Legal Briefing

Points on pre-packs: directors’ duties in an administration sale

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Corporate & Commercial | 16 March 2016

The High Court has ruled in a case regarding a director’s conduct in relation to an administration pre-pack sale. In Capital for Enterprise Fund A LP and Maven Capital Partners UK LLP v Bibby Financial Services Ltd [2015], the secured loan creditors claimed that they suffered loss as a result of one of the directors conspiring with the company’s major supplier and a third-party invoice finance company in arranging a pre-pack administration sale to a connected Newco purchaser of which the director was also a director and shareholder.

The director owned just over 50% of the shares in the insolvent company, a developer of interactive voice messaging software. The company’s main borrowings for working capital were under a loan agreement with a capital investment fund secured by fixed and floating charges. The fund also had a right to acquire shares in the company via share warrants.

The director agreed with the company’s major supplier creditor that a Newco would be formed, to be owned 30% by the director and 70% by the supplier creditor. A new invoice finance lender would be given a secured loan over all of the insolvent company’s business and assets enabling it to appoint administrators over the company. A pre-pack sale to the Newco would be agreed and signed by the administrators immediately after their appointment. The new invoice finance company would then provide invoice finance to Newco and the supplier creditor would supply the crucial telephony services platform. The director made these arrangements without informing the rest of the board of the insolvent company.

When the facts became known to the secured lenders, they stepped in. It became obvious that part of the reason for the director keeping the scheme from his co-directors was to obtain the lenders’ waiver of rights to priority of their own charge. Given the facts it is rather surprising to learn that the judge held that no damages were payable to the lenders by the defendant.

Creditors’ failure to establish loss

The claimants argued that loss had been caused by the conspiracy, as the company entering administration prevented them from obtaining repayment of their secured loans. They were also deprived of the opportunity to subscribe for shares under their warrants. They argued that the debt to the major supplier would have been rescheduled and the business could have been sold to an independent purchaser with repayment of their secured loan.

As the judge noted, the claimants had already accepted a significant sum from the director, the Newco and the supplier creditor under a settlement agreement arrived at by the threat of litigation against those parties alleging conspiracy to defraud. The defendant finance company argued that the claimants’ losses were the unavoidable effect of the company’s insolvency and that its assets were worth less than the sum paid by the other parties under that settlement. The judge agreed with the defendants in deciding that ‘the overwhelming probability’ was that the insolvent company would have had to cease trading anyway and on the evidence it had been hopelessly insolvent since before the events in question.

The inability of the secured lenders to establish that their loss flowed from the conspiracy was the reason that their claim failed against the defendant invoice finance company, although it was established that the director breached his duties to the creditors as a whole and to the company. In summary, they established the ‘unlawful means’ component of the conspiracy involving the director, the Newco and the major supplier creditor, but not that loss flowed to them as a result.

However, the judge underlined the fact of the director’s fiduciary duties to the insolvent company referring to the principle that a director cannot obtain for himself any business advantage belonging to the company but must at all times act in the best interests of the company.

Main points on Capital for Enterprise

The case confirms the long established principles that where the company is insolvent:

  • The directors must run the business of the company in the interest of its creditors as a whole.
  • That means it is not lawful for a director to act in a way that prefers one creditor’s interest over another or that defeats the interest of creditors generally.
  • The directors must not put the rescue of the business ahead of the interests of the creditors as a whole (West Mercia Safetywear Ltd v Dodd [1988]).

Therefore, despite the failure of the claim against the invoice finance company, directors should certainly not read this case as any kind of relaxation of these principles.

Other points on pre-packs
  • Directors planning a prepack administration sale to a Newco with which they are connected should take special care to carry out their duties to the creditors of the insolvent company.
  • To minimise the risk of conflict, the connected Newco purchaser and the board of the insolvent company should retain different legal advisers.
  • Purchasers and their advisers should be aware of the requirements of the revised SIP16 published by R3 last November and the ability of the purchaser to voluntarily appoint an expert from the Pre-Pack pool to ‘vet’ the pre-pack sale for reasonableness. This provides an element of protection for directors of a connected purchaser but note that there are question marks over the practicality of this new procedure.
  • Businesses planning staff cutbacks as part of a pre-pack sale leaving premises/branches and their employees behind need to take specialist employment advice to make sure, for example, that they do not fall foul of the Trade Union & Labour Relations Consolidation Act 1992, which requires notifications to the Secretary of State.
  • These notifications must be made within certain time frames before the date of the first redundancies; 30 days in the case of 20 or more redundancies within a 90-day period at one establishment; 45 days before where there are 100 or more redundancies.
  • Failure to notify leaves directors open to criminal prosecution – although in the recent City Link case (BIS v Smith, Peto and Wright [2015]) the directors were acquitted.