Pre-pack sales by administrators are now used frequently enough for most people in business to be aware of them and many have come across them in their business lives. A small amount of controversy still attaches to pre-packs, but it is probably right to say that they are now an accepted part of the UK business scene as a useful means of rescuing a business in difficulty and preserving some or all of the jobs connected with the business.
SIP161, the guidelines for insolvency practitioners carrying out a pre-pack sale, issued in 2009 by the Association of Business Recovery Professionals (and commissioned by the Joint Insolvency Committee (JIC)2) have been revised. The revised guidelines took effect from 1 November 2013. The revised SIP16 defines a pre-pack sale as follows:
‘… an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator and the administrator effects the sale immediately on or shortly after, his appointment.’
In January 2012, the government announced that it had shelved plans to introduce legislation to control the use of pre-packs. Instead, the government commissioned a detailed review into the workings and impact of pre-pack deals, referred to below in more detail. Since 2009, annual surveys have been carried out by the Insolvency Service (part of the Department for Business, Innovation & Skills) which have revealed that in the majority of pre-pack sales, the insolvency practitioners acting as administrators have complied with SIP16. In only a small percentage of cases in 2010 and 2011 did the administrators fail to comply with the most important of the guidelines. The information the insolvency practitioner acting as administrator is required to supply to the creditors under the SIP16 guidelines is intended to make the pre-pack sale transparent in order to allow creditors of the insolvent company to fully assess the circumstances. The administrator is required to provide to creditors full information about, for example, the reasons the pre-pack was entered into and details of the buyer, the price and independent professional valuations of the assets to be sold.
There is one obvious objection to pre-packs that will always rankle with unsecured creditors and that is the fact that, by definition, the negotiation of the pre-pack sale is done in private and the buyer is unveiled on the day the administration is announced publicly with the business having shed its creditors and continuing to trade. The right of creditors to pre-approve the terms of the sale of the business, as in an ordinary administration, is lost. It is for this reason that the SP16 guidelines permit a pre-pack to be done only in cases where the price that is obtained for the business and assets together with full information to justify the use of the pre-pack are provided to the creditors. The upside – the preservation of jobs and supplier contracts and the better return to creditors overall than there would have been without the pre-pack – is sometimes overlooked by disgruntled creditors who, quite naturally from their own perspective, are seething at their bad debts. Some creditors complain that the pre-pack sale is not far removed from the ‘Phoenix’ sale, prohibited ever since the introduction of the Insolvency Act 1986. However the reality is that the contemporary pre-pack sale is highly regulated and monitored and is a world away from the ‘Phoenix’ sale, a scam which was carried out by unlicensed liquidators and rogue directors and shareholders to benefit themselves. Insolvency practitioners are themselves highly regulated today, unlike the liquidators in the pre-Insolvency Act 1986 days.
The fact is that many in government and insolvency regulatory circles appear to have come to the view that the usefulness of pre-packs as a business rescue mechanism now outweighs the objections raised against them. The debate has moved on for them and many others: it is a long time since the courts first recognised the validity of the pre-pack sale, if conducted properly3. However, the jury is still out, so to speak.
PRE-PACK ADMINISTRATION REVIEW
The government, through the Insolvency Service (IS), has recently commissioned a review of ‘pre-packaged administration’, whose findings will be presented to ministers at the end of 2013; there will be a final report ready for publication in Spring 2014. The IS notes in announcing the review:
‘Pre-packs are a growing tool for rescue of a business. They can be an important means of rescuing businesses as the sale can be undertaken quickly, reducing the likelihood of key employees and contracts being lost, and preserving the value of the business and hence returns for creditors.’
However, the IS goes on to note that there are problems with pre-packs, chief of which are that the process is not transparent; there may be damaging effects for some and possible longer term harm. Among the specific issues raised are the following:
- Sales to connected parties and sales at undervalue with no open market valuation.
- For the insolvency practitioner possible conflicts of interest in relation to the directors and any charge holder.
- Lack of involvement of unsecured creditors.
- Targeting of company directors by advertising.
- Unfair market advantage with the leaving behind of debts.
- Longer term harm caused by allowing an inefficient business to survive.
