On 8 October 2020, the UK Government published draft regulations applying to sales in administration by way of a 'pre-pack' to a connected party purchaser.
UK pre-pack administrations
A pre-pack administration is where:
- a company goes into administration;
- the assets of that company (typically the business) are sold by the administrator as soon as the company enters administration (or very soon thereafter); and
- the terms of that sale were negotiated and agreed before the company entered into administration, ie the sale by the administrators was 'pre-packaged' before the administration started.
Pre-pack sales, in particular to a 'connected person' (someone who has been involved with the business as, for example, a manager or shareholder) have over the years attracted a fair bit of criticism, often by unsecured creditors who felt that they were cut out of the decision making. Their concern has been that:
- the first they hear is that the company has gone into administration (ie insolvency);
- unknown to the unsecureds, the directors or shareholders have bought the business back and are trading on; but
- the unsecureds are paid very little in the administration.
The concerns have in general arisen in the SME market, and not for companies with larger capital structures.
The Graham Review
As a result of these concerns, in 2014, the Government commissioned Professor Theresa Graham to conduct a review into prepacks and to consider potential regulation. The Graham Review concluded that, although pre-pack administrations were a useful tool for struggling businesses, there were clear concerns around the transparency of the process, particularly for unsecured creditors.
The Graham Review recommended several voluntary measures to address these concerns, including:
- the creation of a group of experienced professionals who could be consulted on the appropriateness of a proposed pre-pack sale, known as 'the pre-pack pool';
- six principles of good marketing to be included in the SIP16 report, including the breadth of any marketing and independence in the process; and
- an option for a connected party purchaser to provide a 'viability review' on the new company’s survival prospects for the next 12 months following the administration purchase.
In case these voluntary reforms proved ineffective, the Insolvency Act 1986 was also amended to give the Government the power to introduce legislation regulating pre-pack sales to connected persons. This power to legislate was subject to a sunset provision that saw it expire at the end of May 2020. There was no such legislation by May 2020 and the power expired. However, the Corporate Insolvency and Governance Act 2020 has revived the power until June 2021.
The Government has now concluded that concerns remain around pre-pack administrations to connected parties. It noted that, while there had been some improvements to the marketing of pre-packs, there was low use of the pre-pack pool and continued concern around transactions under market value.
In response, the Government has detailed its draft regulations. Where an administrator wishes to dispose of all or a substantial part of a company’s assets within the first eight weeks of the administration to one or more connected persons, then the administrator will need to obtain creditor approval or an independent written opinion by an 'evaluator'. This written opinion will be made available to the creditors and a copy will need to be filed at Companies House (although commercially sensitive information can be redacted).
The written opinion must be commissioned by the buyer and should include:
- a statement whether the evaluator is or is not 'satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances';
- the evaluator’s reasons for coming to their opinion;
- the consideration that will be paid; and
- the identity of the connected person and their connection to the company.
The evaluator must not be the administrator or one of their associates, nor may they be connected to the company or the connected person themselves. Furthermore, they cannot be any individual who has provided insolvency or restructuring advice to the company in the 12 months preceding the report, thereby excluding any incumbent financial adviser. In order to be qualified to make the report, the evaluator must believe that they have the requisite knowledge and experience to do so.
Where an opinion does not recommend the disposal, an administrator can still choose to proceed with the sale regardless, but they must provide a statement setting out their reasons for doing so.
Although the Government is focussed on further regulation of pre-pack administrations, it is reassuring that it has not chosen to ban these completely and recognises that they are a valuable rescue tool for businesses.
It is also encouraging that there is no ban on pre-pack sales to connected parties. Instead, the connected party purchaser simply has to get an independent opinion in support of the sale. Subject to the legislation, this seems like a good balance between the stated concerns, and not blocking a valuable business rescue tool.
The proposed legislation does not give extensive guidance as to who would be an appropriate evaluator. The only criteria is that they must be independent and believe they have the requisite knowledge and experience to provide the report (although this could be given in the form of guidance at a later time). It is unclear whether the pre-pack pool will continue in existence to provide an opinion.
An administrator is not bound to accept the evaluator’s opinion. However, it is difficult to see how, as an officer of the court, an administrator could be comfortable effecting a pre-pack sale in the face of a negative opinion.
There is little clarity on the potential liability of the evaluator. As it is the buyer who commissions the opinion, the position of the company’s creditors is uncertain, although the evaluator could potentially have tortious liability to parties like creditors.
Finally, the position of secured creditors also remains to be clarified. The Graham Report had deliberately excluded from the definition of connected parties secured lenders who, as part of their normal business activities, have voting rights over one third or more of the shares in the insolvent and the new company. Although a footnote to the Government’s statement suggests that a pre-pack sale to secured creditors would be exempt from the regulations, the published draft regulations themselves do not contain this carve-out. It is hoped that the Government will fix this in the long-form legislation.
Insolvency practitioners have been invited to comment by 5 November 2020. It is unclear if or when the regulations will be made in light of a packed Parliamentary schedule (not least with Brexit and COVID-19), so watch this space.