Welcome to our latest edition of Collateral. In this
edition, we are talking insolvency and focusing on some recent
legislative changes which are expected to have
a significant impact on pre-pack administrations in the
UK.
Unlike a standard administration sale where administrators
commence marketing of the business post-appointment,
a “pre-pack” is an arrangement where a sale of
some or all of a company’s business and assets is
negotiated with a buyer prior to the appointment of
an administrator and completes either upon or shortly
following their appointment.
Pre-packs have long been a key tool in the
corporate rescue toolbox and are becoming more
prevalent. Despite low headline insolvency numbers
in 2020, pre-packs accounted for around 30% of UK
administrations and were particularly noticeable in
the retail, dining and travel sectors.
But pre-packs are not popular with everyone. They have come
in for criticism particularly when businesses are sold to
a “connected person”, such as to
directors or shareholders where those parties
are closely involved in the
company’s management. This has led to arguments that
pre-packs lack transparency and prejudice the rights of
creditors.
Partly as a response to criticism of pre-packs, the
government introduced The Administration (Restrictions on
Disposal etc to Connected Persons) Regulations 2021
(Regulations) which impose requirements on
pre-packaged administration sales to connected
parties commencing on or after 30 April 2021 and aim
to provide creditors with reassurance that pre-pack transactions to
connected parties are fair, appropriate and
transparent.
This article explores 5 key effects of
the Regulations on creditors
and other stakeholders and our observations
on some of the key reforms.
1. Greater transparency
Unless it has been approved in advance by the creditors, an
administrator will only be able to dispose of
a substantial part of a company’s assets to a
person connected with the company within the first eight
weeks of administration if it obtains a written
opinion from an evaluator, which is made
available to all creditors and which is also filed
at Companies House. The evaluator must be independent and
cannot have provided any insolvency advice to the company in
the 12 months prior to providing the opinion.
Comment: In the absence of creditor
approval, the requirement to obtain a written report from an
independent evaluator which is made publicly
available is a step in the right direction
and should provide more transparency
around a connected party sale which did not exist before
the Regulations were
introduced. Although a ‘pre-pack pool’
1 was established to oversee pre-pack sales to
‘connected persons’ following the Graham
Review in June 2014, approaching the pre-pack pool was on
a voluntary basis for a purchaser. And with no legal
requirement for purchases to be referred, referrals were
low. What is ‘substantial’ is
not defined, but the guidance which accompanies
the regulations sets
out certain criteria which
an administrator should consider including the
value of the business, assets or
both and whether the trading style and goodwill of
the business forms part of the disposal.
2. More scrutiny
The Regulations introduce heightened scrutiny
during the administrators’ decision-making process
leading up to the pre-pack sale. The
Regulations stipulate
that the evaluator’s written opinion
must assess whether or not the grounds for
the substantial disposal
are ‘reasonable’ (see further below). The
opinion should contain details of the transaction, the nature
of the relationship of the connected party with the company
and a summary of the evidence relied upon to
make the recommendation. If the report
does not recommend a sale, an administrator can still
proceed with the disposal but the
administrator will be required to provide a statement setting
out the reasons for proceeding with the sale as part
of its SIP 16 Statement,2.
Comment: Although additional scrutiny is to be
welcomed from a creditor perspective, it is unclear from the
Regulations what recourse any creditors may have should the
administrator proceed with the sale despite a negative report from
the evaluator. Likewise, although there is clearly risk in
ignoring a negative assessment, there is no appeal mechanism
against the evaluator’s decision and nothing to stop a
purchaser from (literally) obtaining a second
opinion. A prudent
administrator will therefore likely advise a
potential purchaser to engage with an
evaluator as early as possible in
the process so that they can work through all
options before any decisions are made.
3. ‘Reasonable grounds’
As mentioned above, the evaluator must state
whether it is satisfied that the sum payable for the business
or assets and the grounds for the substantial disposal
are ‘reasonable’ in the
circumstances.
But it is unclear how the evaluator makes this reasonableness
assessment and whether the evaluator is also being asked to decide
whether alternative options for the company (rather than the
substantial disposal) can be justified.
Comment: To make a
recommendation based on ‘reasonable grounds’, we
would expect an evaluator to have to review a
wide array of information, including from the
seller (via the administrator). Therefore, although
the
evaluator acts independently, the information it
relies on may not be impartial. Evaluators are naturally
likely to be cautious and we can see situations
where evaluators opt to review more information rather
than less and take
independent professional advice before providing
their recommendations.
4. Qualifications
Under the Regulations, there is (somewhat surprisingly) no
qualification criteria for the independent evaluator and the
evaluator is not required to be a member of a regulated
professional body, for example. Instead, the
Regulations leave it up to the evaluator
to self-certify that they have the requisite knowledge
and expertise to provide the report, though
the administrator also needs to consider whether
there are any grounds to believe the evaluator does not
meet the requirements. An evaluator must also have
professional indemnity insurance in place and provide details in
their report.
Comment: The guidance accompanying
the Regulations states that the most likely candidates for the
role of evaluator are accountants, surveyors, lawyers and
insolvency practitioners. But every transaction is different so not
imposing a formal qualification requirement and allowing
someone with specialist knowledge of the business to take the role
may prove helpful to getting a transaction
away.
However, it remains to be seen
whether insurers can operate to effectively regulate the
suitability of evaluators in the absence of
clear qualification criteria. Some industry bodies have
suggested that a ‘white-list’ of approved
evaluators should be agreed up-front and
the members of pre-pack pool
have also indicated that they will be providing
evaluation services under the Regulations.
5. Secured Lenders
The Regulations adopt a broad definition of a
‘connected person’ purchaser reflecting how that term
is used in The Insolvency Act 1986, to
include a party who has a significant prior
connection to the company such as directors, shareholders and
any family members of such directors
or shareholders. The wide
definition theoretically means secured lenders who have
taken security over more than one third
of shares in the debtor company and have the
ability to exercise voting rights in respect of those
shares could fall within the definition of ‘connected
person’ and within the parameters of
the Regulations for any pre-pack in their
favour.
Comment: It will take a fair amount
of due diligence to confirm whether or not a buyer
is ‘connected’ for the purpose of
the Regulations but the inclusion of secured lenders is
quite a radical change given that SIP 16 previously stated
that secured lenders were outside the scope of connected parties.
The inclusion of secured lenders as a connected person does not
prevent pre-pack sales to them but any loan to own strategy pursued
by such parties inevitably becomes more complex and time-consuming
and if they fall within the connected persons definition, they too
will need to go through the process of seeking creditor consent or
getting a report from an evaluator.
Conclusion
Contrary to some expectations, the Regulations have
not banned pre-pack sales to connected parties!
Instead, the introduction of the Regulations
seems to suggest that the government has recognised, at
least for now, that pre-pack sales to a ‘connected
person’ can be an appropriate tool to
maintain the going concern of a business. Equally, the
Regulations are a step in the right direction
towards promoting more transaction scrutiny, which subsequently should reduce criticism of these
transactions from creditors and improve public
perception. But it remains to be seen who will
fulfil the crucial role of the evaluator role in
practice, and how the additional cost and time in
obtaining the evaluator’s opinion will impact pre-pack sales,
which are often time critical. In the final
analysis, only the future use of connected party
pre-packs will determine whether the Regulations hit
the mark in increasing stakeholder confidence and
transparency.
Footnotes
1 A group of experienced insolvency professionals who
could be consulted on the appropriateness of a proposed pre-pack
sale
2 A statement prepared by the administrator setting out how the
decision to opt for a pre-packaged sale was reached and the other
alternatives that were considered.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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