New pre pack rules are coming… but will they help or hinder business rescue?
Despite its regular use as a rescue tool, the “pre pack” Administration has always had a somewhat tarnished reputation amongst creditors and the general business press.
Following an independent review into the use of pre pack sales in 2014 (The Graham Review) a number of voluntary industry measures were introduced in 2015 to deal with the key issues identified. These were aimed at resolving the lack of transparency within the process and to address the concerns of creditors who often felt that they were being excluded from the process where deals were completed that were not necessarily in their best interests.
This lead to the introduction of the pre pack pool who offered opinions on the marketing principles and the viability of the proposed sale to connected parties and also a raft of Regulatory Guidance for Insolvency Practitioners dealing with pre pack sales.
The requirement to use the pre pack pool however, remained at the discretion of the connected party purchaser and, as a consequence, was very much underutilised.
Rescue options post-pandemic
The Covid-19 lockdowns have left many businesses in financial distress. Although many companies will have taken advantage of Government support in the short term, there is likely to be a requirement to reconfigure their businesses or restructure their debt as they look towards the post pandemic future.
Many companies will have simply “parked up” certain liabilities taking payment holidays and utilising deferral schemes whilst adding to their debt burden by taking out CBIL or Bounce Back loans.
Ultimately, these debts will need repaying against a back drop of the withdrawal of support measures and the difficulty of restarting up, which we have already seen may take time to switch back on order books and supply chains.
With this in mind, the UK rescue procedures available to Insolvency Practitioners are based around the Administration and Company Voluntary Arrangement (“CVA”) processes which are aimed to help business owners’ deal with their debt whilst minimising the impact on the wider supply chain and saving jobs.
The recent change in status for certain HM Revenue & Customs liabilities from 1 December 2020, so that VAT, PAYE and certain other liabilities now have preferential status and rank ahead of the supply chain, make the likelihood of using a CVA to restructure the business in the short term more difficult (especially those who have deferred their VAT).
As a consequence, for many business owners in this predicament, looking at a restructure through the pre-pack process may be the preferred alternative.
Proposed changes to sales to connected parties
The Government has now considered further reforms regarding the transparency of pre pack sales to improve creditor confidence. Following consultation new Regulations are currently going through Parliament to bring in major changes as to how Insolvency Practitioners will be required to conduct pre pack sales to connected parties and are expected to come into force from 30 April 2021.
In short, this will ensure that an Administrator cannot sell a business to a connected party before a period of 8 weeks has elapsed from the date of their appointment, unless creditors have approved the proposed sale, or an Evaluator has provided a report on it.
If the Administrator is to seek approval from creditors of a potential sale, rather than a qualifying independent report being obtained, then he must forward a statement of proposals to all creditors seeking their approval to the proposals.
Obtaining such approval prior to the transaction is good in theory, but less so in reality. On a practical level, Administrators may be reluctant to take an appointment with a possibility that a sale will not complete within a very short time frame from their appointment.
Administrators must manage the business as agents of the company while they fulfil their duties which comes with a level of risk and potential personal liability and the associated costs of monitoring ongoing trading may prove prohibitive to concluding the sale. Consequently, the level of uncertainty for all parties under this new process may bring into question its practicality.
The Evaluator’s Report
Given the unlikelihood that an Administrator will want to wait to seek creditors’ approval for a sale to a connected party, the preference is likely to be for that connected party to appoint an independent Evaluator to provide them with a report instead.
This has echoes of the approval previously sought from the pre pack pool but is no longer “optional” unless creditor approval is to be obtained instead.
A major criticism of these proposals is the current lack of guidance concerning the necessary qualifications of the Evaluator.
The Regulations provide that an Evaluator must be independent from the Administrator and Purchaser, and should believe that they have the requisite skills and experience to provide the report, there is no further qualifying criteria other than for the Evaluator to carry professional indemnity insurance.
More than one independent report can be obtained and all reports must be provided to the Administrator who must send them to every creditor. Where a qualifying report may state the case is not made for the support of the substantial disposal, the Administrator may still proceed with the substantial disposal although they must set out their reasons for doing so.
As a result there remain many unanswered questions and the duty of care of the Evaluator appears to be to the purchaser and the additional costs involved in the preparation of this report may prove prohibitive for many SME businesses.
Evaluator’s Report not binding?
One of the biggest failures of the previous requirements of the pre pack pool, was the fact that this was not a mandatory requirement for connected parties and there was no requirement for the Administrator to follow the recommendations, provided the Administrator provided their opinion as to why the sale could proceed.
The Administrator has their own duties and obligations, including the requirement to act in the best interests of creditors as a whole and it is therefore probably right that the Evaluator’s report is not necessarily binding on the Administrator. However, as a consequence, this remains a fundamental flaw that the Evaluator does not carry any weight in the process other than facilitating the sale which begs the question is the new process any better than the pre pack pool?
Will it increase confidence in the pre pack process?
As the Evaluator’s role seems to lack any real “teeth” is it simply box ticking and potentially at the cost of the estate if the purchaser reduces the offer price to reflect the additional costs incurred? This is particularly the case where there may be no credible alternative purchaser and therefore it is questionable whether the new measures will increase confidence in the new process.
Administrators, as licensed Insolvency Practitioners, are answerable to their respective Regulatory Bodies and are required to meet stringent timeframes and regulations when conducting pre pack sales, whether to connected or unconnected parties.
Pre pack transactions should have a real role to play in helping Businesses recover from the effects of the pandemic and at a time when they will continue to need unprecedented support, these proposed changes could prove to be more of a hindrance than a help.