On 30 April 2021, reforms to the UK’s regime governing sales in administration by way of a ‘pre-pack’ to a connected party purchaser came into force.
The centrepiece of the reforms is a new requirement for a connected party purchaser to obtain an opinion from an independent ‘evaluator’ on whether the terms of the sale are reasonable.
While the reforms add additional process points that must be navigated in relevant cases, they will bring improved transparency to an important rescue tool which has, at times, attracted warranted criticism.
In this blogpost we summarise the context of the reforms (as also considered in our blogpost on the draft regulations published in October 2020) and the provisions of the new legislation, along with providing some commentary.
UK pre-pack administrations
A pre-pack administration is where the assets of a distressed company are sold as soon as it enters administration (or very soon thereafter) and the terms of that sale were negotiated and agreed before the company entered into administration – i.e. 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 director/manager or a shareholder), have over the years attracted criticism. These were often by unsecured creditors who felt they were cut out of the decision-making process. Their concerns are typically that:
- the first they hear is that the company has gone into administration;
- unknown to the unsecured creditors, the directors or shareholders have bought the business back and are trading on; but
- the unsecured creditors 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. This is typically because companies with larger capital structures have a higher degree of creditor and advisor involvement due to the larger amount of value at stake.
Background to the reforms
In light of these concerns, the Government commissioned a review into pre-pack administrations in 2014 (the Graham Review). The Graham Review concluded that, although pre-pack administrations were a useful tool for struggling businesses, there were concerns around the transparency of the process.
The Graham Review therefore proposed a number of voluntary measures which were adopted by the industry. These included:
- the creation of a group of experienced professionals known as the ‘pre-pack pool’ who could be consulted on the appropriateness of a proposed pre-pack sale; and
- adding six principles of good marketing to Statement of Insolvency Practice 16 (SIP 16). (SIP 16 requires an administrator to deliver to creditors a ‘SIP 16 statement’ within seven days of a pre-pack sale, providing creditors with information about the circumstances of the transaction.)
In case the voluntary reforms recommended by the Graham Review proved insufficient to address the concerns identified, the Insolvency Act 1986 was amended to give the Government the power to regulate, either to ban pre-pack sales to connected persons altogether, or to impose restrictions.
The Government subsequently concluded that, while there had been some improvement as a result of the voluntary measures, the number of referrals to the pre-pack pool had been considerably lower than expected and concerns remained about the transparency of the process. The Government therefore introduced the Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021/427 (the Pre-Pack Regulations). In doing so, it stopped short of banning pre-pack sales to connected persons, opting instead to introduce a mandatory process which builds on some of the recommendations of the Graham Review.
The Pre-Pack Regulations
Under the Pre-Pack 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, the administrator will need to obtain an independent written opinion by an 'evaluator' (unless creditors have approved the sale). This written opinion will be made available to all creditors in a report 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, the administrator 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.
In order to be qualified to make the report:
- the evaluator must believe that they have the requisite knowledge and experience to do so and make a statement in the report to that effect;
- the administrator must believe that the evaluator has sufficient knowledge and experience to provide the report; and
- the evaluator is required to hold professional indemnity insurance covering them acting in their capacity as an evaluator, but need not be an insolvency practitioner or a member of a regulated professional body.
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. The Pre-Pack Regulations do not restrict the number of evaluator opinions that can be obtained, but evaluators must state in their report that they have considered any previous reports obtained.
The definition of ‘connected person’ is adopted from existing insolvency legislation without modification, and will capture (among others):
- directors and shadow directors of the relevant company;
- companies controlled by those directors or shadow directors; and
- any person or company that has control over the relevant company, including shareholders with a third or more voting rights.
Unlike the definition proposed in the Graham Review, secured lenders with a third or more voting rights are not excluded from the definition of connected person.
The Government has released guidance regarding the Pre-Pack Regulations (the Guidance) which provides a useful summary, as well as guidance on the interpretation of some of the key provisions.
