What has happened?
The UK Government has published draft regulations under paragraph 60A of Schedule B1 to the Insolvency Act 1986 (the "Regulations") which will require pre-pack administration sales to connected parties to be subject to compulsory independent scrutiny, or advance creditor approval. Connected parties include the insolvent company’s existing directors or shareholders. The Government has indicated that it proposes to enact The Regulations as soon as Parliamentary time allows, and in any event before the end of June 2021.
The Government has also proposed additional non-legislative measures to improve the position of creditors, such as working with regulators to ensure there is a greater adherence to the principles of marketing of an insolvent company and its assets.
What is a pre pack administration sale?
A pre pack administration sale occurs where a company is put into administration and its business and assets are immediately sold by the administrator following appointment pursuant to a sale that was negotiated and pre-agreed prior to the appointment of the administrator. These sales are often completed on accelerated basis with limited marketing and truncated sale process. A key feature of these sales is that creditors and other stakeholders will often only find out about the pre pack post transaction.
Why have the Regulations been proposed?
Pre pack administration sales are an invaluable rescue tool available to administrators. Such sales can often benefit the insolvent company's creditors and other stakeholders on the basis that:
- goodwill and value is preserved (leading to a better realisation for creditors)
- the business continues without interruption leading to minimal disruption to customers, suppliers, landlords etc.
- employees of the business transfer under TUPE without uncertainty or delay
- it avoids costs of trading co in administration and so can result in better return for creditors.
However, these sales have attracted controversy because:
- lack of transparency for unsecured creditors who only become aware of it post transaction
- lack of accountability of administrator notwithstanding regulatory notification requirements
- returns to unsecured creditors may not be maximised on basis that market is not properly tested by administrator
- they are often used to allow sale of business to the very directors/shareholders who have caused the insolvency
- the proposed administrator may have conflict of interest as he is likely to have been introduced to the company by its directors in the context of a pre-pack proposal that the directors conceived
- existing oversight of the regime is seen as light touch and not mandatory.
What do the Regulations do?
The main features of the Regulations are as follows:
- Any disposal of most or all of a company’s assets made in the first eight weeks of administration must first either be approved by creditors (constituting a simple majority of creditors) or an independent evaluator. The Regulations therefore apply to certain post appointment sales as well as to pre pack sales.
- It is the purchasing company which engages the evaluator. The report prepared by the evaluator must confirm whether or not the case is made for the disposal. Where a report states that the case is not made for the disposal, the administrator can still proceed with the disposal but will be required to provide a statement setting out the reasons for doing so.
- More than one report can be obtained.
- The administrator will be required to send a copy of the report(s) to creditors of the company and to Companies House but must exclude any information which is confidential and/or commercially sensitive.
- The evaluator must be independent of the connected party purchaser, the company and the administrator in that they must not have provided restructuring advice to the company (or connected companies) within the 12 months before the date of the report. So long as the evaluator believes they have the necessary experience and knowledge to provide the report, they are qualified, and the administrator must share that belief. The evaluator can be the exiting pre pack pool but does not have to be. The pre pack pool is group of experienced business people who give an independent review of the company's assets during a pre pack sale and suggest improvements to marketing and valuation requirements and to the information provided to creditors.
Pros and cons of the Regulations
Pros
- Where creditors are invited to approve the disposal they may feel directly engaged in the process. This helps to enhance the creditors' perception of transparency and fairness.
- The independent report route and the scrutiny provided for in it should enable connected directors to demonstrate the legitimacy of the sale despite actual of perceived conflicts of interest between their duties to the old company and to the new purchasing company.
- The administrators will have, in addition to the usual independent professional valuation/s in support of the sale, the benefit of a further and independent report on the transaction. This in turn may provide the administrator with protection from criticism or litigation by creditors seeking to later challenge aspects of the sale or to unwind it entirely.
Cons
- Finding a truly independent evaluator willing and able to report with the required speed may prove difficult.
- The creditor approval route may be rarely used in favour of the evaluator route on the basis of the time and cost associated with obtaining this approval. This may hamper the effort to achieve better transparency and trust with creditors.
- Either route will necessarily lead to additional costs being incurred which may otherwise have been available for distribution to the creditors of the insolvent company. Depending on the circumstances, these costs may be significant.
- Complying with the new requirements may cause delays which could jeopardise the rationale and viability of a pre-pack at all.
Conclusion
The Regulations are a welcome move to improve transparency and fairness for creditors in respect of a process that has attracted considerable criticism and scrutiny. The evaluator report in particular ought to provide comfort and information to creditors as well as protecting administrators from frivolous claims which can frequently taint pre pack transactions.
As is often the case, the devil is likely to be in the practical effect of the Regulations, as the added costs and delay which could potentially be associated with compliance, may hamper the ability to use pre packs which would be to the detriment of creditors.