Key protections when buying the assets of an insolvent business

The government has recently announced proposed changes to insolvency law to better protect consumers when a business becomes insolvent. This includes a new requirement to honor at least 50% of the value of gift cards and vouchers where the business is continuing to trade, whereas previously these were often rendered worthless. But what can you do to protect yourself if you are looking at buying the assets of an insolvent business?

Where a business is insolvent its residual value tends to lie in its assets. The administrator, receiver or liquidator will likely seek to recover value for creditors through a sale of the business assets to a third party. While buying the assets of an insolvent company can represent an opportunity for buyers, if you are considering such a purchase then there are some key matters to be aware of in order to mitigate your risk.

Due diligence:

Even though the business failed under its previous owners, this does not mean that the assets cannot be used as part of a successful business going forward. However as a prospective buyer, you should undertake a detailed legal, financial and commercial due diligence to ensure you are confident of what you are buying, ensure you are not taking on any unknown liabilities, and that there is scope to use the assets to create a successful business. Your due diligence should include a thorough check of the assets to ensure they are in a suitable condition, able to be used for the relevant business purpose going forward and are not otherwise encumbered by any third party financing or other interests.

“As is, where is”:

A thorough due diligence is all the more important in the case of an insolvency sale as it is unlikely that the seller (being the administrator/receiver/liquidator for the company) will offer any buyer protection by way of vendor warranties or indemnities. This means that you will not have any recourse if it turns out that what you have purchased is not what you were expecting (or is otherwise damaged or lost). Where you consider there may be residual risks, you should factor this into your offer price accordingly, as you cannot rely on any warranty or indemnity protection to make-good any losses that do eventuate.

Insurance protection:

If the “as is, where is” sale is not for you, then you may wish to consider whether warranty insurance is available to create some protection. This product allows the buyer to obtain warranty protection but without downside risk for the seller (as liability will be covered by insurance), and as such may be available in the context of an insolvent sale where warranties would otherwise not be on offer. An application for warranty insurance has become a simpler process over the years, but is still quite involved. If you wish to consider this option then we recommend that you consult your insurance broker and legal advisor early in the process, and note that it will also have a bearing on the negotiation and drafting of the sale and purchase agreement. Warranty insurance is subject to the normal limitations you might negotiate in a business sale, so does not give all encompassing protection against any and all loss, and a detailed due diligence remains critical.

Reputation:

The reputation of the business may have taken a hit due to the insolvency. If you are intending to buy the business branding or otherwise create a similar business going forward, then you need to consider how customer/supplier/employee relationships can be restored. As part of your due diligence, we suggest you undertake an assessment of the current market, customer perceptions and ability to secure continued access to materials, labour and other necessary business inputs.

Planning:

The key to the successful acquisition of an insolvent company’s assets is having a clear plan in place for the business you wish to create. You should ensure you have the resources (including money and expertise) to grow a profitable business from the assets, as well as a strong well thought-out business plan to take it forward. As part of this process, it is worth analysing what went wrong for the seller and consider what you will do differently so that you do not fall into the same traps.

The proposed changes to insolvency law do not create any additional protections for buyers of insolvent businesses, so it is as important as ever to do your research, know what you are buying and seek appropriate advice and guidance. Although an insolvent business is an unfortunate outcome for the owner, it can create an opportunity for a savvy buyer if you take proper steps to manage your risk.

Note that the proposed changes to be included in a future Insolvency Law Reform Bill include:

• A requirement to honour at least 50% of the value of gift cards or vouchers held by consumers, where the insolvent company continues to trade.

• Providing that payments to employees in lieu of notice and for long service leave are to be preferred and protected in the same way as wages.

• Reducing the “claw back” period for voidable transactions for third parties that have dealt with the company in good faith prior to its liquidation from two years to six months.

• Increasing the “claw back” period from two years to four years for “related party” creditors.

If you would like further assistance in buying or selling an insolvent business or with the insolvency process, please get in touch with our business law or insolvency teams.

Business Law team

Gerard Dale, Claire Evans, Graeme Crombie, Evelyn Jones, Anna Ryan, Joelle Grace,  Peter Orpin, Ellen Sewell, Matt Tolan, Carlo Wan, Kristina Sutherland, Jacob Nutt, Whitney Moore, Alex Stone, Ben Cooper

For insolvency queries, please contact Ben Russell