Snapshot: due diligence for distressed M&A transactions in United Kingdom

Due diligence

What are the most critical areas of due diligence in a distressed M&A transaction?

The scope of the due diligence should be appropriately limited because of time constraints and limited access to documents. A key area for due diligence is ascertaining why the company is in distress. In the current market, the buyer should assess the pandemic’s impact on the business, including supply chain and employment issues.

For share purchases, change of control provisions, restrictive covenants, financing arrangements and tax matters should be examined. For asset purchases, the buyer should identify key contracts and leases, as well as any security registered against the assets. Key areas of due diligence will also relate to insurance, employees, IT infrastructure (including cybersecurity and data protection) and historic acquisitions.

What searches of public records should be conducted as part of a due diligence exercise in distressed M&A transactions in your jurisdiction?

Companies House searches should be carried out on the target. Annual reports and confirmation statements should be checked for financial information, liabilities, information regarding shareholders and creditors and any late filings. A Companies Court telephone search is essential to check that no winding-up petitions have been filed. It is prudent to conduct the relevant searches for normal, non-distressed M&A transactions in this context also, such as reviewing IP registers and land registry filings.

What contractual protections and other strategies are commonly used to mitigate diligence gaps in a distressed M&A transaction?

Due diligence gaps arising in distressed M&A transactions are often accompanied by an absence of warranties, leaving the buyer, to an extent, unprotected. To mitigate this risk, a lower price may be paid or elements of the consideration may be held back or escrowed (though these will be resisted by the sellers).

Warranties and indemnities may be obtained, but typically not business warranties where an insolvency officer has been appointed. In the case of financial distress of the sellers, the liability of warrantors is likely to be limited. Warranty and indemnity insurance should be explored. It is possible to obtain synthetic warranties directly from insurers even where no warranties are given by the seller.

The buyer may seek to incorporate an option to terminate the transaction if certain material adverse events transpire prior to closing. The sell side will seek to avoid such provisions, which reduce deal certainty.