The number of German corporate insolvencies is currently at an all-time low (see Leibniz Institute for Economic Research Halle (IWH), press release 21/2021 dated 5.8.2021). However, the ongoing Corona pandemic is not without consequences. Many companies were only able to cope with the pandemic by relying on government liquidity assistance and additional loans. This additional debt burden must be paid in the future. In cases where a company’s business model already appeared questionable before Corona, or in sectors which are affected by major change processes, the challenges are likely to have been exacerbated by an (in some cases significant) increase in the debt burden. Corona-related long-term changes in the markets also should be considered. While potential effects on the retail sector and the commercial rental market, for example, seem rather obvious, it remains to be seen what other effects the current crisis will bring to light over time for many companies and sectors. It therefore seems realistic that the Corona crisis will be reflected in increasing insolvency cases in the medium term.
From the investor’s perspective, the acquisition out of insolvency proceedings offers interesting advantages. At the same time, there are special features compared to ordinary M&A transactions which an investor should consider on the way to a successful offer. This article provides an overview of the most relevant aspects of an acquisition out of insolvency proceedings from the investor’s perspective.
1. Initial situation
Both the insolvency administrator in insolvency proceedings and the management in debtor-in-possession-/protective shield proceedings must take all measures to ensure the best possible satisfaction of the creditors. In this context, the prospects of satisfaction through a sale of the company must also be examined. As a rule, therefore, an M&A advisor is engaged with a sales process shortly after the application of the relevant proceedings. Irrespective of the activities of an M&A advisor, any interested investor is free to approach the insolvency administrator or the debtor-in-possession independently with an interest in acquiring the business. Serious acquisition offers are to be considered accordingly.
In the interest of the best possible satisfaction of the creditors, a bidding process is regularly conducted to achieve a maximum purchase price, whereby other criteria besides the purchase price, such as transaction security and speed, are decisive as well. In addition, the conduct of a bidding procedure serves as evidence that the company has been utilized in the best possible way in the interest of the creditors.
Compared to ordinary M&A processes, the time factor plays an even more decisive role. The insolvency administrator will aim to conclude the purchase agreement as soon as possible after the opening of the insolvency proceedings. There are usually only about three months between the start of the M&A process and the signing of the purchase agreement. Thus, it is highly advantageous from an investor’s point of view to enter the sales process as early as possible and with high speed and determination. Practice shows that potentially promising bids may not be pursued further if the investor simply enters the process too late. Advanced bidders are in danger of being lost if the new – potentially promising – bidder is given the additional time needed without the required transaction security.
Depending on the specific case of the insolvent company, an acquisition of the entire company or only of business units or individual (production) locations may be considered. The acquisition may take the form of the purchase of individual assets (asset deal) or of the entity (share deal) via insolvency plan proceedings. If the insolvent entity owns subsidiaries which are not themselves insolvent, the subsidiaries are generally acquired by way of a share deal.
2. Advantages for the investor
An acquisition out of insolvency can have many advantages for the investor. There is the prospect of acquiring the company at a comparatively lower purchase price than outside insolvency proceedings. Above all, the investor takes over the business free of liabilities from the past and, in consultation with the seller, can make use of restructuring opportunities for the company.
Both in the case of acquisition via an asset deal and in the case of acquisition via an insolvency plan, the liabilities from the past generally remain with the seller, and the company is taken over free of debt (this is only different in terms of a non-insolvent subsidiary, which is acquired by way of an ordinary share deal). This applies, for example, to pension liabilities and other labour law liabilities regarding the period prior to the opening of insolvency proceedings.
For the purchaser, the main opportunity is to restructure the company in connection with the takeover. Since it is possible under insolvency law for the seller (i.e., the insolvency administrator or the debtor-in-possession) to terminate employees with only three months’ notice period and to terminate ongoing contractual relationships prematurely at any time, the investor has the opportunity, in agreement with the seller, to reduce jobs and continue the new company as far as possible with a “desired team,” and to terminate economically disadvantageous contractual relationships. It may also be possible to negotiate restructuring contributions for the period after the takeover with customers that are dependent on continued supply.
