Transactions at an undervalue: selling assets for less than they are worth?

Specialist commercial solicitor, Katherine Waumsley, takes a look at a transaction at an undervalue, and how to mitigate the risk.

The cost of living crisis, the most recent government budget and the current state of the country’s economy has had a significant impact on many industries and as a result, many businesses and companies.

Some business owners are being faced with difficult questions. For example, whether to sell their business, or maybe sell some of the assets of the business?

Businesses that are in financial trouble may feel under pressure to sell assets and therefore offer them at discounted prices in order to make a “quick sale”.

Whilst such offers can seem attractive, there are significant risks associated with turning a blind eye to the circumstances of an insolvent seller. Transactions at an undervalue are always a cause for concern – for both Seller and Buyer.

The dangers of buying at an undervalue

Purchasing assets from a business at an undervalue can present several legal and financial risks, particularly if the seller is in financial distress or facing insolvency. Some of the key risks to consider are as follows:

1. Transfer/Conveyance
   If a business sells any of its assets for less than their fair market value, creditors may argue that the transaction was intended to defraud them. The Courts are able to reverse such transactions, meaning that the buyer will be required to return the assets to the Seller or pay the difference in value.
2. Insolvency Proceedings
   In the event that the seller commences insolvency proceedings, the transaction may be scrutinized by insolvency practitioners or the courts. They again may seek to void the transaction if it is deemed to have been made at an undervalue, especially if it occurred within a certain period before the insolvency, often referred to as the "look-back" period.
3. Creditors' Claims
   In the event that the business has outstanding creditors, they may challenge the transaction, claiming it unfairly deprived them of assets that could have been used to satisfy debts owing to them. This can lead to litigation and potential financial liability for the buyer.
4. Due Diligence Failures
   If the buyer fails to conduct adequate due diligence in connection with the assets they are acquiring, they may inadvertently acquire liabilities associated with the assets, such as environmental issues, legal claims, or defective products.
5. Tax Implications
   Tax authorities may scrutinize transactions at undervalue to ensure that they are not being used to evade taxes. This could result in additional tax liabilities or penalties for the buyer.
6. Contractual Risks
   The sale agreement may include warranties and indemnities that could expose the buyer to further risks if the seller's financial situation deteriorates.
7. Directors' Liability
   The directors of a company that is selling assets at an undervalue may face personal liability if it is determined that they breached their fiduciary duties. This includes failing to act in the best interests of the company or its creditors, especially when the company is nearing insolvency.

Mitigate the risks of a transaction at an undervalue

To mitigate the risks involved with acquiring assets at an undervalue, buyers should:

• Conduct thorough due diligence to assess the fair market value of the assets and the financial health of the seller.
• Seek legal advice to understand the implications of purchasing assets at an undervalue, particularly concerning insolvency laws if they have concerns about the sellers financial position.
• Consider obtaining representations and warranties from the seller regarding the absence of insolvency proceedings or creditor claims.
• Explore insurance options, such as warranty and indemnity insurance, to cover potential risks associated with the transaction.

To mitigate the risks involved with acquiring assets at an undervalue, sellers should:

• Ensure that transactions are conducted at fair market value, supported by independent valuations if necessary.
• Seek legal and financial advice to understand the implications of selling assets at an undervalue, particularly concerning insolvency laws.
• Consider the interests of creditors and other stakeholders, especially if the business is experiencing financial difficulties.
• Maintain transparency and document the rationale for the transaction to defend against potential challenges.

If you are entering a transaction which you are concerned may be an undervalue, the expert commercial and corporate solicitors at Holmes & Hills can advise you on this and all aspects of business law.