Nicola Ross: Tighter regulation of pre-pack deals in administrations
Nicola Ross, partner in Morton Fraser’s litigation and dispute resolution team, discusses the changes in insolvency regulation in relation to pre-pack deals in administrations.
Insolvency legislation has been coming thick and fast in recent months, and this time it’s pre pack sales to connected parties that are facing further scrutiny.
The concern is that the voluntary measures which were put in place a few years ago have not provided enough transparency so new legislative measures are on the horizon. On 8 October the UK Government published a set of draft Regulations which will tighten up the processes around pre-pack sales to connected parties.
A pre-pack is the shortened term for a pre-packaged sale of the business and assets of a company that is usually in administration. In short, it’s where a deal has been agreed prior to insolvency to sell the assets of a stricken company but where the deal completes almost immediately upon the administrator’s appointment. All of the fine details of the deal will have been negotiated and resolved prior to the administrator’s appointment. The proposed administrator would be involved in the negotiation process since they would need to be happy with the deal which would go through after their appointment and they need to be satisfied the deal proposed would be in the best interests of the company’s creditors.
Are pre packs controversial?
Pre-packs can often be a good thing because the deal is done before the formal insolvency meaning that there should be no interruption to the business- this should achieve a better price for the company, a smoother transition for the purchaser and a more positive outcome for the employees.
Despite this, pre-packs have attracted some bad press since many people see them as a carve up and a means for the current directors or shareholders connected to a failing business to cherry pick the assets and leave behind the debt, all to the detriment of the creditors.
The UK Government launched a review into pre packs, headed up by Teresa Graham CBE. Her report was published in June 2014. The report concluded that pre-packs had an important role to play, were of benefit to the employees, were cheaper for the creditors than processes that had more court or creditor involvement (such as CVAs) and tended to mean that the purchaser’s business had a better chance of survival than if the sale had taken place after a period of trading in administration. Downsides were also identified. The biggest drawback was transparency since creditors only find out about the deal after it has been done. Other issues identified included lack of marketing and robust valuations.
One of the key recommendations of the report which was implemented by the Government was the introduction of a “pre pack pool”, where connected purchasers approach a member of a “pre-pack pool” and disclose details of the proposed deal before it is done. The pool member - who is an experienced businessperson - then gives their view on the deal and the proposed price. If the pool member issues a negative statement the pre-pack can still proceed, but the negative report should be disclosed.
The pre-pack pool commenced operations at the end of 2015. Since then, take up has been limited and has been dwindling as the years progress. For example, in 2016 22% of proposed sales to connected parties were referred to the pre pack pool for an opinion. In 2017 that figure was 11%, in 2018 it was 7% and in 2019 it was 9%. In light of this, and concerned about the likelihood of an substantial increase in insolvencies due to COVID-19, the Government has decided it is time to act. In doing so, it’s made it clear that an outright ban on pre-pack sales to connected parties is not on the table. However, it has taken the view that legislation is required to ensure the level of transparency recommended by the Graham Review.
The draft Regulations are aimed at any sale of whole or substantially the whole of a company’s business or assets to a connected party where that sale takes place within 8 weeks of the company entering administration.
Under the Regulations, to complete a pre-pack sale, the administrator will need either (1) consent of the creditors; or (2) an independent written opinion on the sale obtained by the proposed purchaser. That opinion - which will be filed at Companies House and sent to creditors - will set out whether the case is or isn’t made for the proposed sale at the proposed price. Critically, the administrator can still choose to go ahead with the proposed sale even if the independent opinion finds that the case is not made for the sale at the proposed price. In that situation the administrator will require to send the creditors a statement setting out the reasons for going ahead with the sale.
The draft Regulations have not yet been laid before Parliament but apparently will be as soon as Parliamentary time allows. The intention is that they become law before June 2021 and guidance will be published to sit alongside them.
As currently drafted, the Regulations are not terribly clear on who will be qualified to provide the opinion (the wording used is that the person thinks they have the “requisite knowledge and experience”), and nor is there any provision to ensure consistency of approach from the people providing the opinions. That’s all likely to be tightened up, not least because it would appear (highly!) likely that the opinion route will be more attractive to connected purchasers than having the deal approved by the creditors.
These changes should be welcomed. They will provide some guaranteed transparency on sales which - despite perception issues - are often likely to provide the best possible outcome (or the least worst outcome depending on how pessimistic you are!) for creditors.