The consensus view is that as the economic impact of the pandemic continues and Government support tapers off, we will see a significant upturn in distressed situations from the Autumn onwards. Restructurings will not be possible in all cases which means that both financial investors and trade buyers, with an appetite for a degree of risk, will be able to take advantage of opportunities when key stakeholders need to exit a situation.
Successfully completing distressed transactions requires careful planning and implementation within constrained timetables. It is critical that buyers and their advisers focus their attention on the key issues and material risks, a task made more difficult by the likely limited information and contractual comfort made available to bidders.
We identify below the core aspects which will concern a bidder embarking on any distressed M&A process. It is sometimes the case that not all of these receive the necessary attention at the outset and this can lead to problems either during the process or, perhaps more problematically, following the acquisition.
At Burges Salmon we have a team of experienced lawyers well prepared to advise on distressed M&A processes. The team extends beyond the core requirements of restructuring and corporate specialists to include experts in respect of associated considerations which may well impact on both the structure and implementation of a distressed transaction, such as pension obligations, tax and regulatory issues. It is imperative that these additional considerations are identified and addressed as a priority.
As such we will be releasing supplementary notes to address the following issues in the context of distressed M&A transactions:
- Pension considerations (including the potential impact of the Pension Schemes Bill)
- Regulatory considerations (both antitrust and foreign investment restrictions)
- Employment (especially addressing any requirement for employee consultation and the impact of TUPE in the context of compressed timetables)
- Approaches to due diligence, warranty cover and the potential for warranty and indemnity insurance
- Target board considerations and the use of restructuring tools in distressed M&A transactions
In terms of the key considerations applicable to all distressed transactions:
Structure
The term 'distressed M&A' is a broad church with the common theme of the seller, or the business being sold, being in financial distress. Timing, deliverability and structuring are therefore critical. There may be scope for the process to be run on a solvent (share sale) basis or it may need to be implemented on an assets basis, often via a formal insolvency process. Indeed, it is often the case that, whilst transaction timetables will be condensed, at the outset it is not always clear whether an insolvency process (most likely administration) will be necessary. Buyers may also be keen to conclude a deal on a solvent basis to avoid or minimise the damage to reputation, the business and stakeholder relationships which insolvency can trigger.
Typically, where the value of the business breaks in the debt, a buyer will prefer to structure a distressed acquisition as an asset deal, allowing it to leave behind liabilities and to a degree mitigating the risk associated with limited reliance and due diligence. Tactically, an interested party may seek to gain an advantage over other potential bidders by acquiring the secured debt (potentially at a discount). In addition to providing access to information, holding the secured debt provides an opportunity to influence the process, take advantage of restructuring options (see further below) and bid for the business in an insolvency process using the nominal value of the secured debt.
Comprehensive and clear advice as to the preferred structure is key, not least in that it will facilitate a credible and deliverable bid.
Due diligence and warranties
In theory there is no reason why the areas of focus for a buyer’s due diligence exercise should vary significantly from a traditional M&A process. However the information available, scope of reliance and access to management is likely to be limited. The identification of key issues and risks is therefore critical and these will flow through to valuation. There is likely to be limited scope to address these concerns or information gaps by way of post-completion price adjustment mechanisms.
Buyers should not expect to receive substantial warranties from sellers and should the transaction be structured via an insolvency process warranties will not be available in any event.
This concern might be addressed if provision is made for management incentivisation (to which warranties can be pinned) or otherwise by arranging 'synthetic' W&I insurance. We will address these issues in more detail in a separate article.
Regulatory issues
Antitrust considerations are often considered to be relevant only in the context of 'mega mergers'. That is not the case. Distressed M&A is often seen as a route to consolidation within a buyer’s sector and this can fall foul of competition law scrutiny. During the pandemic to date the UK’s Competition and Markets Authority (CMA) has not, as some imagined it might, been prepared to 'wave through' consolidation acquisitions. As such careful consideration must be given at an early stage as to whether a transaction will fall within the CMA’s jurisdiction and, if so, an assessment made of its likely approach to it.
Similarly, the pandemic has prompted an acceleration in the move towards 'de-globalisation' which had emerged over the last two years. This has resulted in governments (including the UK Government) taking a more interventionist line in terms of policing and scrutinising cross border transactions. Whilst this is unlikely to impact the vast majority of UK transactions it is a development of which overseas buyers should be aware. The intervention tends to be focused on certain sectors, such as healthcare and those involved in national security.
We will also expand on these regulatory issues in a subsequent article.
Board Considerations and Restructuring Tools
In distressed situations, the board of the target company will be under increasing pressure given liquidity constraints in the business and the risk of personal liability for breach of directors' duties. It is possible that not all creditors will have been paid in full and that the business risks further irreparable deterioration if the transaction becomes prolonged. Speed is a critical factor but there is also a need to understand the capital structure and how to formulate an offer so that requisite value is returned to the stakeholders that are in control of the transaction process.
Particularly in light of recent changes to the UK insolvency regime introduced by the Corporate Insolvency and Governance Act, interested parties may, in order to address the financial difficulties facing the target company, also wish to consider structuring their investment in a way that interposes a statutory or consensual restructuring. Acquiring a business through a pre-pack administration is a well-rehearsed transaction but comes with its own challenges. Alternative ways to structure an investment may involve gaining control by acquiring some or all of the target’s secured debt (and possibly equity) and using this as a means to implement a restructuring using a Scheme, Restructuring Plan or CVA to compromise other claims. These procedures may also help to retain greater value in the underlying business (for example, the use of tax losses and strategic leases and contracts) than may otherwise arise in an administration process.
If you would like to discuss any of the issues in this article please contact Rupert Weston or Andrew Eaton.