3. Offer and purchase contract negotiations
Timing is a decisive criterion for the insolvency administrator at all stages of the process. It is therefore of considerable importance whether the insolvency administrator gets the impression from the offers submitted that it will be possible to get across the finish line with the respective investor within the time available. To ensure this, it is beneficial to have legal advisors with insolvency experience supporting the bidding phase. Since the binding bid usually must be submitted together with a mark-up of the draft purchase agreement prepared by the seller, the form of this mark-up is also of decisive importance in order to reach the final round of negotiations with the seller. The insolvency administrator will immediately recognize whether advisors with insolvency experience prepared the mark-up. When preparing the mark-up, it is essential to focus specifically on the relevant provisions and to take into account relevant pressure points for the insolvency administrator under insolvency law. Points that should be taken into account in the relevant contractual clauses include transaction security, clearly calculable payments to the insolvency estate, and the allocation of the purchase price to individual secured or unsecured assets. Nevertheless, not everything that would be desirable from the perspective of an insolvency administrator must simply be accepted. It is therefore important to know which points are negotiable and to what extent. If investors and advisors start with the negotiation standards of a regular M&A process, they may considerably impair the acceptability of the offers.
The binding bids, together with the mark-ups of the draft purchase agreement, are evaluated by the insolvency administrator, supported by the M&A advisor and the lawyers involved, and presented in summary form to the preliminary creditors’ committee. Together with the preliminary creditors’ committee, the insolvency administrator then decides which bidders should enter into the final round of negotiations (usually two or, at a maximum, three bidders). If time permits, it is customary for the insolvency administrator to obtain unilateral offers of sale before the insolvency proceedings are opened, and to make a final decision on their acceptance together with the creditors’ committee after the insolvency proceedings have been opened.
4. Purchase agreement
Structure and Content of the Purchase Agreement
Asset purchase agreements on a sale out of insolvency usually contain the following essential elements:
- Determination of the objects of purchase (excluding cash, receivables and payables)
- Assumption of rights and obligations arising from contracts and differentiation of (past and future) rights and obligations under the contracts between the seller and the buyer
- Additional regulations for sold real properties and shares
- Purchase price payment
- If necessary, purchase price adjustment in relation to inventories
- Transfer of ownership and retention of title rights
- Compensation payments for down payments and subsequent payments after closing
- Transfer of employees and restructuring options (so-called BQG/acquirer model, discussed subsequently herein)
- Execution requirements/conditions
- Seller’s right of withdrawal in the event of default or long stop date for closing
- Subsequent cooperation obligations of the purchaser in the event of insolvency proceedings
- Exclusion of warranty, statute of limitations (as far as possible)
- Exclusion of the insolvency administrator’s liability
Purchase Price Provisions
For the insolvency administrator, it is necessary to have the greatest possible certainty as to the purchase price flowing into the insolvency estate at the time of signing the purchase agreement, because this has an impact on the amount of the insolvency quota to be distributed to the insolvency creditors. Therefore, the insolvency administrator will try to agree on a fixed purchase price for all assets sold. Since the various assets often serve as security for individual creditors, a purchase price allocation determined in the purchase agreement has significance for the insolvency administrator in the subsequent distribution. In turn, the purchaser has an interest in terms of the purchase price allocation to make use of available valuation options within accounting regulations in order to achieve advantageous depreciation potential and balance sheet effects.
Since it is important for the insolvency administrator to secure the actual payments to the insolvency estate, subsequent adjustments to the purchase price are only conceivable to a limited extent. However, it is customary to record and account for the inventory actually existing at the time of closing and to deduct from the purchase price any assets sold that are not available or not owned by the insolvency administrator.
If non-insolvent subsidiaries are sold, it makes sense from the investor’s point of view to demand a net debt/working capital adjustment of the purchase price allocated to the respective shares. If the parties also agree on a fixed purchase price (locked box), the purchaser should ensure by agreeing on so-called no-leakage provisions that no outflows can occur which erode the value of the investment to be acquired without reducing the purchase price. When selling shares in subsidiaries, it should also be noted that the insolvency administrator will try to exclude the enforcement of any intra-group claims of the subsidiary against the insolvency debtor in the purchase agreement in order to avoid subsequent reductions of the insolvency estate.
Special Features of Contractual Relationships to Be Taken Over
As part of the transaction, the purchaser will take over the supplier and customer contracts and other contracts with continuing obligations of the insolvency debtor insofar as these are economically significant for the business operations to be taken over. In this context, the acquisition out of insolvency proceedings offers the opportunity to reorganize (continuing) obligations and certain contracts insofar as these have not yet been completely fulfilled on both sides. As a result of the insolvency administrator’s special right to terminate these contracts at any time after opening of the insolvency proceedings, the purchaser can leave behind economically unattractive contracts, which the insolvency administrator then terminates.
It should be kept in mind that the transfer of contracts requires the consent of the contractual partner. If this consent cannot be obtained in individual cases, but the contract cannot be substituted for the purchaser in the short term, often an arrangement can be made with the insolvency administrator, if necessary, so that the latter continues the contract with the contractual partner for a transitional period and passes on the rights and obligations with economic effect internally vis-à-vis the purchaser. However, the insolvency administrator will only agree to such an arrangement if it is economically risk free.
