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The pre-pack regulations - is this the end of the pre-pack?

On 8 October 2020 the Government issued its “Proposed draft regulations to require scrutiny of pre-pack sales to connected parties” (Regulations).

Requirement for approval or evaluation

The Regulations would apply to any disposal or series of disposals to a connected person, during the 8 weeks after a company has entered into administration, of all or a substantial part of the company’s business or assets (Substantial Disposal).

An administrator must not make a Substantial Disposal unless: (a) the administrator has obtained creditor approval; or (b) the connected person purchasing the assets has obtained an evaluator’s report.

Creditor approval for these purposes means approval as part of the approval of the administrator’s proposals submitted in accordance with paragraph 51 of Schedule B1 Insolvency Act 1986.

An evaluator’s report sufficient to proceed with the Substantial Disposal must include a conclusion and reasons why, the evaluator is satisfied that the consideration to be paid and the “grounds” (a term which is not explained) for the Substantial Disposal “are reasonable in the circumstances”.

So, clearly, the identity of the evaluator is important. However, it is required simply that this person “believes that they have the requisite knowledge and experience to provide the report”, meets an independence requirement, and is not disqualified (for instance by reason of being convicted of a dishonesty offence or being an undischarged bankrupt).

The independence requirement is that the evaluator is not an associate or connected person of the administrator or the buyer, has not provided advice in respect of the company, and neither “knows or has reason to believe that the individual has a conflict of interest with respect to the substantial disposal”.

The administrator must conclude that there are no reasons to believe that the evaluator was not sufficiently qualified or independent. A copy of the evaluator’s report must then be sent to every creditor (with minimal exceptions) and a copy filed at Companies House.

Would the regulations help?

This is not a positive development.

In the government’s announcement on 8 October, following the conclusions of the 2014 Graham report, the Business Secretary recognised that pre-packs are “a useful tool to rescue businesses, saving jobs and preserving value”.

We agree. Pre-pack’s are an important tool which can be used to achieve a fast business rescue. In the current climate, it is more important than ever that a useful business rescue tool is preserved.

At the same time, it is important to protect creditors from abuse. But would the new regulations help achieve that protection or do they just add to cost and delay?

Practical difficulties

Of the two routes for achieving a pre-pack under the regulations, the prior approval of creditors would seem to be a non-starter in many cases and push up initial costs in all cases. 14 days’ prior notice is required for creditor approval to the administrator’s proposal. If that is a pre-condition to the sale, it may be hard to justify structuring the deal as a pre-pack rather than an open marketing of the business during the administration period. For administrators to go through an open marketing process would be prohibitively expensive in most cases and often cause irreparable damage to the business- killing off the rescue attempt.

Even when proposals are put to creditors for approval, the reality is that creditors are often not sufficiently familiar with the issues to analyse and respond to increasingly complicated administrators’ proposals. And even if some creditors are sufficiently sophisticated, they can be outvoted.

That then leaves the option of obtaining an evaluator’s report. The evaluator can self certify themselves for eligibility on a vague basis. No guidance is offered on how the evaluator assesses the reasonableness of the “grounds” or level of consideration payable. It is not clear whether the administrator would owe a duty of care (and liability for breach) or how the evaluator’s fee would be structured – could, for instance, they be paid more for a positive conclusion?

For an unscrupulous administrator this would seem to be a licence to find an unscrupulous evaluator to compile a shoddy report. For more cautious administrators, this adds a significant burden to comply with standards the administrator assesses as sufficient.

Is there a better way to protect creditors?

Creditors wishing to challenge pre-packs will be left with court challenges. While there have been some reported successful challenges of abusive pre-packs, challenge is not easy. The details of legal duties and remedies against directors, connected buyers or insolvency practitioners for abusive pre-packs is not clear, despite ever more complex regulation of these transactions. The new regulations do nothing to strengthen or clarify the scope and availability of such challenges. This should have been the focus of the government’s efforts. Adding clarity to duties of the parties and court remedies while avoiding additional complexity. Which duties, if any, should give a right to a subsequently appointed liquidator or minority creditor to get recompense from directors, buyers, or IPs; unwind the transaction; or change the administrator (if still in office)? This could give clear guidance as to how to conduct transactions of this nature in a fair way and give a remedy to those adversely affected. Meanwhile, those regulations which give no right to a clear remedy could be stripped away to avoid the cost of compliance sucking scarce cash away from the business rescue.

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