Liabilities when buying an insolvent business

A business that has gone bust can represent a real opportunity for a canny acquirer, but the legal rights of the existing employees must be taken into account.

A business that’s gone bust can represent a real opportunity for a canny acquirer, but the legal rights of the existing employees must be taken into account. Kathryn McConnell, senior associate at law firm Nabarro, explains.

When you acquire an insolvent company, the rights of that company’s staff (and hence your liabilities) depend on the category of insolvency.

Compulsory liquidation and the appointment of a receiver by the court will result in an automatic termination of all employment contracts with immediate effect. The other categories of insolvency, administration or voluntary liquidation, do not have that effect, although it may be the case that an insolvency practitioner will want to make redundancies (to which normal legislation applies).

In most solvent business sales, the Transfer of Undertakings (Protection of Employment) Regulations 2006, or TUPE, automatically transfers to the purchaser of a business the employees of that business, on their existing terms and conditions with no break in their period of employment.

This does not apply when a business is sold subject to compulsory liquidation, creditors’ voluntary liquidation or bankruptcy. In these cases, the purchaser can decide which employees it wants to keep, though certain obligations to consult staff and keep them informed still hold.

If a company is sold subject to administration or a voluntary agreement, however, TUPE will apply as it would to the sale of a solvent business. All liabilities in relation to employees will transfer to the purchaser of the business, though there may be scope to make “permitted changes” to ensure the company’s survival and certain debts which relate to the insolvency (such as unpaid wages, holiday pay or pension contributions) can be met by National Insurance.

The old rule of “buyer beware” applies more than ever for the purchaser of an insolvent business, particularly given that the seller is unlikely to offer any warranty or indemnity protection. In due diligence, the buyer should focus on key issues such as numbers of employees, employee costs, debts owed to employees, onerous contractual provisions and existing or threatened litigation. You may be pressed to make a quick decision with limited information, but be sure you have all the essential numbers to avoid any nasty surprises.

Marc Barber

Raven Connelly

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.

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