Pre-pack reform – help or hindrance for business rescue?

10 key features of the proposed regulations

Pre-pack sales by administrators are often considered controversial when there is a sale back to the existing management. Following a pre-pack to a connected party, typically the business continues in some form, free of its debts, under the same management, and often then asks those who were left unpaid to trade with the new entity, while those same suppliers can expect pennies in the pound, if anything, in respect of what they are owed. Creditors, deeply affected by these decisions, are typically not part of or consulted about the process, and can be unhappy that the existing management, whom creditors may blame for their unpaid debts, continuing to manage the business through a new entity, even in circumstances where this represents the best outcome achievable from a company’s administration.

After the Graham Report in 2014, the “Pre-Pack Pool” was established to enable some independent review of proposed sales to connected parties. However, the pool, which was accessed by proposed purchasers on a voluntary basis and required the payment of a fee for the pool to review the proposed transaction, was not widely taken up.

New draft regulations affecting pre-packs

During debates during the passage of the Bill that became the Corporate Insolvency & Governance Act 2020, pre-packs came under renewed focus.  

In response to concerns raised recently, the Department for Business, Energy and Industrial Strategy published a further report on 8 October 2020 which found that allowing pre-packs to continue as a recognised option may result in the best outcome of an insolvency, but there should be restrictions on their use.  The government proposed new draft regulations with its report that would require creditor approval or an independent opinion before a sale to a connected party in the first 8 weeks of an administration could be effected. 

              The key parts of the proposed regulations are:

  1. They will apply to all administrations which commence after the regulations come into force, whether commenced under paragraphs 14 or 22 of Schedule B1 to the Insolvency Act 1986, or upon the making of an administration order
  2. They apply to a “substantial” disposal by an administrator, which means a disposal, hiring out or sale to one or more connected persons in the 8 weeks beginning with the date the company enters administration, and can include a series of disposals
  3. “Connected person” has the meaning given in paragraph 60 of Schedule B1
  4. A substantial disposal must not be made by an administrator unless either:
    1. A decision of creditors pursuant to paragraph 51(1) or 52(2) of Schedule B1 is sought and approved; or
    2. The connected party purchaser has obtained a report in the form required by the regulations.
  5. The report is to be undertaken by an evaluator who is not the administrator, an associate of the administrator or connected with a company with which the administrator is connected
  6. The evaluator must be independent and satisfied they have no conflict of interest as defined in the regulations, and must have the requisite knowledge and experience to provide the report. They must have mental capacity, and must not have any unspent criminal convictions and not have been bankrupt, subject to an IVA or DRO (or Scottish equivalents) in the past, and not have been disqualified as a director.
  7. The report must be in writing, dated, and authenticated, and include a statement that the evaluator meets the criteria and how he has the requisite experience and knowledge.
  8. The report will also need to confirm whether:
    1. the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances (a “case made opinion”), or
    2. the evaluator 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 (a “case not made opinion”)
  9. The administrator is obliged to send a copy of the report to Registrar of Companies and creditors at the same time as the proposals pursuant to paragraph 49(4) of Schedule B1
  10. If the report is a “case not made opinion” and the transaction proceeded anyway, the administrator must include a statement setting out the reasons for proceeding notwithstanding the opinion.

The proposed regulations in practice

Creditor approval is most likely to be sought in situations where the proposed sale is intended to be several weeks after appointment of the administrators, when creditors already know about the administration, rather than when the intention is for a pre-pack to be timed with commencement of the administration. Consulting the whole creditor body in advance about a proposed transaction timed for commencement of an administration seems unlikely to occur, as not only are administrators not in office to seek pre-approval from creditors during the negotiation of such pre-packs, but those sorts of transactions generally happen when there is a desire to avoid news of the impending insolvency becoming public in order to preserve goodwill. Consulting creditors in advance would undermine this.

Therefore, for true pre-packs, negotiated in advance and completed immediately after the administrators’ appointment, the second option of seeking an opinion on the proposed transaction is much more likely.

For this opinion, while it is likely that most administrators or proposed administrators will seek an opinion from another IP, there is no obligation for this to be the case. Anyone independent who has the requisite knowledge and experience and meets the other criteria can provide an opinion.

Administrators will need to be careful in their selection of an appropriate person. Creditors (and regulators) would likely be unhappy if an administrator pointed connected parties to the same independent IP or otherwise suitably experienced and knowledgeable person to provide a report for each proposed transaction, particularly if this was a reciprocal arrangement.

For more information on the article above please contact Katie Farmer.

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