Although distressing for the owners and employees, an insolvent businesses can represent an opportunity for a buyer. One of the benefi ts of insolvency is that it can release the underlying business (which may be profi table in itself) from debts and give a buyer the opportunity to make a fresh start.

In doing so, however, buyers should beware of the employment law risks represented by any employees who remain in the business through the insolvency process.

The Acquisition

An insolvent business is usually acquired by way of an asset sale, eg a sale of the assets of the business such as property and machinery, and an assignment of the business’ sale and supply contracts and goodwill. This process leaves the corporate owner of the business with a debt-ridden shell which its administrators can wind down in an orderly fashion.

The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) will apply to an asset deal and will have the effect of transferring, automatically, the contracts of employment of the business’ employees to the buyer on completion, along with all the employment liabilities they carry with them.

When TUPE was amended in 2006, much was made of the exceptions which are made to the effect of TUPE on insolvent businesses, the aim being to promote a ‘rescue culture’ by allowing buyers of insolvent businesses greater fl exibility than in a standard business acquisition where TUPE applies.

One of the main advantages for buyers is that not all liabilities will transfer. Some payments owed to employees during the administration, such as compensation for statutory notice and redundancy payments, will not transfer and employees will need to recover these from the National Insurance Fund or from the administration itself as unsecured creditors.

However, somewhat surprisingly, TUPE is drafted so that the exceptions giving greater fl exibility to buyers in respect of dismissals or variations to employee terms apply only to sales of businesses which are being wound up (predominantly sales by liquidators and receivers) and do not apply to the majority of administrations (which are generally conducted with a view to the sale of the business as a going concern).

The effect of this is that, for most buyers, the full effect of TUPE will apply, without the additional fl exibilities of TUPE’s insolvency exceptions, and without the niceties of consultation, formal due diligence and warranty and indemnity protection.

Employee Liabilities

Liabilities which pass to the buyer under TUPE include full liability for any dismissals (whether before or after the transfer) which were made ‘in connection’ with the transfer (potentially including dismissals the buyer did not even know about, if they were carried out by the administrators solely in order to make the business more attractive to the buyer).

Under TUPE, any such dismissal will be ‘automatically unfair’ and the employee will have a claim against the buyer for damages for loss of earnings for the reasonable time it will take to find alternative employment.

In addition, the buyer will be jointly liable with the seller for any failure by the administrators to inform and consult with employee representatives pursuant to TUPE. This is a significant risk, as penalties can be up to 13 weeks’ pay per employee.

The sale of the business will invariably be carried out by administrators appointed by the courts to run the insolvent company for the benefit of its creditors. As the administrators’ primary duty is to the creditors, they are prevented from entering into agreements which are detrimental to the dividend, and so will not give indemnity protection to buyers as part of the deal.

However, some may agree a price reduction in order to achieve a sale if the buyer is willing to put a value on the possible TUPE liabilities, and negotiate accordingly.

Integration and Harmonisation

Having acquired a business, the buyer will need to continue to think about TUPE. As noted above, any employee who is dismissed for a reason which is connected with the transfer will have a claim against the buyer, unless the buyer can show that the dismissal was for an ‘economic, technical or organisational’ (ETO) reason which entails a change in the workforce.

This is likely to be the case where the buyer genuinely needs to reduce headcount as a result of duplication, but will only succeed where all employees (not just those who have come in through the acquisition) are considered for the remaining jobs and scored fairly against objective criteria.

Another effect of TUPE is to protect employee terms and conditions, as any attempt to vary the terms and conditions of the employees acquired by the transfer will be void at law, including extended notice periods and restrictive covenants (although in practice most employees will accept the changes provided the overall package is similar or perhaps more beneficial).

Further, these changes will almost certainly be ‘measures’ on which employee representatives should have been consulted, which could represent a risk of claims by employees for failure to inform and consult them over the transfer.

Practical Steps

When considering the purchase of an insolvent business, buyers should carry out as much due diligence as possible in the three main areas in which liability will pass to the buyer: (a) the number and costs of the remaining employees (b) the amount of consultation (if any) carried out during the administration and (c) the number of dismissals made during the administration.

Often administrators will be happy to provide information which is readily available, such as numbers of employees, salary costs and the actions they have taken since appointment. More difficult to obtain may be details of past liabilities, especially if, as is often the case, administrative staff who would have the knowledge to hand have already been dismissed.

Having established the numbers, the prospective buyer can calculate the maximum financial liability it could face on the employment front and factor this into price negotiations at the outset, as warranty and indemnity protection will be difficult to secure.

With the information to hand, buyers can then consider its strategies as to integration and harmonisation following completion of the acquisition.