Coronavirus: Accelerated & distressed M&A and opportunistic acquisitions

The dramatic spread of COVID-19 has disrupted lives, businesses and communities globally.  The first corporate casualties of COVID-19 have already emerged. An increasing number of businesses in the UK are laying off staff and may have closed their doors for the last time as they continue to run out of cash and struggle to obtain emergency funding.

A recent survey conducted by the British Chambers of Commerce revealed that 57% of companies have less than three months' cash in reserve and 6% reporting that they had now run out of money.  These figures are expected to rise quickly in the coming months and many companies will face a cliff-edge scenario. With a global recession proving inevitable according to economists, struggling businesses are likely to face insolvency proceedings (see our Insolvency FAQs). However, as we learned from the last recession in 2008, where there is a shock to the market, there are many opportunities and certain sectors will thrive. In this article we will:

• give an overview of some of the options available to companies in financial distress;
• give an update in relation to the new measures introduced by the UK government to help to alleviate some of the pressure on struggling companies;
• outline the distressed or accelerated sale process; and
• give some insight into considerations for buyers and sellers when embarking on a distressed sale or purchase of a company (or of its business and assets).

Subject always to complying with their duties as directors (see below), one of the main objectives of a company in financial crisis is to enhance the amount of free cash in the business by reducing liabilities and overheads and maximising the liquidity of assets. This can be done in a number of ways including debt for equity swaps, invoice discounting or stock finance, standstill agreements (to keep liabilities fixed for a certain period), implementing a creditor's voluntary arrangement with creditors or entering administration. Each of these options give the struggling company a chance to rescue the business before entering into a more formal winding-up procedure.  Improving liquidity and cash flow is likely to prove difficult for many businesses in the current economic environment where trading has been curtailed and the cost of operations may outstrip income.

When all options for improving the cash position of a company have been exhausted, it will often be the creditors of that company that drive the sale of the company or its business and assets. The government has introduced a number of measures to try to alleviate some of the pressure on struggling companies. On 28 March 2020, Business Secretary, Alok Sharma MP, announced changes to the insolvency regime as part of the government's overriding objective “to help UK companies which need to undergo a financial rescue or restructuring process to keep trading” by giving “those firms extra time and space to weather the storm and be ready when the crisis ends whilst ensuring that creditors get the best return possible in the circumstances.” The changes to the insolvency regime announced by Mr Sharma include:

1. a moratorium for companies, giving them breathing space from creditors enforcing their debts for a period of time whilst they seek a rescue or restructure;
2. protection of their supplies to enable them to continue trading during the moratorium;
3. a new restructuring plan, binding creditors to that plan;
4. key safeguards for creditors and suppliers to ensure they are paid while a solution is sought; and
5. a temporary suspension of wrongful trading provisions with retrospective effect from 1 March 2020 to give company directors greater confidence to use their best endeavours to continue to trade during this pandemic emergency without the threat of personal liability should the company ultimately fall into insolvency. For further detail, see: Coronavirus and directors' duties.

There are a range of insolvency processes and procedures available for a UK company. However, for the purpose of this article we will consider the administration or liquidation procedure. In both cases, an insolvency practitioner will be appointed to the company. See also our FAQs on Insolvency. When a company appoints an administrator, it is afforded a statutory moratorium which gives a window of opportunity for the company to be rescued by way of a reorganisation or realisation of its assets. During the administration process, creditors are prevented from taking enforcement action in respect of their claims against the company. The administrator, (appointed either by a court or out of court) by the directors or shareholders of the company or by its secured creditors, takes over control of the company's business and assets from the company's directors, in order to achieve one of the statutory purposes of administration, being:

1. to rescue the company as a primary objective;
2. if (a) is not reasonably practicable, to achieve the best result for the creditors of the company than on a winding up without administration;
3. if (a) and (b) are not reasonably practicable, to realise property of the company to distribute to secured and preferential creditors if it does not harm the interests of all creditors as a whole.

