Insolvency: Securing creditor confidence in pre-packs

While there is no definition of a pre-pack administration in the insolvency legislation, the IPA’s Statement of Insolvency Practice 16 (SIP16) defines it as “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, appointment”.

About half of all pre-pack administrations involve a sale of the whole or a substantial part of the business in administration to a person connected with that business. Because pre-packs are, by definition, presented to creditors as a fait accompli, the potential for abuse of the process has long been a concern to government.

SIP16 already exists. It’s aimed at ensuring insolvency practitioners don’t find themselves subject to a conflict of interest. Nevertheless, the optics for creditors often give the appearance (warranted or not) of debtor companies escaping their liabilities and carrying on regardless. It was against this background that the Graham review was undertaken in 2014, resulting in the Small Business, Enterprise and Employment Act 2015. That Act gave powers to the Secretary of State to make provision (including for full prohibition) for the sale of a business to a connected person. That power was then effectively re-enacted as part of the Corporate Insolvency and Governance Act 2020. To date, it hasn’t been used. However, the Government announced on 8 October its intention to apply such powers and has since published draft regulations.

Call in the evaluator

The draft regulations are to apply only to administrations commencing on or after the date that the regulations come into force. They apply only to a “substantial disposal” by an administrator to a “connected person” (as defined in para 60A of sched B1 to the Insolvency Act 1986). A “substantial disposal” is a “disposal, hiring out or sale to one or more connected persons during the period of 8 weeks, beginning with the day on which the company enters administration”. It must be in relation to the whole or a substantial part of the company’s business or assets. What is considered “a substantial part” is a matter for the administrator’s opinion. Importantly, the definition includes disposals effected in a series of transactions.

Where the regulations apply, the administrator has two routes to effect a pre-pack administration. The first is to obtain a decision of the creditors of the company under para 51 or 52 of sched B1. Given that many pre-packs are driven by a desire for secrecy and to prevent market speculation, it is unlikely this option will be widely adopted. The second route is for the administrator to obtain a report from a person known as the “evaluator”.

The regulations contain a number of provisions regarding who can be an evaluator. Most importantly, the evaluator must be independent of the administrator and of the company. Their role is to examine the proposed transaction and to give either a “case made” opinion or a “case not made” opinion. The former is an opinion that the consideration or price provided for the relevant property and the grounds for the disposal to a connected person are reasonable in the circumstances. The latter is where the evaluator is not so satisfied.

Seen to be independent?

The regulations suggest that it is the connected person themselves who must obtain and provide the administrator with the report. Subsequently, the administrator must consider the report and make a decision on whether to proceed. Notably, the regulations do not prevent the administrator from proceeding with the transaction, even where the opinion is a “case not made” report. However, the administrator must, if they proceed with the disposal, provide a copy to every creditor (other than opted out creditors) of whose claim they are aware. If the transaction proceeded in the face of a “case not made” opinion, the administrators must give their reasons for proceeding. Copies of the report(s) must also be filed with Companies House (redacted for commercially sensitive information if required), together with the administrator’s statement of proposals.

This independent scrutiny of the transaction may serve to improve creditor confidence in the process of administration, particularly when taken alongside the Government’s stated aim of working with regulated professional bodies to strengthen SIP16. However, there is a risk that creditors’ suspicions around the fairness of the process might shift to suspicion about the independence of the evaluator over time, especially if the same evaluator is seen in multiple insolvencies. Consequently, a truly independent evaluator is key to the success of the proposal.