Every five years or so, the insolvency profession seems to try and wrestle with the public outcry about the use of so-called pre-packs. In its simplest terms, this is where “Widget Manufacturing Limited” goes into administration, and the very next day “Widget Manufacturing 2021 Limited” is operating the same business and being owned by the same shareholders. The only crucial difference is that several key liabilities (usually owed to landlords) are left behind in the insolvent business.
Attempts to further regulate this area of insolvency practice led to reforms in 2008 and 2013. The introduction of Statement of Insolvency Practice 16 (“SIP 16”) mainly relied on the insolvency industry regulating itself by a mixture of greater transparency and emphasis on valuation of transferring assets.
Feedback remains that SIP 16 is not fit for purpose and given the increased level of business failures (with plenty more Covid insolvencies waiting in the wings), it is no surprise that the Government has had yet another attempt at facilitating change.
The background to the changes
Pre-packs are back on the Government’s radar as they continue to be a source of concern for creditors. On 8 October 2020 the Government published a review into pre-packs administration, setting out Draft Regulations addressing pre-packs administration sales involving connected parties (the “Draft Regulations”). It is hoped that the new publication will boost stakeholder confidence and mitigate the adverse consequences caused by the potential increased use of pre-pack sales during the Covid-19 pandemic. The new proposed ‘Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021’ came into effect for all companies entering administration on and after 30 April 2021.
A pre-pack is the process whereby all or part of a company’s business is sold through an arrangement made prior to the company entering administration. Once formally appointed, the administrator can rescue the business by completing the asset sale. It is effectively a restructuring strategy which seeks to preserve the value of the business.
Throughout the years, the number of pre-pack sales has been steadily increasing and reported transactions have gone from 345 in 2016; to 450 in 2018 and 473 in 2019. This will continue to increase as the impact of Covid kicks in and the statutory moratorium falls away at the end of June 2021.
While pre-packs are a valuable rescue tool, they have also been subject to numerous criticisms. These mainly involve the process of declaring the company insolvent; transferring the same business to a new corporate vehicle managed by the same shareholders and/or directors, whilst leaving certain debts behind. Pre-packs also lack transparency as unsecured creditors are often unaware that one has been lined up and cannot therefore influence the process in any way. Often, those buying the assets, have previous connections with the business which feeds into speculations of favouritism over potential third-party purchasers, with sales taking place at an undervalue and lacking proper marketing. Unsecured creditors, therefore, risk missing out on maximising their returns.
Previous attempts at reform
Due to the concerns raised, a set of voluntary measures were introduced to regulate insolvency practitioners and pre-pack administration sales. The Statement of Insolvency Practice 16 (“SIP 16”) increased the reporting requirements of office holders by incorporating the recommendations put forward in the 2014 Graham Review. A brief description of the reforms introduced by SIP 16 is provided below.
Information to creditors
Within seven days of completing the sale, creditors are provided with a detailed explanation and justification of the transaction as well as with the marketing strategies and alternatives considered. Where possible, an independent valuation should be conducted and if that is not possible an explanation outlining why that is the case is to be provided.
Marketing strategies
The administrator is required to consider various marketing strategies. The business should be broadcasted to a wide pool of potential buyers, possibly through online marketing as well. The process should be documented to creditors and justifications should be given in relation to the amount of time spent publicising the business as well as the adequacy and the independence of the process, especially when the sale is to a connected party.
The pre-pack pool
Where the sale is to a connected party, a prospective purchaser can apply to a pre-pack pool (the “Pool”), where an independent and experienced business reviewer assesses and evaluates the information. The cost is £950+VAT and while the process is voluntary, the insolvent practitioner is obliged to advise on this. Connected parties may also be asked to prepare a viability statement.
A statement of proposals is required and filed at Companies Houses within eight weeks. If the sale is to a connected party and the opinion of the pre-pack has been sought, this needs to be included as well.
The new road ahead
The measures introduced in 2015 have been subject to numerous reviews. In 2017 the Government found that more businesses were being marketed externally, increasing from 49% of sales prior to the measures to 77% in 2016. However, stakeholders were still concerned by the low number of referrals to the Pool, only 36 referrals in 2016 out of 163 eligible transactions and 18 in 2018. Disappointment was also expressed over the price at which the company’s assets were sold, less than market value in over 25% of sales.