Liquidation or the winding-up of a company is a procedure through which the assets of a company are realised and distributed to creditors in satisfaction of the debts that they are owed and in order of priority as set out in the Insolvency Act 1986. The main difference between liquidation and administration of a company is that company administration aims to help the company repay its debts in order to escape insolvency (if possible), whereas liquidation is a more terminal process which consists of selling all the assets before dissolving the company completely. A company can be wound up using either a compulsory liquidation procedure (through the UK courts) or through a voluntary liquidation procedure (instigated by either the members of the company or the creditors). The directors of a company in financial crisis and entering into an insolvency process must be mindful of their directors' duties. As soon as it appears that the company may become insolvent, directors' duties change and, the best interests of the company's creditors should be prioritised. This does not mean that the other directors' duties fall away - these should still be adhered to. If directors' duties are breached, this can result in personal liability for those directors and disqualification from acting as a company director for a period of 2-15 years. For further information on directors' duties, please refer to our article entitled “Directors duties and Coronavirus - How to run your ship when the tsunami hits”. Business shut downs and the restrictions imposed by governments in the wake of COVID-19 means that unfortunately, for many businesses, a distressed sale of the company (or of its business and assets) may be the only remaining option in order to pay creditors. We expect to see an increase in these types of transactions in the short-term following alleviation of the lockdown. Distressed or accelerated sales of UK corporates differ from traditional sales of “healthy” companies in that the timeframe is likely to be much shorter and may often be run through an insolvency procedure i.e. a “pre-pack administration”. This invariably has an impact on legal and financial process for due diligence and the transaction timetable. The level of due diligence a potential buyer can undertake will be limited and they will receive very little, if anything, in the way of warranty and indemnity protection. Any issues identified in relation to the business or assets of a company should, therefore, be dealt with by way of a reduction to the purchase price as other remedies in the sale agreement are likely to prove ineffective for a buyer. Potential buyers are likely to fall into three categories:

1. cash-rich buyers pursuing opportunistic acquisitions. These may be domestic but we are likely to see increased interest from overseas buyers;
2. acquirers who recognise an opportunity to buy a business at a potentially reduced price complimentary to their existing business. This may include acquiring businesses that form part of the supply chain so that control, continuity and capacity is maintained throughout the supply chain to the end customer;
3. those looking to acquire a competitor to increase their market share.

Tactical considerations for buyers and sellers contemplating distressed M&A

For buyers

• Make use of public information and useful contacts - there will be a plethora of information on the internet about sectors and companies that are in financial distress.  This includes the register of winding-up petitions with the UK courts.  Review these regularly for potential opportunities. Make your interest in a potential acquisition known to lawyers, accountants and insolvency practitioners who will have a wide network of contacts.
• Appoint the right team of advisers - ensure that your legal and financial team of advisers are experienced in both the corporate M & A process and restructuring.  Familiarity with distressed or accelerated M & A procedures is vital to a successful transaction.
• Make your offer as attractive as possible - this does not necessarily mean the highest price.  An offer that does not give rise to structural complications or uncertainty in obtaining the consideration for the shares or business and assets of a company may prove to be the winning bid. Note that risk allocation in a distressed sale will fall more on the buyer and the buyer should be mindful of this when making an offer.
• Make provision for post-completion and integration costs - what do you want the business to look like once it has been acquired by you? Have you budgeted for the extra costs of this?
• Employment matters - Will any employees be made redundant or will they be absorbed into your group workforce? TUPE will apply on a business and asset sale so this must not be overlooked.
• Time management and availability - ensure all of those officers and advisers are available to stick to a demanding acquisition timetable. Delays will impact negotiations and could adversely impact the transaction.

For sellers

• Appoint the right team of advisers - ensure that your legal and financial team of advisers are experienced in both the corporate M & A process and restructuring.  Familiarity with distressed or accelerated M & A procedures is vital to a successful transaction.
• Preparation - being prepared and organised is the difference between a smooth sale process and a time consuming and arduous one. Allowing your lawyers and financial advisers to prepare an organised and easy to navigate virtual data room at an early stage of the process will help to avoid price chips and unnecessary delays.
• Time management and availability - ensure all of those officers and advisers are available to stick to a demanding acquisition timetable. Delays will impact negotiations and could adversely impact the transaction. There are likely to be supplemental questions and enquiries of the seller and a prompt and sufficiently detailed response will assist the process greatly.
• Keep all key stakeholders and creditors informed of progress - communication will be key as you will require their consent to a sale.

We hope insolvency won't be the result for many companies and business owners and that they expeditiously receive access to the government grants promised and emergency funding via the CBILS scheme - see our FAQs on Government-backed business support for further information. Here at Freeths, we have a wealth of experience and expertise in handling distressed sales, corporate restructures and insolvency processes. Please feel free to contact us for any corporate and restructuring advice.

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If you would like to talk through the consequences for your business, please email us and one of our team will get in touch.