Contributors
The new pre-pack regulations have been approved by Parliament and come into force on 30 April 2021.
Pre-packs: an overview
A pre-negotiated administration sale (a "pre-pack") is a sale of a company's business or assets that is negotiated prior to and completed on the appointment of administrators. It is common for purchasers in a pre-pack scenario to be 'connected parties'[1] and it is normally the case, due to confidentiality and the need to act quickly, that trade creditors do not know about the sale or the identity of the purchaser until it has completed. As one of the key features of a pre-pack is that unsecured claims are 'left behind' with the old company, which often results in trade creditors suffering losses, pre-packs have received a lot of bad press over the years. This has culminated in The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 ("Pre-Pack Regulations"), and a renewed focus to address creditor concerns in this area.
Whilst pre-packs are an extremely useful tool for rescuing a business as a going concern and preserve value for creditors, there are many criticisms of the current process, including a perceived lack of transparency and accountability and the risk of disadvantaging creditors. To address these concerns there have been a number of pre-pack reform initiatives in recent years. The most notable amongst these being the 2014 Graham Review which introduced the 'Pre-Pack Pool'[2] (the "Pool") and a redraft of SIP16[3] which came into effect on 1 November 2015.
The Pool has not, however, had the impact the Graham Review hoped for, with referral levels remaining low. This is undoubtedly because there are no sanctions for a connected party purchaser or an administrator if the opinion of the Pool is not sought or, indeed, disregarded. The use of SIP 16 has also ensured a greater level of transparency for creditors around the marketing of a company's business/assets and the rationale for a transaction proceeding although, it appears, for many creditors SIP 16 does not go far enough.
The Pre-Pack Regulations are aimed at addressing the longstanding concerns of creditors and improving stakeholder confidence by introducing additional mandatory requirements on connected party sales transacted via an administration.
What is changing?
From 30 April 2021 an administrator will be unable to make a substantial disposal of a company's business and assets to a 'connected person' within the first eight weeks of the administration, without either the approval of a majority of creditors or an independent written report from an ‘evaluator’.
As the utility of a pre-pack is its speed, it is anticipated that the main route to compliance with the Pre-Pack Regulations will be to obtain an evaluator's report rather than seeking creditor approval. Whilst allowing creditors to have a say in the sales process will enhance confidence that route may, ultimately, take too much time and remove the key benefits of using a pre-pack as a restructuring tool. This has, understandably, meant that most of the commentary on the Pre-Pack Regulations has focussed on the role of the evaluator.
Who is the evaluator?
The Pre-Pack Regulations require evaluators to be independent, to hold relevant knowledge and experience and to hold professional indemnity insurance. Beyond this, however there are no requirements for an evaluator to hold any professional qualifications making them suitable for the role. It is anticipated, given the requirement for an administrator to be satisfied that an evaluator has sufficient relevant knowledge and experience to make a qualifying report, that the role of the evaluator will be fulfilled by accountants or lawyers with restructuring and insolvency experience but that is not guaranteed given the apparently low threshold for being qualified to give a qualifying report.
Responsibility for obtaining the evaluator's report lies with the 'connected' purchaser. The connected party can obtain more than one report (although the opinions contained within any earlier reports must be disclosed). The Pre-Pack regulations also seek to discourage parties from obtaining multiple reports in the hope that one might be favourable, although this is not prohibited.
What do these changes mean?
Only time will tell whether the Pre-Pack Regulations will go far enough to address the existing concerns of creditors. However, there are concerns amongst industry professionals that without prescriptive requirements relating to professional qualifications it will be left to the market to regulate the evaluator position, which could lead to more lenient evaluators being favoured over those considered as stringent. In addition, the potential for of opinion shopping to circumvent unfavourable reports arguably undermines the objectives of instilling stake holder confidence in the pre-pack procedure and increased transparency.
Colin Haig, President of insolvency and restructuring trade body R3 and Head of Restructuring at Azets commented:
“A better alternative would have been for the Government to agree to maintain a list of approved Evaluators. This […] would have given stakeholders greater confidence that these reforms were robust.”
Finally, the evaluator's report will not be binding. If neither the evaluator nor the creditors support the proposal for a pre-pack sale, the Pre-Pack Regulations will allow an administrator to proceed regardless. However, there is an extra administrative layer where this is the case, and the administrator must send the evaluator's report to the registrar of companies and all creditors, setting out their reasons for proceeding in this manner.
What next?
The Pre-Pack Regulations have been created largely to increase stakeholder confidence in pre-packs. It is interesting, therefore, that they in fact cover any substantial disposals to connected parties within the first 8 weeks. This is perhaps to address the fact that both the Pool and SIP 16 only apply to pre-packs so there are no additional reporting or other requirements in place for connected party transactions arising after an administration has commenced. Extending the Pre-Pack Regulations to cover wider category of sakes is perhaps unnecessary as one would expect that the reason for a sale at a later date, rather than on a pre-pack basis, would be to allow more time for marketing, with the assumption that a sale concluded after a longer period is less likely to be challenged on the basis that it was not appropriate in the circumstances.
Over the coming months we shall see whether these changes to the regulation of connected party transactions address the concerns of pre-pack detractors, or whether further changes will be needed to address the new concerns over the role of the evaluator. Either way, the impact is sure to be monitored closely, and the Insolvency Minister Lord Callanan has said that the Government may look to pursue further reforms, or reconsider banning connected-party pre-pack sales if the new regulations do not work.
Whilst the Pre-Pack Regulations are far from perfect, it is now incumbent on us as a profession to make them work as best we can, and to help ensure that stakeholder confidence in this important business rescue tool is improved rather than damaged. A pre-pack is a valuable restructuring tool, and for the most part the insolvency profession will be keen to ensure that it remains an option for business rescue particularly in the current climate where many thousands of businesses are experiencing financial distress due to the impact of COVID-19. Pre-packs may once again have their chance to be in the limelight rather than under the spotlight.
Attributed to Hannah Frost, Trainee Solicitor
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[1] Usually directors or shareholders of the company in administration
[2] An independent body the directors of a connected purchaser can go to for an opinion on whether a proposed pre-pack sale is fair in the circumstances.
[3] Statement of Insolvency Practice 16 – a report provided by administrators to creditors following a pre-pack providing sufficient information for a reasonable and informed third party to conclude that the sale was appropriate and that the administrators have acted with due regard for the creditors' interests.
