A ‘pre-pack’ is where a company in financial difficulty arranges the sale of its business before entering administration (a form of insolvency process). Immediately upon the company entering administration, and without first notifying creditors, the administrators sell the company’s assets to a third party. Creditors of the company that has entered administration are only likely to be paid if the pre-pack sale generated enough money to pay its outstanding debts. The administrators who conducted the pre-pack sale will get paid in priority to creditors. Very often, creditors of the company in administration will only be paid a fraction of what they are owed.
Unsurprisingly, creditors often complain about pre-pack sales. In some cases the licensed administrator will have clear grounds for believing the best obtainable price for the company’s assets, and so the best result for creditors, will be achieved through a quick pre-pack sale to the existing directors. There are other occasions where the justification for a pre-pack sale is less obvious. There are many examples of pre-pack sales achieving a poor return for creditors.
The guardians of the pre-pack process are the licensed administrators who agree and approve the sale. Even an honest administrator, cognisant of their professional obligations, might form an erroneous view of the merits of a pre-pack sale. Where an adminsitrator has been appointed by the directors of an insolvent company in circumstances where those directors wish to benefit from the pre-pack and purchase the company’s assets, administrators must always be mindful that those directors have an incentive to argue for the lowest price possible.
The recent case of Ve Vegas Investors LLC & others v Henry Shinners, Finbarr O’Connell and others  EWHC 186 (Ch) shows that the English courts are concerned to ensure that pre-packs are properly reviewed when there are grounds for concern about circumstances of the sale. The Respondents in the case were the Administrators of VE Interactive Limited (VE Interactive). The Administrators, licensed insolvency practitioners from the firm Smith & Williamson LLP, had arranged a pre-pack sale of VE Interactive’s business to Rowchester Limited, a company controlled by the former management of VE Interactive, for the sum of £1.75 million. The Applicants were creditors of VE Interactive. Those creditors were concerned about the sale price achieved by the Administrators and applied to the court to remove the Administrators. The Applicants wanted to appoint new independent administrators from Deloitte to investigate the pre-pack sale. The Administrators opposed the application for their removal and replacement.
The court held that there were grounds to remove the Administrators from office, finding that there was a “serious issue for investigation” about the circumstances of the pre-pack sale to an entity linked to the directors and management of VE Interactive. The court was not seeking to make a final determination on whether the pre-pack had been improper in some way, but found that it was appropriate for an independent investigation to be carried out, including into whether the Administrators “breached their duties of reasonable skill and care” in agreeing the pre-pack sale to Rowchester Limited. The existing Administrators were in no position to carry out that investigation and had “lost perspective”.
The decision in Ve Vegas Investors will be of interest to creditors who feel they have been disadvantaged by a pre-pack sale. There is little doubt that there have been occasions when administrators have been complicit in pre-pack sales to the existing management of an insolvent company where the sale price has been too low. Creditors often feel that there are no feasible routes to challenge a pre-pack sale. The Ve Vegas Investors case shows that, where there are real questions about the price obtained on a pre-pack sale and the conduct of administrators, the courts will come to the assistance of creditors seeking a proper investigation into the circumstances of a sale.
Creditors should also be aware that there are various other ways to challenge pre-pack sales, not all of which require expensive court applications. Creditors will very rarely become aware of an intended pre-pack, but seeking legal advice quickly after being notified of one will provide much greater scope to challenge sales at an undervalue.