Insights | October 3, 2023

Value from distress: Real estate transactions with distressed companies and bankruptcy estates

As financial landscapes shift in the Nordics, acquiring real estate and other assets from distressed companies and bankruptcy estates emerges as a promising opportunity, especially for buyers with an appetite for ventures of a more atypical kind. However, these transactions, while often financially attractive in terms of the purchase price, carry distinct risks that businesses should take into account and seek to mitigate.

In today’s real estate market in Finland, businesses may find themselves considering transactions with distressed companies and even bankruptcy estates. While these deals may be financially attractive, the elements of urgency and financial predicament should not lead to blindly accepting the associated risks. A seller in distress or bankruptcy may give rise to various complexities for the deal, such as a lack of motivation for the seller to fully enable disclosure of the associated risks, or e.g. situations in which the ownership of the building and the land is split between different estates or owners, bringing even further twists to the arrangement.

But these complications can be managed, and the risks mitigated. We’ve put together some key considerations for potential buyers.

Key considerations for businesses:

1. Map the risk level: Assess the financial health of the seller, including a review of public financial data and any available protest lists. Understanding the seller’s debt and liquidity position provides context and assists in forming a better understanding of the inherent risk level of the transaction.
2. Due diligence: Thorough due diligence is essential in a situation involving a distressed seller due to the increased potential for omissions and insufficient disclosure. In cases where the seller is a bankruptcy estate, there may be a lack of available information. While the asset itself may be priced low, there may be hidden risks and complexities. The buyer’s own research and assessment are highly important, especially if insuring the acquisition by taking out W&I insurance is considered.
3. Manage recovery risk: With a distressed seller, the post-closing recovery risk may be significant if the transaction terms and their basis in the market value are not properly documented, and the seller subsequently ends up in insolvency proceedings. An attractive buyer-friendly transaction may subsequently be claimed to be detrimental to the creditors as a whole and, as such, become subject to a risk of the transaction being reversed. Contemporaneous documentation is of critical importance in managing this risk.
4. Consider enhancing the SPA protection: Bankruptcy estates as sellers do not offer much in terms of representations and warranties but sell “as is”. Further, the pretty representations and warranties given by a distressed seller may, in reality, be of limited value. Where no credible protection from warranties or representations is available, warranty & indemnity (W&I) insurance, especially so-called synthetic W&I insurance elaborated briefly below, may be a solution to consider.
5. Prioritize and execute: Especially if the counterparty’s distress hits after the transaction has been executed (such as in forward purchase or funding transactions where the deal is signed and/or closed well before the completion of the property), identify and decisively execute in the order of priority your most important strategic objectives to mitigate the risk. For further insights and key actions for creditors facing bankruptcy proceedings or other severe distress, please see our recent article on these matters: https://www.roschier.com/newsroom/bankruptcies-on-the-rise-in-finland-quick-checklists-for-creditors-and-distressed-companies/.

Synthetic W&I insurance: an extra layer of protection

One of the emerging tools that businesses operating in the Nordics are using to mitigate risks associated with acquisitions involving distressed companies or bankruptcy estates is synthetic W&I insurance.

Briefly, synthetic W&I insurance refers to an arrangement whereby, rather than the seller giving warranties and representations in the sale and purchase agreement, the W&I insurance policy itself creates and provides coverage for synthetic warranties. The insurer agrees that if a set of statements or facts turns out to be untrue, the insurer must compensate the insured party for the loss. While traditional W&I insurance is still much more widely used, the utilization of synthetic W&I insurance has gained traction in recent years and may become even more popular in the future especially due to its practicality in distressed deals.

In the context of transactions involving distressed companies and bankruptcy estates, synthetic W&I insurance can be particularly useful for the buyer:

1. Risk mitigation: The buyer is exposed to unknown risks if the seller does not offer any warranties and representations. Synthetic W&I insurance can provide coverage for risks that the buyer is concerned about without the need to negotiate the content of the warranties and representations with the seller.
2. Direct recourse to the insurer: With synthetic W&I insurance in place, the buyer has direct recourse to a financially stable insurer regardless of the seller’s financial situation when risks materialize.
3. Limited or no recourse against the seller: In a synthetic W&I insurance setup, the insurers often accept waiving their recourse against the seller even in fraud or willful misconduct situations. This will enable a fully clean liability tail for sellers, which is a lucrative feature for bankruptcy estates or financing banks running the security enforcement, given their limited information of the object of sale.
4. Financing benefits: Synthetic W&I insurance reduces the risk profile of the transaction. Where the buyer is using external debt financing for the acquisition, having synthetic W&I insurance can give lenders more confidence, thereby potentially facilitating financing for the transaction.
5. Increase bid attractiveness: In a competitive bid setting, offering to rely on synthetic W&I insurance instead of requesting broad warranties and representations from the seller may transform into a more attractive bid, and facilitate deal negotiations and deal closure.

W&I insurance in general can be highly tailored to the transaction. It is essential for the parties, especially the buyer, to understand the terms, exclusions, and limits of the contemplated insurance. Furthermore, there is a cost associated with acquiring any type of W&I insurance which must be weighed against the benefits. In the case of synthetic W&I insurance, pricing offered by insurers is typically higher, and the suite of warranties more limited, than for conventional W&I insurance.

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We have extensive experience of transactions involving various complications, including those presented by counterparty distress or insolvency. We work seamlessly cross-practice to combine the expertise of the real estate and M&A teams with that of our insolvency practice and others as necessary.

Our experts are happy to discuss any questions or concerns relating to transactions, insolvencies, or their combinations!