By Mark Blayney,
a business rescue expert,
Carrshield, Newcastle, U.K.

help at turnaroundhelp co uk
http://www.turnaroundanswers.co.uk

One option for a business in difficulty may be to look to sell but how practical is this really in a distressed situation? This article looks at how and why buyers look to find insolvent companies for sale as well as how the Pre-pack Administrations and the SIP 16 insolvency process operates in a sale of an insolvent business.

Selling as an option

If your company is in difficulty you really have three options to consider, which could be summarised bluntly as looking to fix it, close it or sell it.

However marketing and selling a distressed business is completely different from a normal transaction. In most business sales the buyer spends considerable time and effort in due diligence, the process whereby they investigate the target company's assets and liabilities, prospects, likely cash flows, customer base, management, intellectual property, leases, development potential, employee liabilities, outstanding legal actions and so on. This is usually a very thorough investigation to ensure that the buyer is aware of all the risks they may be taking on and has dealt with these as far as possible by way of either an adjustment to the price or through agreement of warranties and indemnities in the sales contract.

There is very little time however to carry out this market testing when dealing with businesses in distress. So the number of potential buyers is reduced to those who either already know the business (such as its existing directors or management), or those buyers who are confident that they know how to deal with the problems that they will face. As a result of this narrow market and the inevitable uncertainty over a distressed business's real state, the price that can be obtained for a distressed business is usually very low, hence the interest of those buyers who are prepared to take the risks involved.

How can you sell?

There are normally two options when selling a business, to sell the company by selling its shares, or for the company to sell the business and assets.

For a purchaser buying shares means buying ownership of the business, but taking it together with all its liabilities. By buying the business and assets from the company, a purchaser can avoid taking most, but not all, liabilities, which are then left behind in the shell of the company to be dealt with from the sale proceeds. For this reason most sales of distressed businesses are of the business and assets rather than of shares.

This type of a sale outside of a formal insolvency process is often known as an accelerated corporate finance transaction and involves a swift and confidential process of marketing the business directly, on a confidential basis, to likely interested parties identified both by the directors and the advisor firm. Given the circumstances, the directors need to ensure that they have demonstrably got the best value possible for the business and therefore they need to take professional advice and to have the business's assets independently valued for comparison to any offer received. Where assets are subject to a lender's fixed charge, the lender will have to consent to the sale.

Once the sale has completed, the company shell may then be put into Liquidation or through an Administration or a Company Voluntary Arrangement (or 'CVA') to distribute the funds received to the creditors.

One of the liabilities that a purchaser will generally be unable to avoid are accrued employee liabilities and terms of current contracts which will come across under the Transfer of Undertakings (Protection of Employment) Regulations 2006 known as TUPE. Employee claims can sometimes be compromised though a CVAs as part of a sale process.

If secured lenders such as banks become concerned about whether management are pressing ahead swiftly enough with a sale process they may take steps to appoint an Administrator to take over the process and push a sale through.

Pre-pack Administrations and the SIP 16 insolvency process

A Pre-pack Administration is one where a sale of the business and assets has been arranged to a party who is able to then complete the transaction immediately upon the Administrator's appointment.

The Pre-pack which refers to some form of a 'pre-packaged insolvency' process has been used for many years, for understandable reasons, in cases where a business's value could be expected to rapidly evaporate if marketed during an insolvency process. So in cases where for example the business's value lies entirely in its staff who would be likely to leave or be poached during the uncertainty of a period of trading through an insolvency, obtaining a quick sale so as to have as seamless a transition as possible has been seen as the best way of preserving and realising the value of the business.

However in recent years the use of this approach has spread to transactions involving a wide range of businesses. Where this has also been combined with sales of the businesses back to the existing management this led to a degree of concern that creditors were being presented with a fait accomplis on which they have not been consulted, and often a feeling that, however much the Administrator may consider that it was the best option available in the circumstances, the creditors often felt they had simply been 'stitched up'.

To address this concern Statement of Insolvency Practice 16 ('SIP 16') was introduced in 2009 under which, in addition to reminding Administrators about their duties to act properly, requires them to provide a detailed explanation and justification of why a pre-packaged sale was undertaken so that creditors can be satisfied that the Administrator has acted with due regard to their interests. It also sets out a detailed list of 17 items that the Administrator has a duty to disclose to creditors in their first notification of the Administrator's appointment. This list covers everything from who originally introduced the Administrator to the situation, through why it was not possible to market the business and sell it in the Administration through to what guarantees the directors had given to prior financiers and whether those lenders are also funding the new business.

The degree to which SIP 16 is providing creditors with enough comfort that pre-packaged Administrations are not being abused is something that the Government's Insolvency Service is keeping a careful eye on, and if they become concerned that it is not doing enough in this direction it is expected they will seek to tighten up the rules further.

Of course the information given in an article such as this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and you should always seek appropriate professional advice on your own particular circumstances before taking any action.

Published - August 2010