UK: Acquiring Troubled Businesses White Knight Or Vulture?

Last Updated: 6 August 2009
Article by Nigel Stanford

It may seem attractive at first glance to buy a business or assets from a company which is in administration; after all, the buyer may be able to get a good deal at a knock down price and be able to cherry pick those bits of the insolvent business that are of interest. Unfortunately it may not be as simple as first thought and in some cases they may be better off buying the troubled company from its owners as opposed to buying its assets from an administrator.

Going into administration is now a relatively speedy process and once a company has gone into administration, the administrator is allowed, for a limited period, to do whatever he thinks fit to save the company's business. In short the administrator's primary objective is to rescue the company and secondary to that, to seek the best possible return for all of the creditors of the company.

A company in administration will always act through its administrator: once the company is placed into administration its directors will not have any authority to act on its behalf unless expressly permitted to do so by the administrator. Therefore if looking to buy some or all of a company's assets, the buyer will be entering into sale and purchase documentation with the administrator. Although acting as the company's agent, the administrator will at all costs avoid any personal liability and will build into any sale documentation express disclaimers of personal liability. Even if the buyer does manage to obtain some warranties and/or indemnities from the selling company, these will be worthless as the company is in administration and is unlikely to exist for much longer after the sale as it is likely to be liquidated. Contrast this to the position under a share sale where the shareholders will be incentivised to give warranties and indemnities to a buyer to encourage it to buy or to the position under an asset sale, where a buyer will be in a stronger position to negotiate carving out certain liabilities from the business it is buying by leaving those liabilities or hiving them out from the target.

As ever when purchasing a business due diligence is a critical process for the buyer. However, such a buyer would do well to be prepared for a number of impediments to the usual due diligence process when buying a company in administration: the existing managers will probably be somewhat disillusioned and the person running the sale process (the administrator) will probably know little about the business and only make limited information available. The administrator is often likely to have removed the owners and/or key managers from the business and thus their knowledge of the business, its staff and customers will not be available to a prospective buyer. The onus will be very much on the buyer to spend time and money making its own investigations into the business with no back up recourse to warranties from the seller whereas in a normal sale, the buyer will have much more leverage to obtain comprehensive information from the sellers, with question and answer sessions, comprehensive warranties and a full disclosure process.

The administrator will seek to get the best possible offer for the business but it may be difficult for a buyer to put forward its best offer until it has all the relevant facts and information about the business. It will also be very difficult for a buyer from an administrator to construct a purchase subject to an earn out – an extremely common way of trying to ensure a degree of alignment between the interests of buyer and seller. This is one reason why when buying from an administrator it is often tempting to cherry-pick desirable assets and leave the rest behind, especially when the timeframe to agree a deal with the administrator is unusually very short. This is far from ideal for an administrator who will prefer to sell the whole business as a going concern and this conflict between getting the best offer but keeping the business whole, can create added uncertainty for the buyer as to the price it offers. Even if the buyer thinks that it is getting a good deal price-wise, it may be taking on additional risks (which it would not have to take on a normal sale) and have less scope to negotiate a favourable purchase agreement.

A preferable situation therefore could well be to offer to buy the troubled business and for the potential acquirer to position themselves as a viable alternative owner of the business and a preferable alternative to administration. The advantages of being able to conduct a thorough due diligence process with help from incentivised owners and managers (as long as the buyer is able to persuade them to be open and frank about the target's affairs and financial problems), being able to negotiate contractual protections such as warranties and indemnities into a sale contract and deferring some of the consideration by way of an earn out or an escrow arrangement should not be underestimated: they put the buyer back in control and can ensure that the buyer's offer price for the business is right.

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.

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