Disaffected employees, customers reluctant to pay and impatient creditors are all likely to contribute to a messy and confused picture for a prospective buyer. The business in financial difficulties will not be a business packaged and made ready for an orderly sale. Reliable warranty or indemnity cover is not likely to be available. Accordingly, whilst undertaking due diligence is clearly of paramount importance, doing so may present considerable challenges, not least in getting reliable and current information. A buyer should expect the actual position to be worse than the position revealed by, or even known to, the seller. In addition to the need for as much detailed financial due diligence as possible, some of the key areas for legal due diligence (which may be required in a number of jurisdictions in the context of a target group with operations in more than one country) are likely to be:
Ownership of assets
Understanding the basis on which key items of equipment or stocks are used by the business will be important. If there are significant retention of title, rental, security or other similar arrangements, then the buyer should clarify (ideally in discussion with the relevant counterparties) how these arrangements will be affected by the new ownership and in particular whether retaining or securing title to the assets will involve the buyer in significant expense.
Time may not permit extensive investigation of title to real estate so if significant operational or other value is attributed to any properties then the deal value should reflect this uncertainty. In addition, key leasehold properties may be at risk of forfeiture for payment or other defaults under the lease in addition, there may be significant title, lease and/or environmental liabilities which will have to be considered.
Key supplier and customer contracts may be in jeopardy and may even have been terminated in consequence of the company’s financial difficulties. Where possible, a buyer would be well advised to hold discussions with important customers and suppliers to assess the current position.
If the business carries on activities requiring it to be licensed, the terms of the licences (including, in the case of financial institutions, the requisite regulatory capital) and any recent dealings with the regulating authority should be investigated.
The purchase of a business in financial difficulties often represents an opportunistic prospect for a buyer. It may be interested in picking up key assets and/or contracts but it may not wish to acquire the entire undertaking of the company concerned and in particular all or large parts of the workforce. In consequence, a key part of due diligence often involves calculating whether the economics of the transaction support those employee costs and ultimately any severance costs which may be required. This will be a relevant area of diligence whether or not the transaction is structured as a purchase of the shares or the business of the target company.
Reliance on the retained group
In the circumstances of a “normal” sale, the buyer’s due diligence would identify services provided centrally by a selling group with a view to negotiating the basis on which such services will continue for a period following the sale until the target achieves operational independence. If the future of the retained group is in doubt, such arrangements may not be practicable. If the business to be acquired has taken assignments of rights under contracts from the retained group, the later insolvency of the retained group is also likely to give rise to termination events under those contracts.
Searches of relevant registries and registers should be undertaken to establish what security exists over the assets to be sold (and indeed to ensure that no winding up petition has been presented). An early approach to lenders and holders of security is recommended to establish any conditions on which they will release the assets to be sold.