Acquiring an insolvent company

from Elmar Hiltner and Christopher Schmidl

After several recent years of very positive economic development, the last few months have shown an increasingly sombre outlook for the German economy. Alongside the general worsening of the economic situation, there are also structural changes occurring in some important sectors of the domestic economy (e.g. automotive production, commerce) with corresponding negative effects on the financial situation of the companies concerned. Financial strain and the resulting distressed situation of companies, which will increasingly spread along the value creation chain to other indirectly concerned businesses, is also likely to have an impact on future market trends on mergers and acquisitions. This will increasingly put the option of acquiring insolvent companies on the table for both domestic and overseas investors. After a total of 19,552 insolvencies in 2018, which was the lowest level for many years, in the next few years we are expecting to see once again an increased number of companies filing for insolvency.

Acquiring an insolvent company

The acquisition of an insolvent company can be achieved either by acquiring the legal entity (the company) through a share deal, i.e. by acquiring the company’s shares, or by acquiring its assets in an asset deal. This is also often referred to as restructuring by transfer. Thus, either the company, or only some assets, are transferred to a new legal entity.

Given the various benefits, including debt relief, less complexity and the release of increased potential from restructuring, an asset deal is the usual procedure in practice. In addition, the desired assets may be acquired selectively, also known as “cherry picking”. If certain rights that are held by the legal entity are fundamentally necessary for the continuation of the business activity (patents, licences, brand names or other public permits issued to people or legal entities), and it is not possible to transfer these without the permission of third parties, it may prove more appropriate to structure the acquisition as a share deal in combination with an insolvency procedure.
The reason for acquiring an insolvent company is, on the one hand, the opportunity to acquire assets at a considerable discount, and on the other hand, the ability to restructure the distressed company with the help of the administrator and the instruments available under insolvency legislation. This gives the potential buyer the opportunity to take over a company in a form that already meets his needs, i.e. with the necessary assets and (key) employees from his point of view, but without the burden of liabilities (such as pension obligations).

In addition, once an insolvency procedure has been initiated, the insolvency administrator is empowered to terminate long-term financial obligations (such as rental or lease contracts) that are disadvantageous or no longer needed. These attractive features of a purchase out of insolvency are also associated with some specific aspects that have an innately higher risk, and the potential buyer must be able to recognise and consider these in making any decision to purchase: For example, the guarantees and warranties that would otherwise form a normal part of other transactions will normally be very difficult to enforce here.

When acquiring an insolvent company, it is also extremely important for the buyer to gain an understanding of the underlying causes of the crisis, identify the restructuring potential, and develop necessary measures for its realisation.

Special features of the acquisition of an insolvent company

Some special features must be taken into account when acquiring out of insolvency, which include the following:

• Time factor: On the one hand, liquidity must be ensured to enable the company to continue operations temporarily; on the other hand, care needs to be taken not to lose the confidence of stakeholders such as suppliers and customers, as well as banks. Therefore, any purchase out of insolvency will normally involve considerable time pressure.
• Partners for negotiations: When acquiring an insolvent company, management bodies that would normally be involved in negotiating the terms for the sale of the company may no longer be available. In addition, their freedom of action will be severely restricted by the insolvency administrator. Therefore it is important to involve the insolvency administrator at an early stage of any potential purchase.
• Tactical Risks: For the buyer, it may make sense to speculate on a target company filing an insolvency application, or to initiate it themselves, in order to negotiate the purchase contract during the initial bankruptcy proceedings. However, there is the potential risk in this context that it may end up benefiting a competing bidder.
• Due Diligence: The objective of a due diligence investigation is, above all, to identify the risks under insolvency law that might arise from the vendor’s ensuing insolvency, and the ability to exploit any existing restructuring opportunities. This should include an evaluation of the operational, tax and financial risks. This all helps to achieve the best possible outcome of the negotiations with the vendor, and gain solidly-based, informed support from stakeholders, in order to be able to construct acquisition strategies and a restructuring plan on this basis.

Conclusion

The rules for acquiring a company out of insolvency are substantially different from those which apply to other transactions. Potentially interested buyers need, therefore, to carefully evaluate the challenges and opportunities involved in an acquisition out of insolvency. The issues presented here represent only a subset of what needs to be checked in any individual case, and further aspects may also apply.