On 24 February 2021, the UK government laid The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 before Parliament.
These draft regulations introduce (among other items) new restrictions on “pre-pack” disposals to connected persons and are seemingly a policy response to growing criticism around the inequity of pre-pack sales.
To some, pre-pack sales allow companies in distress to retain value and protect saleability, reassurance of which often can only be found in connected persons, e.g., existing directors and shareholders who have a personal or emotional interest in the company or otherwise understand its value. However, to others, including creditors whose value is depleted through pre-pack sales, such sales lack the transparency and governance considered appropriate for protecting creditors’ long-term interests.
The draft regulations are expected to enter into force on 30 April 2021. As drafted, they will apply to England, Scotland and Wales.
Pre-Packs and Connected Persons – The Current Position
A pre-pack is an arrangement to sell a company’s business or assets (in part or as a whole), negotiated and agreed before the company enters into administration, but completed on or very shortly after the administrator is appointed.
Prospective buyers who are unsure about the fairness of any pre-pack process or sale can voluntarily make use of the pre-pack pool (a group of independent experts that decide whether the terms of a pre-pack sale are fair and reasonable). The pool’s decision is not binding on those that make use of it. According to the pool’s 2019 annual review, out of the 260 connected party pre-packs in 2019, only 21 (or 8%) were referred. This low take-up likely can be explained by the pool’s limited set of powers.
The draft regulations intend to address this problem by introducing a set of minimum (and mandatory) standards that administrators must follow during a pre-pack sale to connected persons.
The Draft Regulations
Under the draft regulations, if administrators intend to sell all or a substantial part of a company’s assets to a connected party within eight weeks of their appointment, they are required to either get approval from the creditors of the company or obtain an independent written opinion from an independent evaluator as to whether the proposal is reasonable.
Consent to the proposed sale will be obtained if administrators achieve a simple majority vote in their favour. However, if 50% or more of creditors not connected to the company vote against it, approval will be lost. In practice, it seems unlikely that administrators would choose this approach given the time it can take for consent to be achieved.
Independent Opinion from an Independent Evaluator
The evaluator’s opinion will broadly replace the role of the current pool by deciding whether the proposed sale is fair and reasonable. As to who can be an evaluator for these purposes, the administrator need only be satisfied that the appointee is independent from the administrator and the buyer, and has the requisite knowledge and experience to opine on the proposed sale.
The draft regulations set out a non-exhaustive list of reasons why a person should not be appointed as an evaluator (e.g., circumstances that could affect their impartiality). Persons who should not be appointed as evaluators include:
- Associates of the administrator
- Persons who have provided insolvency or restructuring advice to the company in the year leading up to the report.
The draft regulations allow for more than one report to be obtained (and some administrators might prefer this confirmatory approach). However, even where it is not possible to obtain sign-off on the proposed sale being fair and reasonable, administrators can still proceed with a sale provided that they have a statement justifying their decision. This statement will later be circulated to creditors and filed with Companies House).
There has been a great deal of scrutiny of pre-packs over the years and various changes in the regulatory framework known as Statement of Insolvency Practice 16 (SIP16). The draft regulations provide little detail on the recommended contents of the evaluator’s report, but there is seemingly no obligation on the evaluator to consider the future success of the company. The latest draft therefore does not include a “viability statement” comparable to that of SIP 16.
Each opinion (regardless of its conclusion) must be circulated to the creditors of the company and filed at Companies House.
The definition of a “connected person” under the draft regulations is identical to that in 60A(3) of Schedule B1 to the Insolvency Act 1986. Common directors, shadow directors, shareholders and controlling entities (or their associates) will fall into the definition.
The previous regime expressly stated that secured lenders would not fall within this definition. In their current form, the draft regulations do not include a similar express provision.
If the draft regulations are passed as drafted, it would be easy for one to question the practical difference the draft regulations make. Insolvency practitioners have been conducting pre-packaged sales in accordance with the SIP 16 guidelines, and many have well-honed internal procedures to ensure that a sale to a connected party or parties can be justified. The use of evaluators will doubtless increase costs and result in some delay. However, the real issue is that the proposed legislation does not stipulate the qualifications necessary for the evaluators, other than that they should have adequate professional indemnity insurance in place. This has raised concerns in the profession, most notably the Association of Business Recovery Professionals or R3.
As it stands, the soon-to-be-phased-out pre-pack pool cannot block a sale that it construes to be unreasonable, and the latest draft does not address this fundamental point. In addition, there does not seem to be an obligation on the evaluator to address the long-term effects of the pre-pack sale on the company, with the report requirement being limited to addressing any valuation concerns (and in turn, creditor undervalue claims) which may rise as a result.
We await the draft regulations to be debated in Parliament and will update this note accordingly.
This article was previously published by the autors on the website of McDermott, Will & Emery
*Trainee Ryan Clarke contributed to this article