Buying from administrators - a risky business

Despite evidence to the contrary, the impression persists in some quarters that if you buy a business or assets from an administrator or liquidator you will inevitably get 'a bargain'. And yet, it happens that businesses bought from insolvency practitioners go on to fail again - sometimes within quite a short period of time.

Sometimes this will be because the buyers of the business are its previous owners and directors and either they are influenced to pay too much for it or they do not recognise and remedy previous managerial failings.  Occasionally, their activities may even be fraudulent.

But for arm's length purchasers, the risks are different.  This is because when an administrator or liquidator offers a business or assets for sale there are none of the normal safeguards that you would expect to with a willing seller.  Insolvency practitioners give none of the customary warranties or indemnities and there will be no disclosure letter.  Furthermore, they sell only 'such right title and interest' (if any) as the insolvent company has.

This can have a number of implications as follows.

• If the insolvent company has a crucial piece of equipment - such as a printing press - which is believed to be owned outright but, after the purchase, a leasing company lays claim to it, the purchaser will have no recourse to the insolvency practitioners or the insolvent company to recover any of the purchase price.
• Likewise, if there are stocks of parts which have not been paid for and it transpires that a supplier has a valid retention of title clause which specifies that supplies remain his property until paid for, the purchaser will either need to return the parts affected or pay the supplier.
• If it emerges that critical intellectual property or software applications are subject to third party licensing or other rights, the purchaser may be stopped from using them without the agreement of the licensor.
• Property might turn out to belong to other parties - such as other connected or group companies; a landlord; the directors or even members of staff.

A key feature of a purchase from an insolvency practitioner is that, generally speaking, the purchaser acquires the business or assets unburdened from the debts of the insolvent company.  There are, however, exceptions.  For instance, under the provisions of the Transfer of Undertakings Protection of Employment Regulations ('TUPE'), staff entitlements which cannot be met by the insolvent company will fall to a purchaser.  These liabilities, which can include Employment Tribunal awards, can be substantial.

A further consideration can sometimes be 'what happens to any subsidiary companies which are not in administration or liquidation?'  If only the parent company in a group is placed into administration, the subsidiary companies could look like attractive assets to purchase.  Again, care is required in these circumstances in order to assess any contingent or prospective liabilities that a subsidiary might have.

For instance, a subsidiary might have pending environmental violations or court proceedings about which the administrators or liquidators are unaware; it might be a party to property leases; may be a signatory to joint and several guarantees to providers of finance or, as has emerged recently on a matter involving one of our clients, may be part of the group VAT registration - making it liable for the VAT of other insolvent group companies.

In normal circumstances a comprehensive process of seeking warranties, making disclosures and negotiating indemnities would provide protection for the purchaser.  But as referred to, insolvency practitioners are not in a position to provide such safeguards.

A purchase price that is set to reflect these risks is not, by itself, sufficient.  A buyer must consider additional precautions against threats - such as the VAT group liability - that may take months or even years to emerge after any purchase from insolvency practitioners.

A key safeguard is almost invariably the use of a newly incorporated company ('newco') as the acquisition vehicle.  In some circumstances this will seem an obvious choice - for instance in a management buy out where the buy-team do not have an existing entity which could act as purchaser.

In a purchase by a competitor ('trade purchase'), however, it might seem preferable to integrate the acquired business into the purchaser's organisation as quickly as possible.  The danger with this is that if a claim emerges it will lie against the entire integrated business rather than just the part that has been newly-purchased.

Whether a newco is used or not, it is crucial that the purchaser has properly assessed the risks.  Fundamental to this is to secure and understand legal and financial advice from professionals with appropriate expertise.

Peter Whalley is head of business restructuring and insolvency at James Cowper Kreston and holds a diploma in corporate finance from the Institute of Chartered Accountants in England & Wales which licences him to accept formal insolvency appointments and can be contacted on +44(0)207 2422088 or pwhalley@jamescowper.co.uk.