The Pre-Pack Regulations can only apply if there is a disposal of ‘all or a substantial part of the company’s business or assets’. What amounts to ‘substantial’ is not defined, but the Guidance sets out the following criteria which an insolvency practitioner should consider when determining whether a disposal is substantial:
- the value of either the business, assets or both involved in the disposal;
- how much of the business is being disposed of; and
- whether the trading style and good will of the business forms part of the disposal.
Under the Pre-Pack Regulations it is the responsibility of the connected person to select the evaluator. In this context, the Guidance explains that ‘it is not necessary for [the evaluator] to have insolvency experience’. However, the Guidance notes that ‘[t]here are certain professions that are more likely to have the relevant knowledge and skills required to act as an evaluator. These include accountants, surveyors, lawyers with a corporate background, insolvency practitioners’, but the Guidance goes on to say that it will also depend on the nature of the business, and someone with specialist knowledge may be more suitable.
The Pre-Pack Regulations also require the administrator to be satisfied the evaluator has sufficient knowledge and experience, and in this context the Guidance says that the following points should be considered:
- experience, both length and type;
- any professional qualifications;
- any specialist knowledge regarding the proposed disposal; and
- any other information the administrator believes to be relevant.
Regarding the definition of ‘connected person’, the Guidance notes that ‘[t]his could include secured lenders’, without providing any further context or explanation. In this regard, it is worth noting that the definition is reasonably technical and in practice determining whether a secured lender is ‘connected’ is likely to require a careful analysis of the facts.
Revised SIP 16
The ICAEW has issued a revised SIP 16 which will come into force from 30 April 2021 in line with the Pre-Pack Regulations. The updated SIP 16 will continue to set out best practice for insolvency practitioners engaging in pre-pack administrations. The principle remains, as explained in SIP 16, that:
‘[t]he insolvency practitioner should assume, and plan for, greater interest in and possible scrutiny of such sales where the directors and/or shareholders of the purchasing entity are the same as those of, or are connected to, the insolvent entity.'
It is reassuring that the Government recognises the value of pre-pack administrations (including to connected persons) and has sought to improve the process (and perceptions of it) rather than ban them altogether. In addition, while the additional requirements of the Pre-Pack Regulations clearly amount to more process (and will add additional time, expense and potentially complexity), the process does not appear to be overly onerous, and the additional transparency and reassurance for unsecured creditors - and stakeholders more generally - should be welcomed.
There are however two points worthy of separate mention.
No carve out for secured lenders from ‘connected persons’
During the legislative process a number of stakeholders expressed the view that secured creditors that would otherwise fall under the definition of ‘connected persons’ by virtue of having voting rights associated with their debt should be excluded from the definition. (This would have been consistent with the approach proposed in the Graham Review.)
As part of a consultation process in connection with the Pre-Pack Regulations, the Insolvency Service concluded that ‘the overall purpose is to ensure greater transparency and scrutiny of pre-pack sales to connected persons’, and noted that ‘[i]n recent years there has been controversy over a number of high-profile pre-pack sales involving secured lenders’. It therefore declined to include a carve out for secured lenders.
Concerns may therefore remain among some stakeholders that the definition will bring within its scope transactions which need not be. However, in practice, and while the Pre-Pack Regulations do add an additional hurdle, the additional requirements should not prevent an appropriate transaction from being capable of implementation.
No formal qualification requirement for evaluators
Not imposing a formal qualification requirement (such as a requirement to be a member of a regulated professional body) is intended to ensure the field of professionals able to provide an opinion is not restricted unnecessarily.
It would of course undermine the utility of pre-pack administrations if the qualification requirements for an evaluator were overly prescriptive or restrictive. There is also no doubt a number of individuals suitable for the role that are not members of a regulated professional body. However, it remains to be seen whether the insurance market can operate to effectively regulate the suitability of evaluators in the absence of clearer qualification requirements. Further, the D&O insurance market in recent years arguably has highlighted some pitfalls that can arise if expecting a market to serve a public policy objective in addition to its primary commercial purpose.