The government has published draft regulations designed to tighten up how administration sales to connected parties will work. The hope is that this will increase creditor confidence and improve transparency in the process.

So, what are pre-pack administrations, what is wrong with them, and what is the government going to do about it?

What are pre-pack administrations?

A pre-pack administration is simply a ‘teed up’ sale of a company’s business and assets before it enters administration, which is completed immediately after administration.

Unsecured creditors will typically know nothing about the administration or the deal until they have happened.

This is not the first time pre-packs have found themselves in the ‘cross-hairs’ of the government of the day. In 2014, the Graham Review, commissioned by the Department for Business, Innovation and Skills, endorsed the importance of pre-packs whilst recommending voluntary reforms for greater transparency, better survival rates of the purchasing company, and better returns for creditors. This was followed by regulations brought in by the Small Business, Enterprise and Employment Act 2015 giving the government powers to impose conditions on pre-packs involving a connected party purchaser.  Those delegated powers expired in May but were replaced within the Corporate Insolvency and Governance Act 2020 and extended until June next year. It is those powers that the government has now decided to use.

What is wrong with Pre-packs?

It is about perception: It is difficult to criticise creditors for taking issue with a secret process that removes the assets from the debtor company and renders their debt uncollectable. Meanwhile, they see (in a connected sale) the directors of the old company with a new company, owning the business and assets of the old one having (in the creditors’ eyes at least) bought them for a bargain, and debt-free at that.

On the other hand, pre-pack administrations rescue businesses and saves jobs, where the alternative would be a fire sale of the assets, and redundancies. This makes them an essential rescue tool within the UK insolvency regime, and one which governments have therefore over the years continued to recognise and support.

What is the Government doing about them?

The government seems, above all, to want to change creditors’ perceptions of pre-pack administrations as cosy deals that only serve the connected purchasing companies. No doubt their hope is for a greater return to creditors as well, but whether that will be achieved remains to be seen.

The proposed regulations do not just apply to pre-pack administrations. They apply to any disposal of all or substantially all of the company’s business or assets within 8 weeks of it going into administration. As such, even a deal agreed and done after the company goes into administration will be caught by these new rules.

The regulations will require creditor approval or a report from a third party ‘evaluator’ before the administrator can sell the business or assets to a connected company.

The main points to note about the regulations are:

• Any disposal of most or all of a company’s assets made in the first 8 weeks of administration must first either be approved by creditors or an independent evaluator.
• It is the purchasing company which engages the evaluator.
• More than one report can be obtained.
• So long as the evaluator believes they have the necessary experience and knowledge to provide the report, they are qualified, and the administrator must share that belief.
• The administrator must have no reason to believe the evaluator is not independent of the connected purchaser.
• The administrator may proceed with the disposal even if the evaluator does not support it, but will be required to justify their decision.

What are the pros and cons of these regulations?

Pros

• Where creditors are invited to approve the disposal they should feel directly engaged in the process thus improving perception.
• The independent report route should enable connected directors to demonstrate ‘arms-length legitimacy’ of the deal despite conflicts of interest between their co-existing duties to the old and new companies.
• The administrators will have, in addition to their own professional valuation/s in support of the sale value, the benefit of an independent report on the deal as a whole. This should provide the administrator with protection from undue criticism by creditors seeking to later challenge it.

Cons

• The report may only be as good as the information provided to the evaluator.
• Finding a truly independent evaluator willing and able to report at speed may prove challenging in some circumstances.
• The creditor approval route may be rarely used in favour of the evaluator route, which could defeat the attempt to establish better transparency and trust with creditors.
• The requirement for a report may end up as a hidden cost of the administration process by being factored into the purchase price.
• These new requirements may cause critical delays which jeopardise the viability of a pre-pack at all.

Conclusion

As with all new legalisation, it is only when these regulations hit the ‘fresh air’ of real situations that we will find out whether they produce the desired effect. The concern is that, instead, they will produce an unwelcome layer of cost and bureaucracy which threatens the viability of the use of pre-packs in certain situations.

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