The New Pre-pack Regulations – Controls on Transactions to Connected Parties
Pre-pack administration sales, or pre-packs, remain a useful tool in the tool box for quickly and discreetly achieving a rescue of a distressed business. However, that must always be balanced with the need to protect the credibility of the restructuring process and the interests of creditors as a whole. In response to criticism of pre-packs, and a recent review of existing industry measures, the Government has introduced The Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (Regulations) ), which aim to provide creditors with reassurance that pre-pack transactions to connected parties are fair, appropriate and transparent. The Regulations apply to all companies entering administration on or after 30 April 2021.
A summary of the proposed regulatory framework is set out below:
- The Regulations come into force on 30 April 2021 and applies to all companies regardless of size.
- The Regulations will apply where there is a disposal (hiring out or sale) in administration of all or a substantial part of a company’s business or assets.
- An administrator will be unable to dispose of property of a company (including disposals effected by series of transactions) to a person connected with the company within the first eight weeks of the administration without either the approval of creditors or an independent written ”qualifying” report has been obtained. The connected party buyer will be required to obtain the qualifying report.
- The provider of the qualifying report (referred to in the Regulations as the Evaluator) must be independent of the connected party buyer, the company and the administrator, and must meet certain eligibility requirements. There are no specific qualifications required of the Evaluator, only that the Evaluator believes they have the requisite knowledge and experience to make the report.
- The administrator must have no reason to believe that the Evaluator is not independent of the connected party or does not meet the eligibility requirements.
- The written report will contain either a statement that the Evaluator is satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances (case is made opinion) or that the Evaluator is not so satisfied (case not made opinion). The report will set out the Evaluator’s principal reasons for giving its statement and summarising the evidence it relied upon.
- A connected party buyer may obtain more than one report.
- An administrator must consider a report from an Evaluator.
- Where a report contains a case not made opinion, an administrator can still proceed with the disposal but will be required to provide a statement setting out the reasons for doing so.
- An administrator will be required to send a copy of the report(s) to creditors of the company and to Companies House at the same time it sends a copy of its statement of proposals (ie by no later than 8 weeks after the company enters administration).
“Note the regulations are not just about pre-packs. Connected party sales are caught by the regulations as are any sales of all or a substantial part of the company’s business or assets within 8 weeks of the start of the Administration. This could have substantial implications for a whole range of different transactions and rescue transaction timetabling so we will be watching developments closely.”- David Ampaw, Partner
It will be interesting to see if there is a rush of pre-pack sales prior to 31 April 2021 and how the Regulations play out and settle down in practice from this date. We will monitor its application but some initial thoughts are set out in table 1 below.
The Government has said that it will monitor the operation of the Regulations and, where necessary, they will consider a ban on pre-pack sales altogether, or modify the Regulations accordingly (which can be done even after the enabling power in paragraph 60A of Schedule B1 to the Insolvency Act 1986 expires on 30 June 2021).
Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2020 – some initial observations
Creditor involvement (if creditor approval is sought)
Provides greater transparency and an ability for creditors to inspect the transaction in a sensible fashion.
Seems unlikely that creditors will be regularly asked to approve the transaction – at least 14 days prior notice is required for creditor approval so query whether the benefits of a pre-pack (i.e. speed, shielding from an open marketing period which avoids possible value diminution) will hold true.
All creditors will have the ability to review the proposed transaction.
Creditors will vary in levels of sophistication and/or motivations. Will they be able in all cases to sensibly digest the proposals without specialist advice?
A company which has gone through a debt for equity swap may render certain persons “connected” in a way that has not necessarily been dealt with as yet. Will they be included in the creditor review and/or will this dissuade lenders from credit bidding?
Useful for administrators to have an independent review (commissioned by the buyer) of the transaction which can credibly be used to deflect any criticisms.
An administrator is not bound to accept the Evaluator’s opinion (but will need to provide an explanation of why they have proceeded despite a “case not made” opinion). However, there is clearly risk in ignoring a negative assessment. There is no appeal mechanism against the Evaluator’s decision, but nothing to stop a buyer from obtaining a subsequent report, ie “shopping around” for a favourable report. However, obtaining two or more reports will take longer and increase transaction risk.
The Evaluator must have relevant knowledge and experience.
The administrator must be satisfied the Evaluator has sufficient relevant knowledge and experience to make the report.
