Pre-Pack Administration - The Risks of Purchasing Distressed Businesses

Whilst purchasing a distressed business through a pre-pack administration can seem like a good value opportunity, any such deal comes with a number of risks and issues.

Whilst purchasing a distressed business through a pre-pack administration can seem like a good value opportunity, any such deal comes with a number of risks and issues.

Following the challenges of the pandemic and the end of covid-support, we are witnessing a rise in the number of businesses. This month, administrations have been at the forefront of the news, with premiership rugby club Wasps following Worcester Warriors into administration, but it is not only large businesses affected by administration; we are noticing a rise in the number of pre-pack administration deals, where a purchaser is able to acquire a substantial amount (if not all) of an insolvent company’s assets from the administrator, through a pre-agreed deal.

When acquiring a solvent business, there are a range of important benefits, such as plenty of time for due diligence before agreeing to a sale, along with agreeing warranties with the seller to provide confidence in the sale. When it comes to purchasing a distressed business through a pre-pack sale, whilst it is possible to buy a business for a lower investment, many of the usual features of buying a solvent business are not a possibility.

Key issues associated with purchasing a distressed business

Limited due diligence

When it comes to a pre-pack sale, the purchaser’s ability to carry out due diligence depends on how willing the insolvent company’s management is to cooperate. Typically, a considerably shorter period of time is taken to complete the purchase of a distressed business, so there is little chance for directors of the distressed company to respond. In many cases, the administrators will have little information on the business for sale, so cannot offer more than the information provided to them.

It’s also important to note that no warranties will be received from the administrators for the assets purchased. All company assets are sold on an ‘as is’ basis. 

Purchasing key assets

In a pre-pack administration deal, the purchaser of the business has the opportunity to acquire important assets such as the name of the company, their intellectual property, alongside any physical property. This allows for the company to continue as a going concern, but leaves behind the liabilities and debts of the old directors. It’s important for the purchaser of the distressed business to identify the assets that they wish to be included in the sale, as well as those that they do not wish to acquire.

When purchasing the name of an insolvent company in liquidation, it’s also important to understand the risks, particularly in relation to section 216 of the Insolvency Act 1986. If the party seeking to purchase an insolvent company through pre-pack administration is a connected party, for example, an existing director, then an evaluator’s report from an independent evaluator may be required to ascertain that the terms of sale are fair.

Indemnities covering liabilities are non-negotiable

When purchasing a distressed business in administration, you should understand that the appointed administrators will expect the purchaser to indemnify them against any liabilities that could arise as a result of the sale of the business, or its assets. This is non-negotiable.

There’s no guarantee that a purchaser will be assigned a lease for a distressed business’s premises

Due to the small timeline of a pre-pack administration, it’s not usually possible to take an assignment of the lease for business premises, though, the landlord of a leasehold property may allow a licence to occupy the premises for an agreed time, which may allow the purchaser time to negotiate with the landlord over a lease agreement.

Customer contracts do not transfer automatically and trade licences may require reinstating

As with leasehold agreements, key contracts with customers and suppliers do not transfer automatically to the purchaser of the business. It can’t be guaranteed that key customers or suppliers will wish to keep working with the new business owner, and if they do, they will wish to renegotiate contracts for financial security, including recouping losses where possible.

In order for the new business to trade legally, the purchaser will also need to ensure that any necessary trading licences are in place. For example, premises licences for entertainment or the sale of alcohol will automatically lapse when administrators are appointed. Any necessary licences must be coordinated in time with the sale so that they are reinstated or transferred to the new owner.

Employee liabilities are transferred

In most cases of buying a distressed business through a pre-pack sale, all existing employees of the business will transfer automatically to the new business owner under the Transfer of Undertakings (Protection of Employment) Regulations 2006. As a result, the purchaser will take charge of all obligations and liabilities around transferring employment contracts.

Pre-Pack Administrations Advice

A pre-pack sale must be concluded quickly, before the appointment of administrators, so in order to ensure the deal is conducted quickly and legally, it’s important to seek professional advice.

To arrange a consultation, call BEACON on 02380 651441.


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