Posted: 05 Nov, 2020
On 8th October the Government published draft regulations intended to increase transparency and confidence in administration sales to connected parties and make independent scrutiny of pre-pack sales to connected parties compulsory. Section 8 of the Corporate Insolvency and Governance Act 2020 gives the government until 30 June 2021 to implement the relevant legislation. It is anticipated that the relevant legislation will come into force in early 2021 (assuming that the legislative timetable is not diverted).
The proposed regulations
While most likely to affect pre-pack administrations, the proposed regulations don’t just apply to pre-packs. They apply to any sale of all or substantially all of the company’s business or assets to a connected party that takes place within eight weeks of the company going into administration. This means a sale by administrators to a connected party after a period of trading would also be caught. Administrators will not be able to complete such sales without either creditor consent or an independent written opinion on the sale obtained by the connected party purchaser. It is for the proposed connected party purchaser to obtain the report and it can be from someone who "believes that they have the requisite knowledge and experience to provide the report". This has proven to be contentious in the industry as there is no clear guidance as to what the requisite level of knowledge and experience must be and this may damage the integrity of the report.
When obtaining an independent written opinion, the evaluator’s report will either confirm the value of the sale and justify it or will make a case against it. The administrator must then consider the report but is not required to follow its recommendations. Where the report advises against the sale, but the administrator proceeds with it, the administrator must provide a statement justifying their reasons for doing so. The report will be sent to creditors and filed at Companies House.
What does the Government hope to achieve?
While the regulations will affect all sales by an administrator to connected parties, the Government’s primary aim is to change the perception of pre-pack sales.
For turnaround and restructuring professionals, the pre-pack process is a valuable rescue tool that helps to preserve the value of a business while saving jobs by allowing it to continue to trade. But when connected parties are involved, creditors tend to distrust the process often believing that they are disadvantaged because transactions benefit connected parties leaving their debts uncollectable.
There is a further issue for the government in that public perception of pre-packs is one of a perceived close relationship between insolvency practitioners and the buyers of insolvent companies which is made worse when the buyer is a connected party. This perception still exists, despite the recognition that most pre-pack sales achieve the best price possible and may be attributed to an understandable anger felt when suppliers and other creditors are not paid.
In fact, the vast majority of restructuring professionals are always aware and take into account the impact that any pre-pack sale will have on various stakeholders, including creditors, and instances of abuse surrounding pre-packs, principally where transactions pass value to connected parties at the expense of creditors, are actually very low. Indeed, those involved in the sale, whether valuers or insolvency practitioners, are both professionally regulated and independent of the parties which allows them to be objective when approving any sale.
But while this may be the case, creditors still distrust the process and unsecured creditors typically know nothing about a pre-pack sale until the transaction has completed, fuelling their perception of the process as one which isn’t in their best interests.
So, with creditor and public confidence in pre-pack administrations low, the Government’s intention is to increase transparency and enhance confidence in the process. However, it also recognises the tool as an important component in the UK’s restructuring and rescue regime and doesn’t want to reduce its effectiveness.
Will the proposed regulations have a positive or negative impact on the process?
The Government’s aim to increase confidence and transparency in pre-packs is not unwelcome by those in the turnaround profession. But will the new regulations achieve this without also negatively impacting the process?
First it should be noted that the regulations do introduce some positives for those in the turnaround and restructuring profession by providing an extra layer of protection from challenges by creditors. For administrators the independent report (if supportive of the sale) will provide documentary evidence to support their decision about a sale and will help protect them from criticism by creditors looking to challenge the sale at a later date. For directors, the independent report also provides them with an opportunity to show independent scrutiny of the proposed deal.
For creditors, the creditor approval route should serve to achieve the Government’s aim of increasing confidence in the process by inviting their direct involvement in the sale. In practice, however, it is unlikely that this route will be used in favour of the independent opinion route. Only when there are a limited number of known creditors that are supportive of the sale is the creditor approval route likely to be adopted, otherwise, there is a degree of uncertainty and also the issue of convening a creditors meeting. It is therefore likely that creditors will still have little to no role in the process and confidence could remain low since the decision will still be made by professionals, as with the current approach. Indeed this is made worse by the notion that more than one report could in theory be obtained to try and find the favourable scrutiny needed to allow the deal to pass through. The shopping for independent scrutiny reports is to be discouraged and it is perhaps for the Insolvency Practitioners to take a hard line in this process by refusing to transact if they become aware of the existence of an adverse report. If multiple reports are obtained they must be sent to Companies House and the creditors. Further, the administrator must justify his or her decision to transact notwithstanding the adverse report.
Looking at the practical impact, some are concerned about the regulations impacting the speed at which pre-packs can be concluded. Speed is often a key component of successful pre-pack sales and delays have the potential to cause damage to the business. The new regulations will require an as-yet-unknown amount of preparatory work to obtain an independent opinion and it is not yet clear who will provide it or how and when that opinion will be delivered. Swift evaluations and reporting will be essential so as not to impede efficient sales. However, it should be remembered that the regulations only affect sales where connected parties are involved so perhaps a likely consequence will be fewer sales to connected parties, and possibly lower realisations.
Additionally, it is not clear how and how much the independent evaluator will be paid although the report is to be obtained by the connected party buyer. As a consequence, any opinion, while independent could be open to criticism given that the connected party is the customer. Those unhappy with the report’s recommendations could also argue the opinion is open to influence from referring parties such as the administrator.
As with all new legislation, it’s impact won’t truly be known until it is implemented and used but those in the turnaround and restructuring profession will hope that the aim to improve creditor and consumer confidence in pre-packs will be achieved without also having a negative impact on this valuable rescue tool.
“The Covid 19 Pandemic has led to a number of recent changes to the UK insolvency regime although concerns regarding prepacks have been around for some considerable time. It is hoped that the new regulations will go some way to improving confidence in what is often a valuable weapon in the UK restructuring arsenal. However a lot will depend on Insolvency Practitioner’s managing reputational risk proactively and engaging with suitably qualified and reputable independent evaluators to promote integrity in this area”. Andrew Cawkwell, TMA UK Director
TMA UK is part of TMA, a global organisation that represents the interests of turnaround professionals as its members who have the skills needed to assist in these unprecedented times. If you need assistance, please contact our helpline on 0844 804 0116.
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