Transaction structures and sale process

Common structures

What sale structures are commonly used for distressed M&A transactions in your jurisdiction? What are the pros and cons of each, and what procedures and legal requirements apply?

Distressed M&A transactions are often structured as asset purchases where the business has entered insolvency. Asset sales offer more flexibility to the buyer as they can cherry-pick assets (mitigating the risks associated with limited due diligence) and avoid inheriting unwanted liabilities. However, additional third-party consents may need to be obtained from contractual counterparties. A further consideration will be that the employee arrangements of those associated with the relevant business will transfer to the buyer automatically under the Transfer of Undertakings (Protection of Employment) Regulations 2006, known as TUPE.

Asset sales may require VAT to be charged in addition to the purchase price, although it is often possible to structure transactions as a VAT-free ‘transfer of a business as a going concern’. Where assets include UK real estate, buyers should be aware that stamp duty land tax (in England and Northern Ireland), land transaction tax (in Wales) or land and building transaction tax (in Scotland) may be chargeable in addition to the stated purchase price.

Share sales may be utilised more often pre-insolvency to reduce the need to seek third-party consents to transfer contractual arrangements. It may be that the business is restructured through a hive-down, transferring relevant assets into a new company free from elements that the buyer does not acquire; combining the advantages of an asset sale but simplifying the transfer to the third-party buyer. Care should be taken on hive-downs to avoid crystallising unnecessary tax liabilities. Stamp duty is chargeable on shares and some debt securities at 0.5 per cent of the consideration and is usually paid by the buyer.

Shareholder agreements may be required on the buyer side, for example, if lenders are participating alongside the original owners or management. This will give rise to further antitrust and accounting considerations as to the treatment of any preference instrument.

The insolvency practitioner (typically an administrator or liquidator), when managing the sale process, will normally have the power to effect the sale without seeking third-party or court consent.

Loan-to-own structures broadly involve a lender or an investor lending or acquiring secured distressed debt with the intention of converting that debt to equity. The most common procedures for converting debt to equity are through a consensual contractual swap, a statutory cram-down (ie, schemes of arrangement, restructuring plans or company voluntary arrangements) or an enforcement of share or other security. By opening up a company’s debt structure to a loan-to-own lender, companies have access to a larger pool of lenders. However, the borrower may be concerned that a minor breach may result in the enforcement of security. Loan-to-own documentation will typically follow normal loan terms, although depending on how the loan-to-own is structured, it may be necessary to obtain shareholders’ approval to allot shares and disapply pre-emption rights.

Packaging and transferring assets

How are assets commonly packaged and transferred in a distressed M&A transaction in your jurisdiction? What procedural, documentary and other requirements apply?

Distressed M&A may be effected through a share or asset sale. To simplify the sale to the ultimate buyer, the seller may also first seek to reorganise the business through a hive-down by which only the relevant assets and liabilities intended to be acquired are transferred to a special-purpose vehicle.

If these are effected prior to an insolvency process then the normal approvals process will apply. The seller directors have the power to effect the sale subject to any counterparty consents needed under change of control or similar provisions, lender consents or regulatory approvals. Where the seller is listed, it may also need shareholder approval under the Listing Rules. Where the business is insolvent, it may be possible to take advantage of limited exemptions for failing firms in relation to antitrust approvals or from seeking shareholder approval under the Listing Rules.

Distressed M&A may also be effected through a pre-pack administration. This involves arranging a sale of a business of a company prior to that company’s administration, but the sale is effected by the administrator of that company after the company enters into administration.

Pre-pack administrations have the benefit of speed and efficiency, thereby enhancing creditor returns. Furthermore, the reality may be that a pre-pack administration is the only viable course of action to avoid liquidation. It should be noted that pre-pack administrations have attracted criticism, for example, for not being transparent (often, unsecured creditors do not know that a pre-pack sale is taking place) and for resulting in conflicts of interest (often, the purchaser is connected to the directors of the insolvent business).

Pre-pack administrations are subject to the Statement of Insolvency Practice 16 (SIP 16), which sets out the principles and compliance standards that administrators are expected to adhere to in the course of effecting a pre-pack administration.

The Corporate Insolvency and Governance Act 2020 introduced a new restructuring cross-class cram-down procedure to eliminate, reduce or mitigate the financial difficulties impacting on the operation of a business as a going concern.

Application to the court is necessary to convene meetings of creditors or members. At the meeting, the participants will be requested to approve the plan. If 75 per cent in value (of creditors’ debt or members’ shares) approve it, then the plan is approved. Unlike schemes of arrangement, there is no numerosity requirement. The court can bind dissenting voters if certain conditions are satisfied.

Transfer of liabilities

What legal requirements and practical considerations should be borne in mind regarding the acceptance and transfer of any liabilities attached to the distressed company or assets?

On a share sale, typically all relevant assets and existing and potential liabilities will pass to the buyer, even those of which the buyer may potentially be unaware.

