In this blog, Director of Business Recovery and Insolvency George Dale explains the proposed change to insolvency legislation on sales to connected parties.
In his introduction to the recent new draft proposals, Lord Callanan, Minister for Climate Change and Corporate Responsibility said “I recognise that pre-pack sales are a valuable part of the insolvency landscape, representing around 29% of all administrations. They can be a useful tool to rescue businesses, saving jobs and preserving value. However, creditors are often unaware of the sale until the transaction has completed and pre-packs can be controversial where the business is sold to a person connected with the insolvent company, for example existing management or family members. Although this may sometimes deliver the best outcome possible in the circumstances”.
To set this in context, the main difference between a Pre-Pack Administration and an Administration relates to whether the sale of the business and/or assets takes place before, or after the appointment of the Administrator.
In the case of a pre-pack, unsecured creditors typically express suspicion and mistrust, suggesting they were not consulted, or fair value was not obtained for the assets, or a director has formed a “newco”, has started again in the same line of business and left the “old co” company debts behind. Creditors simply need the reassurance that a pre-pack is the right option in the circumstances and that it was, or will be conducted properly.
The integrity of the process comes under the spotlight for particular examination where the sale is to a connected party. That said, it is important for unsecured creditors to appreciate that a sale to a connected party can be the best outcome for all stakeholders. Tangible and intangible assets (the latter referring to examples such as brand value, goodwill or trademarks) can depreciate in value once an insolvency process is made public, which can hinder the successful rescue or restructuring of the business. In such circumstances debtor collection can become problematic and work in progress where possible, needs to be completed and invoiced. It was for this reason the pre-packaged administration was introduced to help facilitate continuity of trading and preserve that value.
It should also be considered that the Administrator will not have the cost of trading the business to preserve asset value prior to finding a buyer if a pre-pack deal can be secured. This in theory can leave more funds in the pot for unsecured creditors, but each case stands on its merits.
The introduction in Nov 2013 of guidelines (Statement of Insolvency Practice 16) for insolvency practitioners was designed to provide a structure for such transactions to ensure transparency and disclosure of the material facts surrounding the deal. SIP 16 sets the standard expected of Insolvency Practitioners and compliance is monitored by the RPB’s (recognised professional bodies), such as the Institute of Chartered Accountants in Scotland – ICAS, or the Insolvency Practitioners Association – IPA.
For sales to connected parties (such as directors, shareholders, or their respective families) a Pre-Pack Pool (https://www.prepackpool.co.uk/) was established in Nov 2015 as a key recommendation of the now Dame Teresa Graham CBE report in 2014 into Pre-Pack Administration procedure. The Pre-Pack Pool describes itself as “an independent body of experienced business people who will offer an opinion on the purchase of a business and/or its assets by connected parties to a company where a pre-packaged deal is proposed”. Consulting the Pool was never made compulsory and connected party purchasers did not engage to the extent originally envisaged seeking that independent assessment of the suggested transaction.
The Small Business, Enterprise and Employment Act 2015, (Section 129) allowed the Government to make regulations prohibiting or imposing conditions on Administration sales of property to connected parties, including pre-packs.
Those powers expired in May 2020 and were extended to June 2021 by The Corporate Insolvency and Governance Act 2020. Following on from this, the Government published a report on 8th Oct 2020 reviewing the process to provide a greater level of scrutiny and improve transparency in pre-pack administration sales.
The draft regulations will (unless amended) introduce mandatory independent scrutiny and a responsibility on an Administrator to obtain creditor approval before proceeding to conclude a pre-pack sale to a connected party. The connected party purchaser should obtain the opinion from anyone who “believes they have the requisite knowledge and experience to provide the report”.
The draft regulations are designed to offer a greater level of enquiry into the process for all parties where there is a proposed disposal of all, or a substantial part of a company’s assets in administration. Administrators will be unable to dispose of the assets of a company to a connected person within the first eight weeks of administration, without either the approval of creditors or an independent written opinion from an ‘Evaluator’.
As yet there is no clear guidance as to who can be appointed the “Evaluator” and therefore further clarity will be required around their independence, qualifications, and relevant experience. The new regulations will offer added protection and welcome guidance for Insolvency Practitioners when dealing in such matters. They will hopefully also provide creditors with an added layer of confidence, trust and integrity in the process and endorse the actions of those involved in its delivery.
The government said further details on exactly how mandatory scrutiny will be enforced will be provided in due course.
Lord Callanan, Minister for Climate Change and Corporate Responsibility said; “pre-pack sales play an important role in rescuing viable businesses, while protecting jobs and supporting our economy. He continued, “as we continue to tackle Covid-19, it is more important now than ever that people have confidence in the insolvency process. This new law will ensure all sales to connected parties are properly scrutinized — protecting the interests of creditors and the general public, as well as the distressed company,”
Further details can be found here; https://www.gov.uk/government/publications/pre-pack-sales-in-administration/pre-pack-sales-in-administration-report