some of these
considerations and more detail can be found at here.

On your marks… Because a seller will want to
conduct an accelerated process, a buyer who is able to move
swiftly, on an unconditional basis, will be more attractive than a
buyer who cannot. This means ensuring that financing is lined up,
deal teams are well briefed and identifying (and then limiting) any
regulatory or third party processes to ‘must haves’ rather
than ‘nice to haves’. Another key area of pre-deal
preparation is identifying where the target sits on the distress
spectrum as this will impact timetable, who a buyer is dealing with
(directors or an insolvency practitioner) and the sale process if
the target is actually in formal insolvency proceedings.

Share or asset sale? If a buyer is concerned
about what is in the Pandora’s box being bought it is likely to
prefer structuring the deal as an asset sale so it can ‘cherry
pick’ the attractive assets and leave behind, to the extent
legally permissible, the liabilities. An added advantage of this
approach is that the buyer can focus diligence on an identified
pool of assets (and their ability to be sold freely and cleanly).
However, it is critical that the tax and accounting implications
are considered as early as possible. Depending on the level of
distress, a buyer may also feel safer biding its time until the
target enters a formal insolvency process and then contracting with
the administrator as it removes the risk of a deal being challenged
as having been implemented at an undervalue.

Due diligence Diligence is unlikely to be
conducted at the buyer’s leisure and there is unlikely to be a
full suite of material available. Nor may buyers have access to
accurate financial information or key employees. Buyers need to
identify which areas are material to them and whether these have a
purely financial consequence capable of being factored into the
valuation or are of wider concern – for example environmental
liabilities or bribery concerns.

Risk allocation (W&I) In ‘normal’
M&A deals, diligence informs the scope of the warranties and
indemnities to be included in the purchase agreement. In a
distressed deal, however, the seller is likely to be unwilling or
unable to provide contractual comfort and this is a particularly
acute issue when buying from an administrator. It may be possible
to mitigate some of these risks via W&I insurance and the
possibility of putting in place a more expensive
‘synthetic’ policy – where a warranty package is
directly negotiated with the insurer – is particularly helpful when
dealing with administrators. However, this may impact timetable and
coverage is likely to be heavily caveated unless discussions with
brokers are initiated early in the process so as to reflect the
insurer’s demands on diligence scope.

Risk allocation (pricing) There is an
inevitable tension between the seller who wants certainty of
consideration (both as to quantum and timing) and the buyer who is
wary that they haven’t been able to accurately assess the
target’s financial position. For example, a buyer will be wary
of utilising a locked box structure based on financials which are
unlikely to reflect recent stresses experienced by the target
whereas a seller won’t want the delay of preparing completion
accounts and the risk of the headline price being materially
eroded. And similar arguments will arise when trying to bridge a
valuation gap – or providing recourse against future claims –
by way of deferred or contingent consideration.

It’s not over until the creditors (don’t)
sing… all parties should be aware that the deal is not
safe simply because it’s completed. If it transpires that the
transaction was effected at an undervalue then there is a risk of
‘clawback’, in other words the deal being challenged and
unwound. This risk may be more or less acute depending on the
jurisdictions involved. This is one of several reasons why it is
critical that directors of a distressed target and its owners get
appropriate professional advice as to their duties and valuation,
particularly as they risk incurring personal liability if they get
it wrong.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.