By the end of June 2021 it is proposed new mandatory protocols will have to be followed for pre-pack sales of businesses to connected parties. The Government backed off this idea in 2015 making the pre-pack pool voluntary, so what has caused them to do this now as we stand on the verge of UK plc exiting lockdown and with it, financial supports to business?
What is proposed?
To sell a business out of administration by pre-pack sale to a connected party (common director, shareholder, family or business associate), amongst other things the administrator must ensure either a) he gets consent of creditors OR b) the buyer gets an independent report recommending the sale (including price).
How practical is that?
Frankly, from a timing and logistics point of view for any genuine pre-pack sale option a) is simply not feasible. So realistically this only leaves option b).
How do you get a report and what must it say?
An independent person ("the Evaluator") employed by the buyer provides the report. The Evaluator can stipulate their own cost, there is no test of independence and there is no minimum qualification requirement. The Evaluator can therefore be anyone and self certify their own suitability, but must state in the report the basis upon which they consider themselves so qualified.
There is no specified form of report, but some mandatory content is required. It must identify the property sold, the connected party, the consideration and whether the sale is made or not made. It must state its reasons, the evidence relied upon and that sufficient evidence was provided. There are no requirements for what information must be provided or by whom.
The legislation contemplates more than 1 report, so invites the possibility of buyers obtaining another report if not satisfied with a case not made recommendation. So shopping around to get the answer they want.
What is the administrators role?
The regulations state the administrators may in their own opinion determine whether a sale of a business is occurring and thereby whether the regulations apply if the sale is to a connected person. This may helpfully avoid having to obtain reports when not necessary.
The buyer should provide the administrator with his report. The administrator has no rights to affect the choice of Evaluator instructed by the buyer or therefore whether, in the administrators opinion, the Evaluator is suitably qualified. The administrator can proceed with the sale even if the report recommends the case is not made, but must provide a statement of reasons for doing so.
The administrator must file the report at Companies House and provide a copy to all creditors. Given it contains commercially sensitive information discretion should be exercised by the administrator and the report redacted appropriately when filed and circulated publicly.
As the regulations state the administrator must consider a report, not whose report, it does raise the possibility that the administrator could also commission his own report, regardless of the buyers report or even when a buyer refuses or is unable to get one. Hopefully this terminology was deliberate to therefore enable an administrator to comply notwithstanding there is no or an unfavourable or unqualified report in the administrators opinion, thus facilitating a sale, preserving the business and jobs otherwise lost to the new process. Unfortunately the legislation is not fully clear on this point.
So why has Government proposed this change now?
Sadly it is not controversial that as we exit lockdown and with it financial support measures, the economy will come out of neutral and business insolvencies will increase well above current levels. How much more is debateable, but statistically it follows there will be more pre-packs. Some will be to connected parties.
The statutory right to bring this legislation expired in May 2020. What has shaken the Government into resurrecting this expired right and hardening their stance from a voluntary pre-pack pool to a mandatory process?
There has been no recent public out pouring against pre-pack connected sales, the vast majority of regulated restructuring professionals find such proposals beyond their current requirements unnecessary and burdensome, adding cost, uncertainty, delay and increased risk of jeopardising the sale. With it extra job losses and less businesses contributing back to the economic recovery.
Had there been a litany of examples whereby business owners or directors had profited from the pre-pack process at great expense or even worse case, by fraud upon other creditors, that would make it transparently understandable. It seems no such report or study has been published.
Presumably it is to address the concern and therefore criticism of Government that not enough has been done to prevent business owners buying back their business through pre-packs at the alleged expense of other creditors. If so, why wasn't this done in 2015 and why was the right allowed to lapse by Government in May 2020?
Could it be driven by the Government's current concern that Crown debt accumulated during the pandemic might be left unpaid as more businesses fall into administration and owners then compete to buy their company back by way of pre-pack purchase free of accumulated debt, including Crown debt.
Maybe this is also why Government controversially approved legislation effective from 1 December 2020, whereby Crown debt once again ranks as preferential debt in company insolvencies and will get paid ahead of unsecured suppliers and creditor businesses owed money.
It seems at a time when we know we are likely to need as many helpful restructuring tools as professionals can get their hands on to mitigate against increased corporate failures, potentially on a scale not seen for decades, the Government have decided to resurrect legislation than does little to assist that process. By their own statistics, nearly a third of businesses saved out of administration are by way of pre-pack sale. So an important tool contributing to business recovery by any measure.
That said, under this new legislation administrators may find themselves in the invidious, but seemingly very real and contradictory situation, that not trusted to oversee a pre-pack sale to a connected party for value under current laws, they are now being asked under new laws to agree with a report maybe prepared by someone unregulated and less qualified than themselves and jeopardising the sale altogether. If so, to step in and correct it as appropriate.
Maybe on reflection it would be pragmatic to avoid its implementation at this time and trust the regulated professionals and their regulators to continue to oversee the process without adding further cost, uncertainty, delay and any increased risk of failure.
"I recognise that pre-pack sales are a valuable part of the insolvency landscape, representing around 29% of all administrations. They can be a useful tool to rescue businesses, saving jobs and preserving value. However, creditors are often unaware of the sale until the transaction has completed and pre-packs can be controversial where the business is sold to a person connected with the insolvent company, for example existing management or family members. Although this may sometimes deliver the best outcome possible in the circumstances." Lord Callanan Minister for Climate Change and Corporate Responsibility