The terms of reference include the assessment of the long-term impact of pre-pack deals; whether they encourage growth and employment and whether they provide the best value for creditors. There will be international comparisons. The review will also look into any detriment to particular groups of creditors, specifically unsecured creditors. The desired outcome is a report explaining whether pre-packs are generally in the interest of creditors and the wider economy. If the report finds that pre-packs are in the interests of creditors and the wider economy, it will recommend how the benefits from pre-packs can be further increased and how creditor confidence in the process can be improved. If the report finds to the contrary, it will recommend what should be changed. It will be interesting to see what comparisons of the UK statistics for business rescue with those of other states reveal; it is thought that there are fewer successful business rescues and a greater loss of jobs arising out of business failure in states which do not permit pre-pack sales.
The guidelines contained in the revised SIP16 do not have the force of law but insolvency practitioners who breach the guidelines without a reasonable excuse can expect to face disciplinary proceedings from their regulatory body, which can include the withdrawal of the individual’s licence to practice as an insolvency practitioner. Clearly, this is a strong sanction, as loss of the licence will prevent the individual from practising and result in loss of livelihood. All the regulatory bodies for insolvency practitioners, including the Insolvency Practitioners’ Association and the ICAEW (The Institute of Chartered Accountants in England and Wales) have adopted SIP16.
The revised SIP16 begins with a statement about the importance of transparency ‘in all dealings’. The creditors must have confidence in the insolvency practitioner’s professional and objective approach. It is stated that:
‘… failure to demonstrate this clearly may bring the practitioner and the profession into disrepute’.
It continues with some broad principles, including the need for insolvency practitioners to avoid conflicts of interest.
Under the heading ‘Principles’ are provisions dealing with the need for insolvency practitioners to differentiate between their role in providing advice to the company pre-administration and their role after their appointment as administrator. Insolvency practitioners are under a duty to explain this to the directors and creditors. Creditors are to be provided with a detailed explanation and justification for the pre-pack deal and the administrator has to ‘demonstrate that he has acted with due regard to their interests.’
Under the heading ‘Key Compliance Standards’ are guidelines about prepatory work and work post appointment as administrator. To ensure conflicts of interest are avoided, insolvency practitioners should make it clear to the directors that pre-appointment, their duty is to advise the company, not the individual directors. Directors should be encouraged to take independent advice in the pre-appointment period. There are reminders as to the duties and obligations to the creditors of the company in the pre-appointment period. The law in relation to the incurring of credit by an insolvent company applies and the potential liability on individuals involved in the decision-making process is not restricted to the directors of the company. Administrators are to keep a detailed record of the reasoning behind the decision to carry out a pre-pack deal.
After appointment, the administrators must be able to demonstrate that their duties under the Insolvency Act and Rules have been considered in relation to the pre-pack deal. The remainder of SIP16 contains guidelines under the heading ‘Disclosure’, chief of which are as follows:
- Creditors must be provided with a detailed narrative explaining and justifying the pre-pack deal including confirmation of the statutory purpose; that due regard was had to creditors’ interests and that the price obtained was the best reasonably obtainable.
- The information disclosure requirements are to be included in the explanation to creditors. In the case of a sale to connected parties it is unlikely that ‘commercial confidentiality’ would outweigh the need for provision of full information to creditors.
- The explanation to creditors should be provided with the first notification to creditors and, anyway, within seven calendar days of the sale. If unable to meet this time limit, the administrator should provide a reasonable explanation for the delay. The statement to creditors is also to be filed at Companies House with the administrator’s formal proposals.
- Administrators should seek the requisite creditor approval to their proposals as soon as possible following a pre-pack sale, or provide a reasonable excuse for any delay.
- An administrator is entitled to rely on the provisions of the Insolvency Act 1986 permitting non-disclosure of information in certain limited circumstances.
INFORMATION DISCLOSURE REQUIREMENTS
These are contained in the annex to SIP16 and the main points are as follows:
- The source of the initial introduction to the insolvency practitioner (to be named) and the date of the introduction.
- The extent of the insolvency paractitioner’s involvement prior to appointment.
- The alternative courses of action to the pre-pack with an explanation of possible financial outcomes.
- Whether efforts were made to consult major creditors and the outcomes.
- Why trading the business in administration was not appropriate.
- Details of requests for funding working capital.
- Details of registered charges.
- If the assets had been acquired from a previous administration in the previous 24 months (or longer if relevant) this should be disclosed in full detail including any involvement of the administrator’s firm or associates.
- An explanation of any marketing activities or lack of.
