New Zealand’s economy, like many others, has been significantly impacted by global events such as the COVID-19 pandemic hangover (inflation, supply chain shocks and high interest rates). These events have led to an increase in distressed M&A activity as healthy companies seek to acquire those in financial distress. Distressed M&A is not without its challenges. The uncertainty of the distressed company’s true value, potential liabilities, and the risk of subsequent insolvency proceedings can deter potential acquirers.

Recent case law in New Zealand has highlighted the significant personal financial risk for directors who allow their company to continue trading while insolvent. Unless all creditors of the target are paid after (or as part of) the distressed M&A sale, directors on the “sell side” could be held to be personally liable for any shortfall to creditors. Directors on the “sell side” should often consider how to mitigate personal liability risk (i.e. either cease trading or seek new capital (unlikely if you are selling your business or initiating some form of insolvency proceedings)).

The legal framework in New Zealand therefore plays a crucial role in distressed M&A. New Zealand’s main formal insolvency processes are voluntary administration, receivership and liquidation of companies. Each process can have different impact and outcome in the context of distressed M&A.

Voluntary administration

Voluntary administration is a process designed to resolve a company’s future direction quickly and help mitigate personal liability risk for breach of director duties. An entity facing financial distress can enter voluntary administration, where an independent administrator is appointed to take control of the company. This process can be used strategically in distressed M&A in several ways:

Breathing space

The primary purpose of voluntary administration is to provide a company with breathing space from its creditors. During this period, a moratorium is placed on most unsecured (and some secured) creditors’ claims, which can halt any legal actions and provide time for the company to restructure or find a suitable buyer. It is important to note however that it does not prevent suppliers etc from terminating contractual arrangements due to an “Insolvency Event”.

Restructuring

The administrator may consider a deed of company arrangement (DOCA) that details how the company’s affairs will be handled. This could involve restructuring the company to make it more attractive to potential acquirers. The DOCA needs to be approved by the creditors (majority in number and 75% in value), providing them with a say in the company’s future.

Asset sale

Voluntary administration can facilitate the sale of the distressed company’s assets via a DOCA. The administrator also has the general power to sell assets to repay creditors, which could be part of a distressed M&A deal. This can be beneficial for acquirers as they can purchase assets free of liabilities – although as above – if the sale is part of a DOCA it will require creditor approval (majority in number and 75% in value). Importantly from a purchaser’s point of view the voidable transaction and voidable disposition provisions (sections 292 to 296D of the Companies Act 1993) do not apply to a transaction or disposition by a company in administration if the transaction or disposition is:

• carried out by or with the authority of the administrator or deed administrator; or
• specifically authorised by the deed of company arrangement and carried out by the deed administrator.

Sale of shares

Under the voluntary administration regime, an administrator may consent to the transfer of shares in a company in administration if the administrator is satisfied that the transfer is in the best interests of the company’s creditors.

Pre-pack insolvency arrangements

In some cases, a distressed M&A deal can be structured as a pre-pack insolvency arrangement. Here, the terms of the sale are negotiated before the company enters voluntary administration. Once the company is in administration, the sale can be quickly executed, minimising business disruption (once again it will require creditor consent if the sale is documented in the DOCA (majority in number and 75% in value).

Creditor negotiations

The voluntary administrator acts as an independent party who can negotiate with creditors on behalf of the company. This can be particularly useful in distressed M&A situations where the distressed company’s debt levels may be a sticking point in negotiations either through consensual negotiations or via the DOCA. However, using voluntary administration in distressed M&A also carries risks. There is no guarantee that the administration process will result in a sale and/or that the creditors will approve the proposed DOCA.

Receivership

Receivership is another legal process where a receiver is appointed by a secured creditor or court to take control of some or all of a company’s assets. This process can be used strategically in distressed M&A in several ways:

Asset sale

The primary role of the receiver is to sell the company’s assets to repay the secured creditors. In a distressed M&A scenario, this could mean selling the entire business or parts of it to a buyer. The buyer could potentially acquire these assets at a lower price than in a normal market condition and free of liabilities. A sale by a receiver does not require shareholder approval (often a sticking point in distressed M&A transactions where shareholders refuse consent (e.g. for a major transaction) because they are out of money).

Pre-pack receiverships

Pre-pack arrangements are also positive in receiverships. The goal is to preserve the value of the business and facilitate a quick sale, which can be beneficial in a distressed M&A scenario where time is of the essence and/or where shareholder consent is not forthcoming.

The directors of the distressed company, usually with the help of financial and legal advisors, find a buyer for the company’s assets. This could be an existing creditor, a competitor, or another interested party.
The terms of the sale are negotiated and agreed upon before the company goes into receivership (with the receiver ‘shadowing’ the process). A receiver is then formally appointed who immediately completes
the sale according to the pre-arranged terms. The proceeds from the sale are used to repay the company’s creditors in accordance with the statutory and contractual requirements.

This process can be advantageous in a distressed M&A situation because it allows for a quicker sale, which can help preserve the value of the business and maximise returns for creditors. It also provides certainty for the buyer, as they know they will be able to acquire the assets without a protracted bidding process.