Professional indemnity insurance policy must be taken out by the Evaluator in respect of potential liabilities to the administrator, the connected person, creditors or any other person arising from, any matter stated by the Evaluator in its qualifying report.
No formal qualifications required. The Evaluator can self-certify that it has the relevant knowledge and experience sufficient for the purposes of making a qualifying report.
Unclear at this stage how qualification as an eligible Evaluator will work in practice and to whom the Evaluator’s duty of care will be owed (which may in turn affect who will be willing to take on this role).
The quality of the report is only as good as the quality of the material provided so the Seller (and professional agents of the seller) may be the best persons to commission the report rather than the buyer in terms of who has what information. There may be some difficulty in complex situations in facilitating full disclosure.
It is not clear what the terms of the PI policy will be and whether they will be sufficient / of practical use (the market will dictate this over time). the Regulations only require the Evaluator’s report to contain information regarding the (i) risks covered, (ii) amount covered and (iii) exclusions from the cover.
The Evaluator has to state whether it is satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances.
No guidance as yet on what this means in practice (ie how the Evaluator makes this assessment) or whether the Evaluator is being asked to opine on whether a different strategy (rather than the substantial disposal) is or was merited.
Clear in advance that buyer (connected party) must obtain a report from the Evaluator
The report itself may cause some inefficiencies in terms of speed (which may put the transaction as a whole at risk), cost (the cost of the report is likely to be a further transaction cost which will diminish the return to creditors) and transaction risk for buyer (ie of a ”case not made” opinion by the Evaluator).
Secured lenders who control more than one third of voting rights in the seller will be connected persons and so any loan to own strategy they pursue could be complicated.
What is a pre-pack?
A pre-pack sale is a sale of the assets and business of an insolvent company that is negotiated and agreed in advance of the entry of the company into administration. The sale is then carried out by the administrators almost immediately after their appointment. A pre-pack sale can help rescue a business and minimise the loss of value and damage to relationships with employees, customers and suppliers that may result from a prolonged administration.
Why have pre-packs to connected parties been criticised?
There has long been a complaint around transparency particularly where a sale is to a buyer with connections to the insolvent seller (eg buyer having the same directors or shareholders as the insolvent company) with stakeholders only finding out about the transaction after it has completed. Often a sale to a connected person can be wholly legitimate because those are the same people who know the business best and continue the business without material interruption at a juncture when there is often not the luxury of time, due to the underlying condition of the business, to find an unconnected buyer. That said, there is no doubt that many stakeholders (unsecured creditors in SME situations in particular) still perceive pre-packs in these circumstances as a means for directors and/or shareholders to cherry pick the best assets of the business for “newco” whilst leaving behind debts and liabilities in an “oldco” with no assets. This perception, notwithstanding the reality, in large restructurings in particular, that insolvency practitioners are held to an extremely high standard already, is what these new Regulations seek to address.
Other points to note
- Any requirements set out in the proposed new SIP 16 (details of which have not yet been released) will continue to be relevant.
- Insolvency Practitioners will have their own code of conduct in many cases or those of their relevant professional body.
- The Pre-Pack Pool in particular was hoped to balance the competing interests in a sensible fashion and provide some reassurance that there had been some independent scrutiny of the transaction before it was consummated. The Pre Pack Pool is not referred to in the Regulations but its future relevance is doubtful. The members of the Pre Pack Pool are however likely to be ready-made Evaluators given their background and experience.
Are there alternatives to pre-packs to connected parties?
There is arguably a place for pre-packs to connected parties in the right circumstances subject to appropriate safeguards. It is arguable whether the negative perception around pre-packs to connected parties always reflects the reality. Pre-pack transactions vary immensely and any reputable insolvency practitioner will approach these transactions with a high level of care and scrutiny, even without any strict regulatory requirements. However, there are other tools in the restructuring toolbox which are available which can address many of the same issues sought to be addressed by pre-packs . These tools include CVAs and/or schemes of arrangement and the new “Super Scheme” alongside mechanisms introduced by the new Corporate Insolvency and Governance Act 2020 each of which have features ensuring creditors transparency through the restructuring process. It is incumbent on practitioners to evaluate the full range of options, with appropriate cost/benefit analysis to ascertain which process or combination of processes best facilitates business rescue.