The Government has announced that it will introduce new measures to subject pre-pack sales in an administration to a connected person to mandatory independent scrutiny.
A pre-pack sale is a sale of the assets and business of an insolvent company that is negotiated and agreed in advance of the entry of the company into administration. The sale is then carried out by the administrators almost immediately after their appointment. A pre-pack sale can help rescue a business and minimise the loss of value and damage to relationships with employees, customers and suppliers that may result from a prolonged administration.
However, pre-pack sales have been criticised for their lack of transparency as creditors may not become aware of the administration or the sale of the business until it is presented to them as a fait accompli. There is particular concern where the sale is to a buyer with connections to the insolvent seller, such as the buyer having the same directors or shareholders as the insolvent company. This is often the case because the urgency of rescuing the distressed business means that the continuity of management and stakeholders who know the business is needed or there is insufficient time to find an unconnected buyer.
Previous governments have sought to address the perceived murkiness of pre-pack sales. Following the Graham Review, commissioned by the then Business Secretary Vince Cable in 2014, the amount of information that an administrator is required to disclose to creditors following a pre-pack was increased when a revised Statement of Insolvency Practice 16 was issued. Another measure taken was the establishment of the ‘Pre-Pack Pool’. This is a body of experienced business people who could be approached to give an opinion on whether they thought a proposed pre-pack sale was reasonable. It was hoped that this would provide creditors with reassurance that there had been some independent scrutiny.
However, it is fair to say that that hope has been dashed. Seeking an opinion from the Pre-Pack Pool is (at least for now) not mandatory. In most proposed pre-pack sales the conclusion is reached that it is not worth the additional delay, expense and risk of an adverse opinion (although this is not binding) involved in making an application to the Pre-Pack Pool. Only 10% of eligible cases are referred to the Pre-Pack Pool. Indeed, the take-up has been so low that back in May the Times reported (paywall) that the lack of referrals and their associated fees was making the Pre-Pack Pool financially unsustainable and that the Pre-Pack Pool had lobbied for referrals to be made mandatory.
The Government has now published the draft Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2020. When this comes into effect any disposal of all of substantially of a company’s assets to a connected person within eight weeks of the company’s entry into administration will require either (i) the administrator to first obtain the approval of creditors or (ii) the connected purchaser to obtain an opinion from an independent evaluator. We expect that for many pre-pack sales the approval of creditors will not be sought because of the disruption to the business that is likely to be caused by news of an impending administration becoming widespread. Therefore, we expect that many pre-pack sales will opt for the independent evaluator’s opinion.
The evaluator needs to be independent of the company and the administrator and certain individuals will be disqualified from acting as an evaluator such as, individuals who are disqualified from acting as directors, subject to their own personal insolvency procedures or convicted of an offence involving dishonesty. There is otherwise flexibility on who can be the evaluator. Unlike the current regime the proposed regulations will not confine the purchaser to approaching the Pre-Pack Pool. There are no prescribed qualifications that the evaluator must have, although both the evaluator and the administrator must believe the evaluator has the requisite knowledge and experience to give the evaluator’s report. It is therefore sensible to assume that the evaluator will be a professional from a different firm of insolvency practitioners to the administrator, with experience of conducting pre-pack sales
The evaluator’s opinion must state whether or not the evaluator is satisfied that the consideration to be provided by the purchaser in relation to the pre-pack sale and the grounds for the disposal are reasonable in the circumstances. The administrator must consider the opinion but they are not bound by it. The administrator could, if in their professional judgement they consider it proper to do so, proceed with a pre-pack sale even if the evaluator is not satisfied that it is reasonable (a so called "case not made opinion"). The administrator would have to explain their reasons for pressing ahead despite a case not made opinion from the evaluator to the creditors. Nonetheless, the possibility of a case not made opinion would add an extra dimension to the deal’s execution risk, and it may instead be that the administrator’s first action will be to investigate whether the purchaser can increase the proposed purchase price for the assets rather than complete the sale on the basis of a case not made opinion.
In any case, an unintended consequence of the new regulations may be that if administration expenses have to be incurred in assisting and providing information to the purchaser in relation to its application to an independent evaluator and getting an independent opinion then, when combined with the return of crown preference (discussed in a previous post here), it will be unsecured creditors who may lose out. In return, unsecured creditors may get little more protection than they already receive from administrators having to comply with Statement of Insolvency Practice 16 and the administrators’ status as regulated and licensed professionals.