When used correctly, pre-pack administrations can be an effective means of creating an opportunity for the rescue of an insolvent business. However, concerns are regularly expressed about the lack of transparency in the sale process and the potential for poor outcomes for unsecured creditors, particularly where a disposal involves connected parties. These concerns have been exacerbated by some unfavourable media reports about a limited number of high-profile cases, and the speed at which transactions are often required to take place in order to preserve value and jobs.
In light of these issues and the limited uptake of the voluntary measures recommended by the 2014 Graham Review, the Government has introduced regulations that will impose conditions on certain disposals by administrators. The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 (the "Regulations") come into force on 30 April 2021 and will apply to administrations that commence on or after that date.
What is pre-pack administration?
A pre-pack administration occurs when a sale of a company's business or assets is arranged prior to the onset of administration and then completes shortly after the administrator is appointed. They are often agreed without much, or any, advertisement. This is in order to protect the value of the business, minimise administration expenses and preserve connections with stakeholders and employees who might be lost if news of the insolvency becomes widespread. It is therefore not unusual for the purchaser to be someone known to or involved in the insolvent business, who is aware of its situation and has an interest in its survival. These parties often represent the best or, sometimes, only option to obtain value for the entities' assets. However, the lack of visibility leaves the process vulnerable to criticism.
The new conditions
The Regulations impose conditions that must be satisfied before an administrator can make a substantial disposal of company property to a connected party during the first eight weeks of a company entering administration. They will not apply to pre-pack sales to unconnected parties. The Government's explanatory memorandum that accompanies the Regulations (the "Explanatory Memorandum") estimates that the new measures will affect less than 2% of total corporate insolvencies per year.
The conditions require the buyer to obtain an independent opinion from an evaluator on the terms of the sale, unless creditors have approved the sale.
The evaluator providing the opinion will need to state whether or not they are satisfied that the consideration offered for the relevant property, and the grounds for the substantial disposal, are reasonable in the circumstances. They will need to give the principal reasons for reaching their conclusion, together with details of:
- the property;
- the consideration;
- the connection between the parties;
- the evaluator's relevant knowledge and experience;
- the evaluator's professional indemnity insurance policy; and
- any previous report(s).
The Explanatory Memorandum notes that the Government plans to issue guidance to assist evaluators in the exercise of their responsibilities and that this will be available to coincide with the commencement of the legislation.
While the administrator is not bound by the evaluator's opinion, they will need to give a report to the creditors and to the Registrar of Companies setting out their reasons for proceeding with the disposal. As an officer of the court, an administrator would need to have good reasons for proceeding with a sale if the report had reached a negative conclusion.
Neither is there a requirement for the potential buyer to be bound by the opinion they have obtained. They are entitled to seek multiple reports, if time and budget permits. However, the administrator is required to disclose details of a prior report to creditors and the Registrar. Any negative report is therefore likely to make it more difficult for the administrator to conclude that the disposal can proceed.
The judgement of the evaluator is therefore a critical factor affecting the quality of the report. The evaluator must be independent of the company and the connected person and they must not fall into one of the excluded groups listed in the Regulations. These groups include associates of the administrator, undischarged bankrupts or persons with an unspent conviction of an offence involving dishonesty or deception.
There has been criticism of the fact that evaluators will self-assess whether they have sufficient relevant knowledge and experience to make a qualifying report. In contrast to the Pre-Pack Pool, there is no requirement for the evaluator to have professional qualifications and the administrator is not expected to look behind the evaluator's declaration as to suitability; providing they have no reason to believe that the individual does not meet the requirements.
Where the administrator concludes the evaluator does not have sufficient knowledge and experience, the report will not be a 'qualifying report' and the sale will not be able to proceed. It would therefore seem to be in the interests of a connected party to select an evaluator with sufficient standing to avoid introducing another degree of complexity or a potential delay to the pre-pack process. To that end, the Government's expectation that many connected purchasers will use the Pre-Pack Pool to obtain the independent opinion required by the Regulations, would seem to be a good starting point. However, it is not guaranteed and it remains to be seen whether other types of evaluator become involved in the process.
Impact of the new measures
2021 is likely to be a challenging year for many businesses as various support schemes and temporary measures implemented during the COVID-19 pandemic are unwound. As a result, there may be a greater number of entities seeking guidance on considering options for rescue and recovery.
Insofar as the Regulations do not restrict pre-packs to non-connected parties, it is good news in that pre-packs are a valuable tool in the business rescue armoury. It is also good news that the Government has sought to address the transparency concerns arising from the limited number of cases, which could potentially be open to abuse, rather than instigating a ban on pre-packs to connected parties altogether. It is hoped that these measures will help to improve the confidence of the business world and the public in the value of retaining pre-packs as one of the key business rescue options.
However, like many well-intentioned interventions, they may not fully hit the mark. The ability to seek multiple opinions may still lead to "opinion-shopping" by connected-party buyers, and the absence of required professional qualifications may put administrators in a difficult position should they have doubts as to whether the evaluator does in fact meet the relevant requirement. It therefore remains to be seen whether the Regulations are able to entirely prevent the few cases of individuals intending to abuse the system, while still enabling the majority who are seeking an effective solution for a difficult situation.