Pre-packs – some questions answered


Author: Jeremy Whiteson


Pre-packs have had a great impact on the insolvency landscape over recent years. They are now the procedure of choice for many insolvent businesses. At the same time, they have been heavily criticised as being damaging to creditors’ interests. This tension has left a number of questions unanswered, which the courts and regulators have tried to address. We have tried to distil the more significant developments into the Q and A below.

Terminology

We take as a starting point the definition of a pre-pack from Statements of Insolvency Practice (SIP) (the principal regulation for pre-packs) as "an arrangement under which the sale of all business and 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". That is to contrast with an open marketing of assets after the appointment of an administrator or other insolvency office holder, as was traditionally the norm.

Are they legal?

Are pre-packs permitted without getting creditor approval?
It has long been established that an administrator may sell assets prior to the initial creditors’ meeting. In DKLL Solicitors v HMRC [2007], the court went a stage further and appointed an administrator with a view to implementing a pre-pack, despite the opposition of HMRC as the majority creditor.

Can pre-packs be used for foreign companies?
In Hellas Telecommunications [2009], a Luxembourgish vehicle whose main asset was an interest in a Greek telecoms business, was put into administration in the UK with the express intention of implementing a pre-pack. To achieve this, the company had shifted its centre of main interest so as to enable the English courts to assume jurisdiction under the EC Regulation on Insolvency Proceedings (it took steps such as moving its head office, appointing UK resident directors and becoming UK resident for tax purposes). While this particular route is open only to companies incorporated in countries that are party to the EC regulation, companies incorporated in other foreign countries may be able to use different routes such as a request for assistance of a foreign court or using the UNCITRAL model law.

Can pre-packs be used where the sale involves a preference?
In Re Halliwells LLP [2010], the court approved an administrator’s appointment with a view to implementing four pre-pack sales of a solicitor’s practice. The buyers had all required that loans taken to fund partners’ capital contributions be repaid in full, on terms which the court felt were "undoubtedly preferences". However, the court approved the appointment (and implicitly the sales), feeling that it was "driven out of necessity" to do so in order to maximise returns. This also illustrates a growing trend to opt for a court administration appointment in cases which are high profile, difficult or controversial (the LLP had taken initial steps to implement an out of court appointment before taking this course).

SIP 16 and creditor redress

How important is SIP 16 disclosure?
SIPs set out principles and procedure with which insolvency practitioners are required to comply, and which are enforced (if at all) by the applicable regulatory bodies. SIP 16, which deals with pre-packs, was effective from 1 January 2009 and includes a requirement for detailed disclosure of, amongst other things, valuations, reasons why a pre-pack was thought appropriate, any consultation with major creditors and any connection between the purchaser and management. SIP 16 has generated greater attention than earlier SIPs, including analysis of compliance by the Insolvency Service and considerable press attention. Compliance with it is also referred to in several of the cases on administration appointments made with a view to implementing a pre-pack, approval of pre-appointment costs, or challenges to the pre-pack. There is even the suggestion in Clydesdale v Smailes [2009] that a SIP16 statement should be issued for a sale immediately before administration which is "in substance" a pre-pack (although in that case it was held that failure to do so was not sufficient ground for removal of the administrator).

What legal options are open to disappointed creditors?
Armed with the SIP16 information, common approaches are to challenge the administrator’s conduct, apply for his removal or take action for misfeasance. An illustration of powers to replace an administrator in a pre-pack context arose in Clydesdale v Smailes [2009]. The court found a need to replace an administrator to examine the terms of a business sale because the incumbent "…and his firm were so closely involved in the negotiations that he cannot be expected now to conduct an independent review". However, these powers are to be used selectively. As stated in Clark v Finnerty [2010] "if an administrator is unbiased and entitled on the material before him to reach a relevant conclusion his decision should be respected unless and until the court concludes otherwise".

Procedure

How, and on whom, should notice of intention be served?
Where the company or directors wish to make an out of court administration appointment they are required to give to holders of qualifying floating charges at least five business days’ notice of their intention (paragraph 26(1) of Schedule B1 Insolvency Act 1986)*. There is also additional provision for notice to those intending to levy execution or distress, the supervisor of a voluntary arrangement or, in the case of a director’s appointment, the Company (paragraph 26(2)). However, the rules do not specify the period or form of notice under 26(2) and the consequences of not giving such notice are unclear. This has caused confusion.

  • The Insolvency Service in their Dear IP of October 2010 stated that "It is our view that … paragraph 26(2) does not give rise to a standalone requirement to give notice of the intention to appoint an administrator", and that "to interpret paragraph 26(2) as requiring a standalone notice independent of paragraph 26(1) would serve no useful purpose and would be contrary to the policy intention." In Hill v Stokes [2010] the court validated an appointment despite a failure to give notice of intention to a person who had distrained. The court found that the obligations to give notice under paragraph 26(2) were not mandatory, were an example of a requirement on which the court can adopt a flexible approach and a failure to give such notice should not be fatal to the appointment.
  • However, in Minmar (929) Limited v Khalstchi [2011] the court concluded that failure to give notice to the company is a valid ground for objection to an administrator’s appointment (but decided the case on other grounds). Notice is to be "reasonable" and on a manually adapted version of the statutory forms. Clearly, then, care should be taken to give notice in accordance with paragraph 26(2) in all cases.
  • How should administrators deal with past appointments which are non-compliant with the Minmar reading of paragraph 26(2)? In Re Derfshaw [2011] administrators addressing this issue did not consider it practical to argue that Minmar was wrong and, instead, applied for retrospective administration orders validating their appointments. Pending a decision of a higher court over-turning Minmar or a re-writing of the rules, that approach should now be adopted by administrators reviewing existing appointments.