- The names and qualifications of the valuers/advisers and confirmation of their independence.
- The valuations of the business and assets and summary of the basis of the valuations.
- The rationale for the basis of the valuations; an explanation of the sale prices compared to the valuations.
- If no valuation was obtained, an explanation of the reason for that and how the administrator was satisfied as to the value of the assets.
- The date of the pre-pack sale and full details of the purchaser.
- Any connections between the purchaser and the director, shareholders or secured creditors of the company and its associates.
- The names of directors or former directors who are involved in the management/ownership of purchasers/sub-purchasers of any of the assets.
- In group transactions, the administrators should provide full information to provide a transparent explanation eg as to allocation of sums paid.
- Details of directors’ guarantees to prior financier who is involved in financing the new business.
- Details of the assets involved and nature of the transaction.
- The consideration, terms of payment and conditions that could materially affect the transaction; the split of consideration among asset categories and between fixed and floating charge realisations.
- Any option, buy-back agreements, deferred consideration or other such conditions.
- If the sale is part of a wider transaction a description of the other aspects of it.
SUMMARY AND COMMENT
Clearly, the requirements of SIP16 should result in full information about pre-pack sales being available to all creditors in very short order after the sale. The information will allow creditors to quickly identify a sale to connected parties and also to assess whether a proper market price was paid for the business and assets. If creditors identify defects in the sale process or breaches of the law they will have their remedies against the administrators under the Insolvency Act. The revised SIP16 is not radically different from its predecessor and it mainly seeks to be more comprehensive about the information which should be disclosed to creditors and the time limits for such disclosures.
On the crucial point of the consideration paid for the business and assets, creditors are even better protected than previously as the administrators have to demonstrate in great detail their justification for the pre-pack sale and that they have obtained the best price reasonably obtainable for the business and assets. Not only that, but they have to show that they obtained independent professional valuation advice and explain any difference between the price obtained and the valuation advice. It has to be said that the revised SIP16 is really nothing more than the best practice that many insolvency practitioners have already been adopting. Good insolvency practitioners, worth their salt, know that the law requires them to obtain the best outcome for the creditors (not the directors or the shareholders) and this means obtaining the best available market price for the business and assets and that selling at a lesser price would result in exposure to personal liability at the suit of the creditors. For that reason it has always made sense for insolvency practitioners to protect themselves by having systems in place which allow them to demonstrate fully the reasons for the pre-pack sale and the reasons for the particular sale at the particular price.
Without at all wishing to pre-empt the report of the IS due next year, pre-packs are, in the writer’s view, a natural response to the current business landscape. The majority of UK businesses are service providers and are people businesses. The traditional method of trading the administration company while advertising for buyers simply does not make sense in many cases, for a variety of reasons, not least of which is the lack of funding to trade the business. One group who are almost always going to be dissatisfied are the unsecured creditors – the trade suppliers mainly. Those with effective retention of title will be in a better position but suppliers of services do not have that option. The better the price the administrator can obtain for the business and assets, in theory, means the better the dividend for the unsecured creditors. The reality is that there is rarely a very good return for the unsecured creditors but this is a fact of life when a business goes bust – no insolvency procedure, however transparent and fair, can produce more value for unpaid creditors than exists in the business and assets. Of course, after payment of the secured creditors, the costs of the administration and the preferred creditors (mainly employee-related claims) there is very often insufficient to pay the unsecured creditors a significant dividend. Contrast that with a liquidation of the same business though, where typically much more value is lost, resulting in even less for the unsecured creditors. The pre-pack administration sale, in preserving jobs and contracts, automatically reduces the number and size of claims against the company preserving more value for other creditors. In short, it is not the pre-pack sale itself that harms the creditors (the pre-pack sale used skilfully improves the position of the creditors), it is the fact that the business is insolvent and unable to pay its debts.
One fairly prevalent view is that the wider UK economy has been helped in recent years by the use of the pre-pack as a rescue mechanism. However, we must wait for the report of the IS, due out next spring, to see whether official research and statistics bear out this view.
By Richard Baines, partner, Druces LLP.
- SIP stands for Statement of Insolvency Practice.
- The JIC is a forum to discuss insolvency issues and to set standards, set up by the Insolvency Service and the various regulatory bodies of insolvency practitioners.
- See eg Re Transbus International Ltd ; DKLL Solicitors v HM Revenue & Customs ; Re Bluebrook Ltd