What is a Distressed Asset Sale and How Does it Work?

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Table of Contents

• Asset Sale Contract
• Due Diligence
• Solvency of the Seller Company
• Key Takeaways

A distressed asset sale involves a business selling an asset at less than market value to obtain cash quickly. As the seller, you may prioritise speed and cash flow over return on investment. If you operate a business that is having trouble paying its debts, there is a risk that you may be trading while insolvent and it is important to obtain cash quickly to help pay off any debts. A distressed asset sale allows you to increase your available funds quickly and enables purchasers to buy your assets cheaply. This can be a win-win for both sides. This article will outline what you need to know about distressed asset sales and any risks that this type of sale may present.

Asset Sale Contract

Before immediately taking steps to undertake a distressed asset sale, consider whether or not your finances are likely to improve. Once you advertise assets at a low price, it is unlikely that a purchaser will accept a higher price for the same assets in the future. You should also be wary of selling valuable assets for low prices.

However, if you do need to go ahead with the distressed asset sale, it is best practice to enter into a formal asset sale contract as it provides clarity on what is being sold. This is important as it will properly define what:

• the purchaser is getting; and 
• they are not getting.

Warranties

Your contract will include both promises and exclusions. The promises are typically called warranties and can include promises such as that:

• you are the sole owner of the asset; 
• no other person has an interest in the asset;
• no one has threatened or initiated litigation regarding the asset; 
• you have the capacity to enter the contract and sell the asset; and 
• the asset is in good working order and free from any material defects.

You will want to keep the warranties to a minimum and ensure that these promises are all true on the date you sign the contract and on the date of settlement. One way to achieve this is to avoid stating anything as to the future.

As purchasers often pay a substantially lower price in a distressed sale, they typically will not expect the same level of detail with the warranties that you provide in a standard asset sale. A purchaser should expect a reduction in warranties and indemnities, along with the low purchase price.

Limitations

To limit your legal responsibility, the contract should also include exclusions and limitations to these warranties and indemnities. It is standard to include a whole agreement exclusion. This states that the purchaser can only bring a claim because of the promises stated in the contract.

Time and monetary limits on the purchaser’s claims can also be included in the contract. If the purchaser is obtaining a good price, you can use this exclusion to reduce these limits and increase your protection. In a standard asset sale, a typical warranty claim period is one to two years after the sale for the full price of the product. You may be able to decrease this threshold in a distressed asset sale. After the expiry of this time and above this monetary limit, you will not be responsible for claims brought by the purchaser.

Balance of the Contract

Your lawyer will typically prepare a first draft of the contract so that it is favourable to you. While this can place you in the best position possible in your situation, it can also increase the amount of time and costs required to negotiate the contract. Where you cannot afford this time delay, you should be clear with your lawyer that you want the contract to be balanced. This may mean that the contract is in an agreed form and ready to be signed with minimal changes once the purchaser’s lawyer reviews it. It is important to understand that the purchaser’s lawyer will usually suggest some changes to try and place the contract in a more favourable position for the purchaser.

Due Diligence

In most asset sales, the purchaser will want to conduct due diligence on the asset. Due diligence is a legal term that can involve:

• inspecting the asset;
• reviewing any affiliated contracts;
• reviewing the service history;
• conducting searches of public registers; and
• reviewing documents evidencing ownership.

Here, the goal is for the purchaser to verify that they know what they are buying and understand any risks. Your goal is to ensure the purchaser is comfortable with the transaction.

Due diligence can occur either before the sale contract is signed or after. Depending on your situation, it may be best if due diligence occurs after signing the contract. 

Solvency of the Seller Company

If you operate your business through a company, you should also consider the solvency of your company. If your company cannot pay its debts, this is an indication that you may be trading while insolvent. As a director, this is a breach of your director’s duties and can leave you personally responsible for paying any business debts, and you could face other financial penalties. 

Further, anyone that you owe money to can apply for the appointment of a: 

• receiver;
• administrator; or
• liquidator. 

If appointed, these people take over certain powers of the company and can wind back transactions like the asset sale. If you think you may be trading while insolvent, you must obtain professional legal and financial advice before proceeding with any asset sales.

Key Takeaways

A distressed asset sale can be a win-win for both you and the purchaser. The purchaser can obtain a good price, and you can increase your cash-flow quickly and pay off any outstanding debts. As with all sales, the goal is to ensure the purchaser is comfortable and that they understand what they are buying. This is completed through the process of due diligence. Building rapport with the purchaser is critical to winning their trust. The formal asset sale contract will set out the promises that you make about the asset, and these must reflect the price paid and specific asset in question. If you need assistance with a distressed asset sale, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.