Are successive notices of intention to appoint permitted?
Service of a notice of intention to appoint on the holder of a qualifying floating charge by the company or directors creates a moratorium on legal actions and insolvency processes against the company. An administrator’s appointment may not be made by the company or directors after the period of ten business days from filing of the notice of intention to appoint. If they are not ready to appoint within this ten business day period, is it permitted to file further notices of intention to appoint? In Re Cornercare Limited [2010], an appointment within the period of a second notice of intention to appoint was permitted. However, the court there found a genuine reason for delay, and commented that the court had sufficient powers to prevent abuse (without detailing what would constitute abuse). This authority then gives a limited blessing to a second notice of intention but leaves a risk that the procedure is challenged as an abuse, particularly if more than two notices of intention are filed.

Is a formal board meeting required for the appointment?
On a director’s administration appointment, the notice of intention must be accompanied by a "record of the decision of the directors". When read with paragraph 105 (interpreting something done by directors to include "the same thing done by a majority of them"), Sealy and Milman concluded in their authoritative Annotated Guide to the Insolvency Legislation that it does not appear necessary that a formal board meeting be held. However, in Minmar (929) Limited v Khalstchi [2011], the court disagreed, and held that paragraph 105 could not validate an appointment made by directors outside of a formal board meeting. Clearly, those appointing administrators must now take meticulous care to convene a valid board meeting for an administration board meeting even if compliance with necessary procedures would delay or complicate matters.

Costs and expenses

Can rent payable by a buyer be an administration expense?
Goldacre v Nortel
[2009] established that rent will be payable as an administration expense under leases that administrators retain or use for the benefit of the administration. This controversial decision has probably encouraged the use of pre-packs in some cases, to enable administrators to say that they are not using the property and so avoid rent liability. However, in a subsequent Scottish case, Re Springfield Retail [2010], a company in administration had sold its business on terms that the buyer occupy the business premises and pay rent pending the grant of landlord’s licence to assign. The new owner failed to pay the rent. The court found that Goldacre compelled them to treat the rent as payable by the administrator as an administration expense. It is yet to be seen whether this is followed in English cases.

Will TUPE apply?
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) provides for the transfer of employment contracts with most business transfers. However, there is an exception for "bankruptcy proceedings or any analogous insolvency proceedings which have been instituted with a view to the liquidation of the assets of the transferor" where no TUPE transfer takes place. There has been uncertainty as to whether administration is a bankruptcy or analogous proceeding. In Oakland v Wellswood [2009], the Employment Appeal Tribunal settled on a fact based approach – the answer should depend on the administration strategy adopted. The Employment Appeal Tribunal decision in that case was heavily criticised. OTG v Barke [2011] reconsidered the issue and concluded that an absolute approach is preferable – administration will never be a bankruptcy or analogous procedure, even where there is a pre-pack, the business is sold immediately after the administrator’s appointment and the administrator’s main role is liquidating the assets. In judicial precedence the OTG decision is of equal authority to Oakland but, in view of the criticism of Oakland, and the fact that OTG was a decision on five listed appeals, it is likely that OTG will be preferred.

Will pre-appointment costs be paid from the administration?
For the administrators and other professional advisers, most of the work in the pre-pack arises before the administrator is appointed, and the company will often have insufficient funds to pay these unless the pre-pack is completed. Rule 2.67A Insolvency Rules 1986 provides, from 2010 onwards, for approval for payment of the administrator’s pre-appointment costs by creditors’ committee or, if none, creditors and, failing that, by the court. However, uncertainty still surrounds the extent of pre-appointment costs which can be approved in this manner and how the court would deal with an application.

Two cases in 2009 give some guidance on the position before the 2010 rule changes and would probably be relied on here, and are not very attractive for a pre-pack administrator. This suggests a need to address costs coverage early in the process.

  • The balance of advantage test:
    This suggests a restrictive approach to court approval of costs. In Kayley Vending the court exercised its discretion to order the payment of pre-appointment costs as an administration expense as it believed that "the balance of advantage" between existing creditors and existing management rested with the creditors. In Johnson Machine Tools, however, the court applied the same test and found that the balance rested with the management, commenting that in a sale to management "it is rarely possible to establish clearly that the balance of advantage is in the creditors’ favour".
  • "Pre-administration costs":
    Johnson Machine Tools put a restrictive interpretation on this, suggesting that it should be limited to preparing appointment forms and any necessary supporting witness statement, and it was not appropriate to pay, as an administration expense, costs of advising the directors on options for dealing with the company’s insolvency or negotiating the sale.

The Future

Are there plans for reform?
Pre-packs continue to generate controversy. On 31 March 2011 a written ministerial statement was issued stating an intention to require administrators to give notice to creditors where they propose to sell a significant proportion of the assets of a company or its business to a connected party, in circumstances where there has been no open marketing of the assets and for SIP 16 statements to be filed at Companies House. If implemented, that would restrict the current waive of pre-packs, or at least some aspects of how they are implemented. The statement has been criticised by the insolvency profession as being damaging to the rescue culture. Meanwhile, landlords’ bodies have said it gives insufficient protection. It remains to be seen what, if any, reforms follow. However, what is clear is that the debate will continue for some time to come.

*All references to paragraphs are to paragraphs of Schedule B1 Insolvency Act 1986.

Jeremy Whiteson, partner, Fladgate LLP (jwhiteson@fladgate.com)

Would you like to hear more?


View by author: