When a business is distressed and is due to run out of cash, advisors are often called upon to carry out an accelerated M&A process. Whilst there may be scope for the process to be run on a solvent (share sale) basis, it may need to be implemented on an assets basis, often via a formal insolvency process. Because of the undeniable threat of insolvency, directors of distressed businesses should obtain specialist legal advice on their duties at the earliest possible stage.
Board considerations
When a company is in financial difficulty, directors face certain additional duties and responsibilities. Whilst the substance of those additional duties and responsibilities (and their effect on the directors’ operation of the business) will differ according to a company’s precise circumstances, directors should always consider: cash flow forecasting, stakeholder management, professional advice; deliverability of plan; and the importance of creating a paper trail (as further explained in our article published on 23 March 2020).
A fundamental concept in insolvency situations is the potential for personal liability arising from wrongful trading. The key question for directors is whether or not there is a reasonable prospect of the company avoiding formal insolvency. If the answer is yes and there is a deliverable plan to achieve a way through the current financial difficulties then this normally justifies continuation of trading. However, if the answer is no then the directors should take every step to minimise loss to creditors and avoid incurring new liabilities that cannot be met.
During an accelerated M&A process, if it becomes clear that the bidders are structuring their offers on an insolvent basis then the directors must draw a line in the sand and ensure that they take every step to minimise loss to creditors from that point in time up to formal insolvency. Bidders will want the directors to continue to trade the business to ensure that there is minimal disruption and consequential loss of value. This trading period always requires a difficult and complex balancing act for directors to manage alongside their duty to minimise losses. Often the best way to protect directors, whilst simultaneously maximising value in the business, is to keep this trading period as short as possible. Bidders and their advisors should remember this when they are carrying out their due diligence and negotiating the transaction documents.
The suspension of wrongful trading provisions in the Corporate Insolvency and Governance Act 2020 was helpful for directors of distressed businesses carrying out accelerated M&A processes during this unprecedented time. However, directors were still constrained by their other fiduciary and statutory duties and so this temporary suspension did not really offer meaningful relief in practice. This has been cited as one of the main reasons why the government did not extend this relief beyond 30 September 2020.
Restructuring tools
Whilst speed is definitely a critical factor, interested bidders should also take advice on the target’s capital structure to understand how best to formulate an offer so that requisite value is returned to the stakeholders that are in control of the transaction process.
In order to address the financial difficulties facing the target company, bidders may wish to consider using more bespoke deal structures and restructuring tools. For example:
- acquiring the business through a pre-packaged administration (please note the government’s recently published Pre-pack sales in administration report, which details additional measures to be imposed for pre-pack sales to connected parties)
- secured lenders using the value of all of part of their debt to credit bid for the business through a pre-packaged administration (provided that the value breaks within their secured debt)
- secured lenders doing a debt for equity swap in order to dilute and disenfranchise the existing shareholders and gain control of the business before injecting new liquidity
- 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 of Arrangement, a Restructuring Plan or a Company Voluntary Arrangement to compromise other claims.
A key feature of the Corporate Insolvency and Governance Act 2020 is the introduction of the new Part A1 Moratorium. This Moratorium is intended to provide directors with a period within which to explore options with the aim of rescuing the company as a going concern. Directors of distressed businesses should take specialist advice on whether or not this new Moratorium could be utilised to support a particular accelerated M&A process.
Conclusion
A business experiencing financial distress and carrying out an accelerated M&A process may be successful in achieving a solvent (share) sale. Whilst the aim is always to avoid formal insolvency, directors should act prudently and seek specialist advice on their enhanced duties and responsibilities.
Interested buyers should, of course, be aware of potential adverse implications of buying a business via an insolvency process. However, distressed M&A processes can present strategic and economic opportunities to buyers that may not be available under normal market conditions. Well-advised bidders will remain flexible and consider insolvency and restructuring tools when formulating their offers and deal structures in order to maximise value for the future business.
This is the final article in our distressed M&A series, which has touched on a range of issues for buyers, sellers and directors involved in such transactions. If you would like to discuss any of the issues in this article or any other article in our distressed M&A series please contact Andrew Eaton or Rupert Weston.
Other articles in our distressed M&A series