However, pre-pack receiverships can also be controversial. There are concerns about transparency and fairness, particularly if the sale is to a connected party. There are also risks for receivers in pre-packs. Receivers have a duty to get the best price reasonably obtainable on the date of sale. The best way to discharge this duty is to run an open market sale process over a period of time. Pre-pack receiverships are, by their very nature, the opposite approach. Also, because the sale is ultimately a receivership sale there will be very limited warranties etc.

Operational continuity

The receiver has the power to continue operating the business while seeking a buyer. This can maintain the value of the business and make it more attractive to potential acquirers.

Independent management

The receiver acts independently of the company’s existing management. This can be beneficial as it can provide more confidence to potential buyers about the integrity of the sale process.

Quick resolution

Receivership is often a quicker process than other insolvency procedures. This can be advantageous as it allows for a faster transition and reduces the period of uncertainty.

Liquidation

Liquidation is the process of winding up a company, selling its assets, and distributing the proceeds to its creditors. It’s typically seen as a last resort when a company is insolvent and cannot be rescued or restructured. However, it can also play a role in distressed M&A in certain circumstances:

Asset acquisition

In a liquidation scenario, the company’s assets are sold off to repay creditors. Potential acquirers may be interested in purchasing these assets, often at a lower price than they would command under normal circumstances. This could include tangible assets like property and equipment, as well as intangible assets like intellectual property.

Debt clearance

The proceeds from the sale of assets are used to pay off the company’s debts. Once the liquidation process is complete, the company’s liabilities are typically extinguished. This can make certain assets more attractive to potential buyers, as they can acquire them free of associated debts.

Market consolidation

If a company in a particular industry goes into liquidation, it can present an opportunity for competitors to acquire its assets and increase their market share. This can be a strategic move in a distressed M&A context.

Quick resolution

Liquidation is often a quicker process than other insolvency procedures, which can be advantageous for potential acquirers looking for a speedy transaction. However, it’s important to note that liquidation is a terminal process – it results in the end of the company. It’s also typically driven by the needs of creditors rather than the interests of shareholders or potential acquirers. Therefore, while it can present opportunities, it also carries significant risks and limitations.

Due diligence issues

Due diligence is a critical aspect of any M&A transaction, but it becomes even more important in distressed M&A because the seller is unlikely to be willing to provide any comfort (ie the usual suite of warranties and indemnities) and even if it is, may not be in a position to pay out if there is a claim. The acquirer should therefore thoroughly investigate the distressed company’s financial situation, including its assets, liabilities, contracts, and potential legal issues. However, due to the urgency of distressed M&A, there may be insufficient time for comprehensive due diligence, increasing risk. The key is to be very clear about the critical success factors of the business you are acquiring and to stress test those factors as much as is possible. And then price the risks accordingly.

Negotiation challenges

Negotiating a distressed M&A deal can be challenging due to the distressed company’s precarious financial situation. The acquirer may need to negotiate with the distressed company’s creditors, who
may have conflicting interests. Furthermore, the distressed company’s employees and customers may be anxious about the company’s future, adding another layer of complexity to the negotiation process. It is important to identify early on who the key stakeholders are going to be so that any dealbreakers can be identified before too much time and money is wasted.

Legal risks

Distressed M&A also carries legal risks. The acquirer of shares may inherit the distressed company’s legal liabilities, including potential claims from creditors, employees, and regulators. Moreover, if the distressed company goes into insolvency proceedings after the acquisition, the transaction may be challenged as a voidable transaction under the Companies Act 1993. Purchasing assets or a business from a company that subsequently enters a formal insolvency regime can carry several legal risks:

Clawback risk

Insolvency laws often allow for transactions made prior to the insolvency to be reversed or “clawed back” if they are deemed to have been made at an undervalue or with the intention of defrauding creditors. This could potentially affect the validity of the asset or business sale.

Liability for pre-existing debts

Depending on the jurisdiction and the specifics of the transaction, the buyer may inadvertently assume some of the insolvent company’s pre-existing debts or liabilities, particularly if the transaction is seen as a de facto merger/share purchase rather than a simple asset purchase.

Warranty and indemnity claims

If the seller becomes insolvent, it may not be able to satisfy any warranty or indemnity claims that arise after the sale. This could leave the buyer with unexpected costs or liabilities. One way to mitigate this risk is
to use warranty insurance. Insurers are, in some circumstances, prepared to cover warranties in a distressed M&A scenario. the key is to ensure that this prospect is canvassed at the outset, so the deal and the due diligence process can be structured in a way that will satisfy an insurers requirements.

Damage to reputation

The buyer may suffer reputational damage if it is associated with a company that has gone into insolvency, particularly if there are allegations of improper conduct by the seller.

Operational disruptions

The insolvency process can cause disruptions to the business being acquired, such as loss of key staff, customers, or suppliers, which can affect its value and the success of the acquisition.

Conclusion

Distressed M&A in New Zealand presents both opportunities and challenges. While it offers the potential for growth and expansion at a lower cost, it also carries risks due to the distressed company’s financial situation and the legal framework. Therefore, companies considering distressed M&A should conduct thorough due diligence, seek expert advice, and carefully manage the negotiation process to mitigate these risks and maximize the transaction’s value.

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