The purpose of the review was also to establish whether the power inserted by The Small Business, Enterprise, and Employment Act 2015 (SBEE) into Schedule B1 of the Insolvency Act 1986, due to expire in May 2020, should be extended. The power allowed the Government to regulate or even ban sales in administration to connected persons and was extended by the Corporate Insolvency and Governance Act (the “CIG Act”) to 30 June 2021.
The new legislation
In an ongoing battle to protect the interest of creditors with the need to promote company rescue, the Government proposed new Regulations on 8 October 2020 which specifically address pre-packs sales to a connected party. On 24 February 2021, the Government laid these proposals before parliament to be debated.
Under the Regulations, an administrator will no longer be able to execute a pre-pack if all of the following elements apply:
- The sale or disposal is of all or substantially all of the company’s assets or business
- This is taking place within the first eight weeks of administration
- The disposal is to one or more connected persons
- Either approval has not been gained from creditors or a qualifying evaluator report has not been obtained.
Paragraph 60A of Schedule B1 to the Insolvency Act provides a definition of a connected person that is relied upon within the Regulations.
The evaluator report aspect is the main focus of criticism of the Regulations. This must be obtained from an independent evaluator by the connected party, addressing whether a case has been made for the sale of the business. The insolvent practitioner will review and evaluate the written opinion and decide whether a case has been made for the disposal. If their opinion differs, they will be required to provide a statement setting out the reasons. A copy of the report will be sent to the creditors and to Companies House.
A key point to note is how an ‘independent evaluator’ is chosen. Under regulation 10(a) of the new Regulations, an evaluator can be deemed qualified if they believe that they are. There are no official requirements or qualifications required other than being independent, solvent, sane and without any director disqualifications. Arguably, this is a low standard to reach when appointing evaluators. They will however need to obtain professional indemnity insurance before operating, though this is likely to have a limited impact on the points of issue. The low bar of qualifications has attracted much criticism.
It is important to be reminded that under the new Regulations the conclusion of the evaluator’s report has no effect on the outcome of the administration, it is merely an advisory process. This has led to some critics viewing certain elements of the Regulations as a tick-box exercise for those who are experienced market participants undertaking pre-pack actions.
Arguably, both the approval process or evaluator’s report routes will delay the process and create additional costs. Paradoxically, the consequences of the new regulations might be higher costs for the insolvent practitioner and therefore lower returns for the unsecured creditors. The Government, however, hopes that this will increase stakeholder’s involvement in the process, promote transparency and save pre-packs sales from their fatal destiny. New provisions that have been added to the Regulations try to discourage potential purchasers from simply obtaining multiple evaluator reports in the hope that at least one will be favourable.
Interestingly, there is no requirement within the Regulations for the sale to be put to a stop if the evaluator is not satisfied. Additionally, there is no further requirement for the report to consider the future viability of the business, the report appears to exist for value alone and is merely advisory.
Colin Haig, president of insolvency and restructuring trade body R3, said:
“We welcome efforts to improve stakeholder confidence in pre-packs, but it may be proved that this legislation has missed the mark. Sales to connected parties in pre-pack administrations will now be subject to creditor approval, or review by the new independent evaluator position. The rationale for this is clear but the practicalities around ensuring that an evaluator is a fit and proper person is where these regulations could fall down. These regulations effectively leave it to the market to regulate the evaluator position. A far better alternative would have been for the government to agree to maintain a list of approved evaluators.“
Many questions remain unanswered. The Government is proposing to issue guidelines to accompany the implementation of the regulation and strengthen the regulatory requirements of SIP 16 by increasing adherence to the marketing principles, reporting and viability reports. It might also give guidance on the future of pre-pack pools and the position of unsecured creditors, currently excluded from the definition of connected parties.
Overall, the Government’s new regulations are certainly a welcome development in the landscape of pre-packs. It remains to be seen whether the Regulations will benefit both creditors and insolvency practitioners following their implementation on 30 April 2021.
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