Distressed M&A: Contestation risks for shareholders and acquirers

published on 21 June 2024 | reading time approx. 3 minutes

Risk management of contestations under insolvency law are crucial in business restructurings and distressed M&A. The parties involved are often unaware of the existing risks.

The entire purchase price payment or the transfer of company shares or individual assets could be contested. Then, without the entire transaction being overturned, the asset advantage obtained previous to the start of insolvency procedures must be returned to the insolvent company. Furthermore, restitution of the asset advantage acquired by the creditor often constitutes in an insolvency claim that can only be partially met following the filing of an insolvency complaint.

Legal Framework

The regulations on avoidance in insolvency can be found under article 129 et seq. Insolvency Code (InsO). Article 129 (1) InsO states that legal acts that were performed prior to the opening of insolvency proceedings and that are detrimental to the insolvency creditors can be contested by the insolvency administrator in accordance with articles 130 to 146 InsO. In particular, a legal act is detrimental to creditors if the insolvency estate is reduced by this legal act. However, the existence of a legal act detrimental to creditors is not sufficient for a challenge under insolvency law. Rather, one of the constellations set out under article 130 to 135 InsO must also be present. For example, according to article 130 para. 1 sentence 1 InsO, a legal act that grants or enables an insolvency creditor to obtain security or satisfaction can be contested if it was carried out in the last three months prior to the application to open insolvency proceedings and if the debtor was insolvent at the time of the act and if the creditor was aware of the insolvency at that time.

In addition, payments on claims that are not yet due can also be contested in accordance with article 131 (1) InsO.

Free services provided by the debtor more than four years prior to the application to open insolvency proceedings can also be contested in accordance with article 134 (1) InsO. This applies in particular for endowments.

According to article 135 (1) No. 2 InsO, however, payments on shareholder loans or on claims that are equivalent to a shareholder loan can be contested one year before the application to open insolvency proceedings.

The legal consequence of insolvency avoidance pursuant to article 143 (1) InsO is, in particular, that everything that was sold, given away or abandoned from the debtor's assets as a result of the avoidable act must be returned to the insolvency estate. However, the counterclaim of the opposing party to the avoidance generally only represents an insolvency claim, which can at best only be satisfied proportionately by the debtor after filing for the insolvency table and subsequent determination.

The contestation periods vary depending on the type of contestation. In some cases, legal acts that took place up to ten years before the application to open insolvency proceedings can also be contested.

The burden of proof for avoidance lies with the insolvency administrator, who must prove that the conditions for contestations are met. Individual presumptions may also help with the burden of proof in this situation.

Risks for Buyers and Sellers

The acquirer of a company in crisis not only bears the economic risk of acquiring unknown legacy assets, but also the risk that legal acts of the selling company could be contested. This could include, for example, the transfer of company shares or individual assets. If the crisis of the target company cannot be averted by the acquirer either, the acquirer as the new shareholder is also exposed to other various risks of avoidance.

The seller of a distressed company may also be exposed to the risk of avoidance, e.g. the transfer of the purchase price could be contested in the event of the insolvency of the acquirer.

In the case of transactions within a group of companies where the purchase price is not always genuine, but rather offset against existing intercompany claims, possible insolvency challenges must be sounded out.

Moreover, in individual cases, the choice between an asset deal and a share deal can also make a significant contribution to minimising the risk of avoidance. In an asset deal, specific assets of the target company, such as machinery or real estate, could be transferred, which may be less susceptible to avoidance than the transfer of company shares as part of a share deal.

Preventive Measures and Organisation Options

Due to the complexity of the legal framework, it is crucial for shareholders and acquirers to obtain legal expertise at an early stage. Working with experienced lawyers and insolvency experts can help to recognise, assess and appropriately address potential avoidance risks. A thorough knowledge of the legal principles of avoidance in insolvency is therefore essential to minimise risks and ensure a successful restructuring or distressed M&A transaction.

Examining acquisition prospects straight out of the insolvency is also worthwhile. In particular through a joint strategic initiation of insolvency plan proceedings under self-administration, in which the purchaser can acquire a stake in the company restructured by the insolvency in an insolvency plan. This not only optimises restructuring potential, but also minimises the risk of avoidance.