What extra due diligence is needed for a struggling business?

A seller under financial pressure changes what a buyer needs to confirm. A review of financials and contracts still applies. On top of it, the buyer should ask whether the sale, or what the seller did just before it, could later be attacked under insolvency law. The federal Bankruptcy and Insolvency Act (BIA) governs that.

Is the seller insolvent?

The Office of the Superintendent of Bankruptcy describes an insolvent debtor as one who cannot pay off debt as it becomes due. The same office licenses and regulates the insolvency profession. You can ask a licensed insolvency trustee how a seller’s position could affect your purchase.

Payments and transfers the trustee can attack

Section 95 makes certain payments and transfers by an insolvent person void as against the trustee. For a creditor at arm’s length, the transfer must have been made with a view to giving that creditor a preference, in the period from three months before the date of the initial bankruptcy event to the date of the bankruptcy. For a creditor not at arm’s length, the test is the effect of giving a preference, and the period starts 12 months before that event. Section 96 lets a court, on the trustee’s application, declare a transfer at undervalue void as against the trustee, or order a party to it or a person privy to it to pay the estate the difference in value. The Act defines it as a disposition for which no consideration is received or the consideration is conspicuously less than fair market value. The arm’s-length case needs a transfer within one year before the initial bankruptcy event, insolvency and an intent to defraud, defeat or delay a creditor; for a party not at arm’s length, s. 96(1)(b) needs neither within that year and reaches back five years if either is shown.

Security held by lenders

Under section 244, a secured creditor intending to enforce security on all or substantially all of an insolvent person’s inventory, accounts receivable or other business property must send a notice, and may not enforce until ten days after sending it unless the insolvent person consents to earlier enforcement. Under section 243, a court may appoint a receiver on a secured creditor’s application if it considers that just or convenient. Ask what security exists, search the personal property security registry in the seller’s province, and confirm that any lender will release its claim at closing.

• Ask for a list of payments to creditors and related parties in the year before the sale.
• Compare the price with an independent view of the business’s worth.
• Request any notices from lenders, the Canada Revenue Agency or landlords.

See the deal red flags checklist and what happens between the LOI and closing for the wider process.