Defined benefit pension schemes are more likely to suffer funding deficits. If the employer withdraws from a multi-employer scheme when the company is sold, the trustees of the scheme may require the employer to continue to pay the seller’s share of the deficit. The employer may enter into a withdrawal arrangement with the trustees that apportions the debt in a different way, or appoint a guarantor to be liable for the debt. A share sale in which the pensions liabilities are transferred to the buyer may also trigger the Pensions Regulator to issue a contribution notice requiring the buyer to contribute to the scheme.

On an asset transfer, the buyer will predominantly assume only the defined liabilities. The buyer can therefore expressly exclude from the sale certain significant unidentifiable or unquantifiable liabilities. As the burden of agreements cannot be assigned, the buyer will need to indemnify the seller for any assumed liabilities unless a tripartite agreement is made with the relevant creditor.

Purchasers in an asset transfer will need to consider the provisions of the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). TUPE transfers employees on their current terms and conditions. Similarly, TUPE can cause liabilities connected with the employees to transfer to the buyer, who could become liable for acts or omissions of the seller. Outstanding debts or threatened litigation in connection with employees should be understood before completing the transaction, even where the due diligence process will be condensed under the time pressures of a distressed sale.

In general, tax liabilities will remain with the entity that incurred them. However, in certain limited circumstances, the purchaser of assets as part of an asset sale may acquire liabilities relating to unpaid national insurance contributions.

Consent and involvement of third parties

What third-party consents are required before completion of a distressed M&A transaction? What are the potential consequences of failure to obtain these consents? In what other ways are third parties commonly involved in the transaction?

Where a lender is providing financing, or a company is otherwise seeking to raise finance to acquire distressed assets, existing financing arrangements and debt structures should be analysed as part of the due diligence process to ensure that there will be no breaches of relevant provisions to avoid acceleration of default or cross default.

Other third parties, such as counterparties to material contracts, may need to provide consent in addition to any mandatory regulatory approvals or, in the case of certain listed companies, shareholder approvals that may be required.

Time frame

How do the time frames and timelines for the various transaction structures differ? Can these be expedited in any way?

The timeline for a pre-pack administration can be expedited by early engagement with the proposed administrator and legal advisers. This will enable the purchaser to arrange financing and the company to procure relevant consents (eg, from a qualifying floating charge holder) without delay.

The timeline for a corporate loan depends on whether the loan will be bilateral or syndicated, whether there are multiple tiers of debt, the extent of the security and guarantee package and the extent of the conditions precedent that must be satisfied to utilise the loan.

Tax treatment

What tax liabilities and related considerations arise in relation to the various structures for distressed M&A transactions in your jurisdiction?

For asset transfers, historic tax liabilities of the business will normally remain with the seller, save in certain limited circumstances where national insurance liabilities may transfer to the buyer. Asset buyers should ensure that an asset transfer is structured as a VAT-neutral transfer of a business as a going concern, or that the buyer can obtain credit for any VAT incurred. Stamp taxes may be payable by buyers in respect of the acquisition of certain shares and securities, and of interests in UK real estate assets.

On a share purchase, historic tax liabilities remain with the target company, so contractual protection or appropriate insurance should be considered. A buyer should give careful consideration before giving value for tax attributes (eg, losses), because anti-avoidance rules may be triggered on a change of ownership that restrict its ability to utilise those attributes against post-acquisition profits or gains, particularly if the nature or conduct of the target company’s business will change post-acquisition. If a target has acquired assets intra-group, possible degrouping charges should be considered.

If the target company’s debt is acquired at a discount to its carrying value in the target’s account a ‘deemed release’ may occur, causing the target broadly to be taxed on the amount of the discount, except for arm’s-length transactions where the target is insolvent or at risk of insolvency and is released from the debt shortly after the acquisition. If the exception is not available, debt capitalisations and debt forgiveness within a corporation tax group can normally take place on a tax-neutral basis.

Auction versus single-buyer sale process

What are the respective pros and cons of auction sales and single-buyer sales? What rules and common practices apply to each?

An auction sale broadens the pool of potential buyers. The seller can try to obtain the best possible price and terms, as potential buyers are encouraged to bid against one another. A competitive auction sale can help to alleviate the risk of challenge as a transaction at an undervalue.

However, the seller’s business may be inappropriate for an auction sale, particularly in a restricted market with few possible buyers. Auction sales tend to be more expensive for the seller as fees escalate when negotiating with multiple prospective bidders. The seller bears the risk that some bidders, perhaps competitors, will only be seeking information about the company (although this should be mitigated to some extent by confidentiality undertakings). If the auction process is publicly unsuccessful, this could result in other potential investors, competitors in the market and customers suspecting that the target company is in irreparable difficulty, which may render future transactions challenging.

The bidder, meanwhile, will be concerned that an auction sale may carry a higher price than if there were only one potential buyer and reduce the chances of success. The lack of due diligence information and warranty and indemnity protection in a distressed M&A transaction is exacerbated in an auction sale, so the potential buyer bears an even greater risk.