Labour Law Specifics
The transfer of an insolvent company by way of an asset deal generally constitutes a transfer of business within the meaning of Section 613a German Civil Code (BGB). Consequently, all employment relationships existing with the insolvency debtor at the time of the purchase agreement’s execution are transferred by law to the purchaser. As a special feature under insolvency law, the purchaser is not liable for employee claims from the period before the opening of the insolvency proceedings, but only for the so-called preferred liabilities of the insolvency estate (Masseverbindlichkeiten) arising as of the opening of the insolvency proceedings. Hence, principally all liabilities relating to the period prior to the opening of insolvency proceedings remain with the insolvency administrator. The only exceptions relate to outstanding vacation entitlements and vacation compensation claims due to termination of the employment relationship after the opening of insolvency proceedings, as well as claims from working time accounts. The purchaser is liable for these claims pursuant to Sec. 613a BGB because of their qualification as preferred liabilities of the insolvency estate. However, the parties to the transaction are free to make a deviating arrangement in this respect in their internal relationship.
The best way to reduce or restructure the workforce is via a so-called employment and qualification company (Beschäftigungs- und Qualifizierungsgesellschaft) (BQG) or the so-called acquirer concept (Erwerberkonzept). In the BQG model, for which specialized providers exist, the employees initially transfer to the BQG while terminating their existing employment relationship. Thereafter, new employment relationships are established with the purchaser. Since the implementation of a BQG entails considerable costs, negotiations must be held with the insolvency administrator on how such costs are to be borne. In the acquirer model, the insolvency administrator terminates employment relationships on the basis of an already existing binding restructuring concept of the purchaser. In the course of this process, reconciliation of interests with a list of names is usually agreed with the works council.
Guarantees and Insolvency Administrator’s Liability
Insolvency administrators are per se not willing to grant guarantees or indemnities, in light of their objective to secure the paid purchase price for the insolvency estate and because they can only gain very limited insight into the company during their short period of activity. An insolvency administrator often finds a disorderly business operation, which the administration must take over and continue at short notice, i.e., without a longer period of acclimatization. The administrator therefore initially lacks a complete picture of the accounting and operations. In addition, warranty and indemnification (W&I) obligations are preferred liabilities of the insolvency estate, which must be fulfilled in full by the insolvency administrator and otherwise lead to the administrator’s personal liability. Guarantees are therefore only negotiable with the insolvency administrator in justified individual cases. This does not include the insolvency administrator’s guarantee that the sold assets actually exist and are transferable to the purchaser. As a rule, however, the extent of the liability will be limited to the pro rata purchase price of the missing asset.
The insolvency administrator will also endeavour to limit legal liability to a large extent. In addition to far-reaching exclusions of liability (such as knowledge of the data room, disclosure in annual financial statements or management accounts, claim against an insurance company), the insolvency administrator will regularly want to limit the total liability to a portion of the total purchase price received. In addition, shorter limitation periods are regularly agreed compared to standard M&A transactions.
Against this background, the purchaser may consider purchasing W&I insurance with an insurance provider specialized in this area. While W&I insurance has become increasingly important on the regular M&A market, the offers in the distressed M&A area are still rather limited. Nevertheless, individual insurers offer insurance policies tailored specifically to the transferring restructuring. These are so-called synthetic guarantee insurance policies, meaning that the insured guarantee catalogue is not one negotiated between the parties to the purchase agreement, but a bilaterally agreed guarantee catalogue between the purchaser and the insurer (outside the purchase agreement). Because of the special situation of insolvency, insurers regularly offer a non-negotiable standard catalogue of warranties that is limited compared to a standard M&A transaction. The guarantees are thereby insured objectively, i.e., not knowledge-qualified. However, the insurer will have extensive due diligence performed by the purchaser’s lawyers or by its own legal advisors. Due diligence findings will result in liability exclusions. Compared to a standard M&A transaction, the costs of this special distressed W&I policy are also significantly higher.
When acquiring a company out of insolvency proceedings, there are typically far-reaching differences for an investor compared to a standard M&A transaction. In addition to purely practical considerations, such as the race against time (safeguarding and continuing workforce and customer relationships), there are insolvency-law-related particularities to observe. In order to prevail over competitors in the bidding process, it is also important to know the relevant aspects for the insolvency administrator besides the purely commercial aspects of the offer. It is therefore advisable to consult a legal advisor experienced in distressed transactions at an early stage in the bidding phase.