Proposed reform to pre-pack sales in administration

The Government announced on 8 October 2020 that it was reviving its power to issue legislation prior to June 2021 to place conditions on or prohibit pre-pack administration sales to connected persons.

The Graham report, issued in June 2014, previously considered the full economic impact of the pre-pack administration process and made recommendations for reform.

The aim of the Corporate Insolvency and Governance Act 2020

The key aim of the new rescue and restructuring measures introduced in the Corporate Insolvency and Governance Act 2020 is to help businesses plot a course through, and eventually bounce back, from the economic impact of the coronavirus pandemic. Clearly, and as recognised by the Government in its latest press release, it is important to have a regime where those who are affected by the current economic circumstances have confidence in the insolvency processes and that such processes are fair and transparent and achieve the best outcome for creditors (and potentially other stakeholders).

Research shows that pre-pack sales are utilised in about 29% of all administrations and hence are a well-established method for ensuring that parts of, if not the entire, business is rescued which in turn is beneficial for employment and preservation of value in the business when compared to the most likely alternative, a liquidation. About half of all pre-packs involve sales to connected persons.

Creditors concerns

A concern that has regularly been expressed by creditors is that they are often unaware of a pre-pack sale until the transaction has completed. Although there are usually valid reasons for a pre-pack sale, in particular, to maintain the value of assets and the continuity of operations and avoid the costs of a trading administration, this lack of transparency has been raised as a potential area of manipulation, particularly in cases where the purchaser is connected with the company entering administration. As administration is a collective insolvency proceeding it is understandable why the lack of transparency is a particular concern.

Following the Graham report, which also recommended the creation of the Pre-Pack Pool, the insolvency industry took steps on a voluntary basis to overcome the concerns by introducing regulations on best practice when considering a pre-pack sale (the Statement of Insolvency Practice 16, known as “SIP 16”). In summary SIP 16 requires administrators to provide creditors with sufficient information such that “a reasonable and informed third party would conclude that the pre-packaged sale was appropriate and that the administrator has acted with due regard for the creditors’ interests” and, in the case of connected party transactions, whether the connected party has approached the pre-pack pool to obtain an opinion as to whether it is not unreasonable to proceed.

Why has the government brought forward legislation?

The Government’s latest announcements on pre-packs states that although there has been some improvement in how businesses are marketed, including the provision of more information being made available for creditors, concerns remain about the transparency of pre-pack sales and whether they are always in the best interest of creditors. These issues were raised during the recent Parliamentary debates on the Corporate Insolvency and Governance Act. The Government has therefore decided to bring forward legislation which places certain conditions on connected person sales in administration and they will also take steps to strengthen professional regulatory standards and improve the quality of the information provided to creditors.

Conclusion

We would expect that practical constraints would mean that the vast majority of pre-packs involving connected persons will follow the route of obtaining an independent written opinion, avoiding the uncertainty of seeking creditor approval unless there are a limited number of known creditors who are supportive of the sale. Obtaining the independent written opinion will presumably require co-operation from the administrator to assess, amongst other things, the appropriateness of the marketing process that has been undertaken and any other valuation analyses. The person giving the opinion may therefore have access to sensitive information regarding the sales process so it will be important for administrators to ensure this does not harm the integrity of the process.

The proposed reforms are aimed at improving transparency and creditor confidence in the pre-pack administration process, a key element of the UK’s insolvency framework, and this should be welcomed by market participants. At the same time, the Government has also made it clear to the restructuring and insolvency industry that the current voluntary approach has not adequately resolved long-standing concerns and that, if need be, they will consider additional legislative changes. The proposed measures are unlikely to affect the overall approach to business rescue but should begin to even out the information provided to creditors in distressed situations. That being said there will be challenges to consider in terms of the practical implementation of these requirements, in particular the preparatory work required to obtain an independent opinion and when that opinion will be capable of being delivered.