Each month of 2023 so far has, sadly, brought news of gradually rising insolvencies, with last month’s official figures being nearly 40% higher than the equivalent figure a year before. Ever increasing borrowing costs are only likely to make that number further increase exacerbating the impact of the high inflation the UK has witnessed over the last year.

However with every cloud, there is hopefully a silver lining.

Opportunity for investors

This scenario of rising insolvencies presents an opportunity for investors to step in and purchase some or all of the distressed business. They can then try to turn it around and leverage their considerable capital, specialist industry knowledge, extensive networks and allow the business to stabilise and grow.

Rescue culture is at the root of the UK’s insolvency regime and one which the government is very keen to encourage.

A number of routes are available when seeking to acquire a business from a distressed situation. Purchasing of discounted debt, more straightforward purchases of shareholding, or asset or business purchases are all paths to take.

Rescue culture is at the root of the UK’s insolvency regime and one which the government is very keen to encourage.

Each may allow purchasers to implement strategic changes, such as operational restructuring, cost-reduction measures, or management reshuffling, in  order to improve the company’s financial health and profitability. However, every path has consequences, risks and indeed rewards as it relates to one of the most important assets of a business: its human capital.

Due diligence

Unfortunately, we often see purchasers trip up when – quite understandably – seeking to move quickly during purchases from distressed situations.

Diligence carried out in haste, which is particularly common, can often (necessarily) fail to properly look under the proverbial bonnet. The result is that a number of potentially material issues that affect not just the profitability of the business but the practicalities of running and turning it around are overlooked.

A post-completion audit of the employment affairs of the business is often prudent and during these we often see purchasers of businesses uncover a range of issues and inefficiencies.

Many of these can be quickly remedied. Within the organisation’s structure issues such as operational inefficiencies, outdated processes, or inadequate management systems are uncovered. 

Employee issues

The list of employee-related issues is longer. For instance, inefficient or misguided remuneration and incentive arrangements that don’t properly encourage activity which generates profit, executive severance and other entitlement issues and failures to fully protect the business against competition or misuse of trade secrets and confidential information, arrangements for non-executive colleagues needing to be brought up to market standard, addressing contractual “gaps” and risks, issues around (often substantial) historic holiday pay and IR35 liabilities and, in businesses in regulated sectors, issues with their regulatory or compliance “culture clashes”.

Every one of these should be considered in the context of a purchaser’s eventual exit options, with a view to removing or reducing potential challenges associated with exiting the investment.

But can one avoid storing up such problems before the purchase takes effect, even where one needs to move quickly? Ultimately, yes, to an extent.

1. Review the absolutely key documents such as executive service agreements and remuneration plans, and ask probing questions to the extent possible.
2. Consult with employees and their representatives as early and as fully as you can; communicate effectively with them and provide necessary information. When the deal is concluded, there will be those who will be asked to help refloat the sunken ship – a significantly easier task if they are kept on side.
3. Obtain accurate and comprehensive employee information from the selling company. This will help you assess potential liabilities and ensure a smooth transition.

Fixing each of these issues can be the first stage in a turnaround of the culture of the organisation, which in turn ensures it is ready to push ahead and return to (or increase) profitability.

Unfair dismissal claims

Aside from having to carry out diligence in haste, we also continually see purchasers fall into common bear traps following asset or business purchases as a result of the TUPE (Transfer of Undertakings Protection of Employment) regulations. When making significant changes to employees’ terms and conditions post-transfer there should be caution exercised. And awareness of the potential reputational risks associated with acquiring distressed businesses (and the steps needed to turn them around) is required.

Investors would also do well to be wary of real-life examples such as cases brought by:

• a large group of employees who claimed unfair dismissal after the business they worked in transferred but their employment was terminated shortly after;
• thousands of employees who, following a company’s collapse and purchase from insolvency, brought claims for significant financial liabilities related to redundancy payments, pension obligations, and legal claims;
• a group of employees who claimed racial discrimination following a transfer of services; and
• employees who alleged that an acquiring company was obliged to honour pay increases agreed by the previous owner prior to the transfer.

These examples highlight the importance of understanding and complying with TUPE regulations, conducting proper due diligence, and seeking early advice to identify and mitigate potential liabilities during an acquisition.

Sadly, as acquisition activity from distressed situations ramps up across the remainder of the year, we’ll undoubtedly see more investors move without doing so.

Critical issues

Being cognizant of the potential liabilities that can transfer is crucial. Employment liabilities can often be regarded as the small tail that should not wag the very large dog in the middle of a fast moving transaction. However, unfair dismissal claims, redundancy costs, discrimination claims, holiday pay and employment tax liabilities, and outstanding generous employee benefits can quickly mount up where a business is labour intensive or in a particularly well-remunerated sector.

In the face of rising insolvencies, acquiring distressed businesses presents an opportunity for investors to make a positive impact. Nonetheless, caution is crucial to avoid hasty decision-making that overlooks critical issues.

By complying with regulations, conducting thorough due diligence, and seeking early advice, investors can mitigate liabilities and safeguard investments. Recognizing and proactively addressing employment issues and liabilities ensures a smoother transition and a prosperous future.