This month the government published draft regulations on pre-pack sales to connected parties which it hopes to introduce in the spring. The purpose of the new regulations is to regulate connected person pre-pack sales with the aim of balancing the rights of creditors affected by business failure with the need to promote viable business rescue options to businesses, especially in the current economic climate.
Following the publication of the Graham Review in 2014, the insolvency industry adopted a package of voluntary measures to address the issues identified in this report, namely the concern that there was a lack of transparency around pre-packs for unsecured creditors who often felt that they had been excluded from the process and the deal was not always in their best interests. These voluntary measures included the establishment of a group of experienced business people to give an independent review of a pre-pack sale (“the Pre-Pack Pool”), improvements to marketing and valuation requirements and to the information to be provided to creditors. Although there was some evidence to suggest these voluntary measures were having a positive impact, ultimately it was not enough. The measures did not have the desired effect of increasing confidence and transparency of connected person sales, and it was acknowledged that there had had been limited use of the Pre-Pack Pool.
With the backdrop of Covid (and Brexit), these concerns were once again raised in the parliamentary debates during the passage of the Corporate Insolvency and Governance (CIG) Act 2020: it had been remarked that the lack of regulation of pre-pack sales could create opportunities to abuse the system and undermine the moratorium measures created in the Act as a response to Covid. Consequently, the CIG Act revived the power under s129 of the Small Business, Enterprise Employment (SBEE) Act 2015 (inserted under paragraph 60A of Schedule B1) for the government to regulate connected person pre-pack sales. The previous power expired in May 2020 and has been revived until the end of June 2021. It is widely expected the new regulations will come into force in the Spring of 2021.
What is a pre-pack?
A pre-pack sale is not defined in law, but it is usually understood to be a sale of all or a substantial part of the company’s business (OldCo) before the company enters into administration; after which the appointed administrator completes the sale, usually on day one of the administration and the business is rescued as a whole or part (NewCo). It is an effective and efficient rescue tool which enables preservation of jobs without the costs of trading a business in administration. However, it raises concerns when the buyers of NewCo are individuals connected to OldCo (e.g. directors or family members).
What are the new regulations?
The new regulations introduce the need for an independent opinion, or creditor approval, of a pre-pack sale to be obtained. They will apply to all connected person sales in administration and will not be restricted to those that would ordinarily be considered a pre-pack sale. A summary of the proposed regulatory framework is set out below:
- The regulations will apply where there is a disposal in administration of all or a substantial part of a company’s assets.
- An administrator will be unable to dispose of property of a company to a person connected with the company within the first eight weeks of the administration without either the approval of creditors or an independent written opinion. The connected party purchaser will be required to obtain the written opinion.
- The provider of the opinion must be independent of the connected party purchaser, the company and the administrator and must meet certain eligibility requirements.
- The administrator must have no reason to believe that the opinion provider is not independent of the connected party or does not meet the eligibility requirements.
- The opinion provider will provide a written report to state that either the case is made for the disposal or that the case is not made.
- A connected party purchaser may obtain more than one report.
- An administrator must consider a report from an opinion provider.
- Where a report states that the case is not made for the disposal, an administrator can still proceed with the disposal but will be required to provide a statement setting out the reasons for doing so.
- An administrator will be required to send a copy of the report(s) to creditors of the company and to Companies House.
It is to be noted that the draft regulations do not just capture pre-packs but also connected party sales (of all or substantially part of the company’s business or assets) which complete within 8 weeks of the start of administration.
How effective will the new regulations be?
The draft regulations published by the government raise several issues and with that, the more important question of how effectively the new regulations will address the concerns they are designed to alleviate. Will they prove to be effective in practice?
For example, draft Regulation 6 sets out the route for obtaining creditor approval which requires mere approval of the administrator's proposals under paragraphs 51(1) or 52(2) of Schedule B1, rather than any specific approval of the pre-pack sale itself. If the independent evaluator decides that a case is not made for the disposal, the administrator can either obtain another independent report (albeit he would have to disclose all reports to the creditors, including the earlier unfavourable one) or he could still proceed with the sale provided that he provides a statement setting out the reasons for doing so. This has led to some concern that connected parties will shop around in order to get a favourable report.
The other issue which strikes us is that the definition of “evaluator” or the independent person who writes and authenticates the report is very wide. Regulation 9 deals with the qualification of the evaluator, it states: “An individual meets the requirements as to qualification if the individual believes that they have the requisite knowledge and experience to provide the report.” This definition is entirely subjective and therefore raises the possibility of the evaluator not being sufficiently qualified. However, there is some protection in that an administrator will only be able to proceed with the sale if they have no reason to believe that the evaluator does not have the requisite knowledge and experience to provide the report.
There is also the other obvious issue in that there will be yet another cost and administrative burden to satisfy.