UPDATED 24 March - Further to its announcement on 8 October 2020, the government has now published its updated pre-pack reform legislation for independent scrutiny of pre-pack administration sales. This is where connected parties, such as previous directors, shareholders or associates, are involved in the purchase. The new legislation, which will come into force on 30 April 2021, aims to improve the transparency of pre-pack sales in administration.
What is a pre-pack sale?
A pre-pack administration sale is a procedure where an insolvent business reaches an agreement to sell its assets to a buyer before appointing administrators to facilitate the sale of the business. This could be a trade buyer, existing directors or a third party.
Pre-pack sales are often arranged between the company and persons connected with the company, such as previous directors. This raises concerns for creditors as they are only informed after the event, which allows them little or no input into the sale.
The Graham Review
An independent review into pre-pack sales took place in 2014 – known as the Graham Review. Following the publication of the Graham Review, a number of voluntary industry measures were introduced in 2015 to address the core issues identified.
The Graham Review concluded that although pre-pack administration sales often helped to preserve jobs, and were a vital tool for rescuing businesses, there were issues around the lack of transparency in the process. This was particularly for unsecured creditors who were excluded, and so felt any deal made was not in their best interest.
As a result of the Graham Review, measures were introduced. This included the establishment of a group of experienced business professionals, known as the Pre-Pack Pool, to offer an opinion on marketing principles. Viability statement and independent valuations or the proposed connected-party pre-packaged sale were also introduced. However, referral to the Pre-Pack Pool remained at the discretion of the purchaser.
In addition, amendments were made to the Statement of Insolvency Practice 16 (SIP 16), which sets out regulatory guidance on how insolvency practitioners should handle pre-pack sales. The aim was to reduce the concerns of lack of transparency by requiring administrators to provide creditors with information about the marketing of the business. Any alternatives to the pre-pack sale were then considered.
The government’s pre-pack sales in administration report
On 8 October 2020, the government published its report on the findings and recommendations of the independent review of the voluntary industry reforms to pre-pack sales in administration, that were introduced in 2015. Although improvements were introduced by the Graham Review, the government considered further reforms were required regarding the transparency of pre-pack sales and to improve creditor confidence. The report was accompanied by a set of draft regulations to increase independent scrutiny of pre-pack sales in administration to connected parties.
On 24 February 2021, the draft statutory instrument of the regulations was published following a period of consultation. The regulations were debated in the House of Commons and the House of Lords and were approved on 23 March 2021. They will come into effect from 30 April 2021.
The new regulations will apply where there is a ‘substantial disposal’ in administration of the company’s assets.
We provide a summary of the regulatory framework below.
Independent qualifying report
- An administrator will be unable to make ‘substantial disposal’ of property of a company to a person connected with the company within the first eight weeks of the administration, without either the approval of creditors or an independent qualifying report produced by an evaluator.
- The connected party purchaser will be required to obtain the qualifying report and provide a copy to the administrator.
- A connected party purchaser may obtain more than one qualifying report.
- Where a qualifying report states that the case is not made for the support of the substantial disposal, an administrator can still proceed with the substantial disposal. However, they will be required to provide a statement setting out the reasons for doing so.
- The provider of the independent qualifying report (the evaluator) must be independent of the connected party purchaser, the company and the administrator.
- The administrator must send to every creditor of the company, other than opted-out creditors, a copy of the report. If more than one report was received, then they must send all the reports.
Statement of proposals
- The report(s) must be sent with the statement of proposals (required to be sent to Companies House and to creditors under paragraph 49(4) of Schedule B1 of Insolvency Act 1986).
- If the administrator seeks creditor approval, rather than a qualifying report being obtained, the administrator will need to seek a decision of the company’s creditors when issuing their proposals, referred to in paragraph 49 of Schedule B1. The creditors are required to approve the administrator’s proposals without modification, or with modification to which the administrator consents.
Provider of qualifying report
The provider of the qualifying report meets the requirements as to qualification. The individual needs to be satisfied that their relevant knowledge and experience is sufficient for the purpose of making a qualifying report:
- They have professional indemnity insurance;
- They are independent (i.e. not a connected person); and
- They are not excluded from acting as an evaluator.
The evaluator must state in their qualifying report that they have considered any previous qualifying reports obtained. This is to avoid connected parties ‘opinion shopping’ for a qualifying report they prefer.
Do the regulations address previous concerns?
While the draft regulations stipulate the criteria which an evaluator must meet in order to produce a qualifying report, which include being independent and insured, the regulations do not require the evaluator to have any specific professional qualifications. The evaluator simply needs to be satisfied that their ‘relevant knowledge and experience’ is sufficient for the purpose of making a qualifying report.
The new regulations will apply where there is a ‘substantial disposal’ in administration of the company’s assets. The term ‘substantial disposal’ has not been defined within the regulations. The reasoning for this is that what amounts to a ‘substantial disposal’ may vary depending on the size of the relevant business. It is also a term that is used in other insolvency legislation and insolvency practitioners are therefore familiar with it.
One concern was that it should be the administrator that should obtain the independent qualifying report, as they have technical experience which may assist the evaluator. However, it remains that the qualifying report is to be obtained by the connected party purchaser rather than the administrator.
What does this mean for the future of pre-pack administration sales?
In the current uncertain times, company insolvencies are likely to increase once the government’s support under the Corporate Insolvency and Governance Act 2020 expires. As a result, this will likely lead to a rise in the use of pre-pack sales and it is therefore inevitable that they will be subject to more public scrutiny than usual. This is particularly due to the costs of the government support packages which will have kept such businesses afloat during 2020.
The requirement for an independent written opinion, or creditor approval to be obtained before a pre-pack administration sale, can be made to a connected person. This, in theory, adds a layer of protection for creditors and should improve confidence in the pre-pack process. Pre-pack sales can then be effectively used by insolvency practitioners to obtain a successful sale which, in turn, should protect both businesses and jobs.
As obtaining creditor approval could be a long and uncertain process, particularly for a company that has many creditors, it is likely that the independent written opinion will be used in the majority of pre-pack sales. Whilst obtaining an opinion does not guarantee that the report will agree with the substantial disposal, and an administrator will still be entitled to proceed with the proposed transaction as long as a statement for his reasons for doing so is provided, it may be a quicker and more convenient course of action than creditor approval.
We’re here to support you
While pre-pack sales do sometimes (rightly) get bad press, it shouldn't be forgotten that they can also be a valuable tool for maximising value to creditors. In distressed situations, often the only buyer in town is a connected party, as the lack of time to undertake meaningful due diligence rules out other buyers.
It remains to be seen how successful the regulations will be at increasing creditor confidence in the pre-pack sale process once they come into effect on 30 April 2021.
For further information, guidance and support on how these changes may impact an existing or planned pre-pack administration process, do not hesitate to contact a member of our corporate, insolvency and restructuring team.
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