Will the proposed changes to pre-packs help business rescue?

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The “pre-pack” Administration has always had a tarnished reputation, even though it is a useful rescue procedure. The draft legislation, set to be introduced from 1 May 2021, whilst well-intentioned, does beg the question as to whether the proposed legislation helps or hinders the role of the pre-pack within our rescue culture.

Insolvency options for rescue post-pandemic

The Covid-19 pandemic has left many businesses in financial distress. Whilst companies have been able to benefit from Government support in the short to medium term, there is likely to be a need for businesses to restructure either their business or their debt as they look towards the post-pandemic future. The UK’s insolvency regime is held in high regard across the world as the UK is seen as having a pro-rescue culture. Our insolvency procedures, especially the Administration and Company Voluntary Arrangement (“CVA”) processes aim to help business owners deal with their debt, whilst also hopefully minimising the impact on the wider supply chain and saving jobs.

Given the change in status for certain HM Revenue & Customs liabilities from 1 December 2020 so that VAT and PAYE (amongst others) now rank ahead of the supply chain, the likelihood of using a CVA to restructure your business in the short term (especially for businesses who have deferred their VAT) will be much lower. For many business owners in this predicament, looking to restructure through a pre-pack process may be the favoured alternative.

The proposed changes to sales to connected parties

Draft legislation is currently going through Parliament to bring in major changes to how insolvency practitioners will be required to conduct pre-pack sales to connected parties. In short, the legislation states 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 transaction or an Evaluator has provided a report on it. Our article setting out the proposed legislation goes into further detail and can be accessed here [Read our Pre Pack Regulations article].

Creditor approval

Obtaining approval prior to a transaction taking place is great in theory, not so much in reality. Administrators are unlikely to be comfortable taking an appointment over a business with a possibility that a sale will not complete very shortly after their appointment. Administrators manage the business of the company over which they are appointed as agents whilst they fulfil their duties and there is always a level of risk with this, not least the potential personal liability that might arise on them. Consequently, the level of uncertainty for all parties created by this new process must bring into question its practicality.

The Evaluator’s role

Given how unlikely it is that Administrators will wait to seek creditors’ approval for a connected party transaction taking place, it feels that the preference will be for the connected party to appoint an Evaluator to provide them with the report instead. There is limited guidance around the expectations of the Evaluator, other than that they will need to have professional indemnity insurance and the “requisite knowledge and experience to provide the report”. Before the legislation is finalised, there needs to be further clarity around the “requisite knowledge and experience” definition. Should there be firmer guidance on what qualifications are needed to become an Evaluator?

In addition, as the Evaluator is providing a report to the connected party, there must be a duty of care from the Evaluator to that party. On the basis that there is a requirement for professional indemnity insurance, the intimation is that there is a risk of challenge to the opinion provided. Does that mean, therefore, that the costs for the preparation of this report will prove prohibitive for SME businesses?  

The outcome of the Evaluator’s report is not binding on the Administrator

One of the failings of this legislations precursor, the Pre-Pack Pool, was that it was not a mandatory requirement for connected parties to seek their opinion on the proposed transaction. Instead, insolvency practitioners advising on a potential pre-pack sale had to make directors/connected parties aware of the Pre-Pack Pool, and make them aware that they should consider preparing a viability statement, but that was it. Even if the connected party chose to pay for an opinion from the Pre-Pack Pool, the transaction could still proceed, as long as the Administrator provided their opinion as to why it did.

The Administrator has their own duties and obligations, which includes acting in the best interests of the creditors as a whole. It is therefore probably correct that the Evaluator’s report is not binding upon the Administrator however there remains a fundamental flaw with the Evaluator role in that it does not bear any real weight in the process, other than facilitating a pre-pack transaction to a connected party. So how is this new process any better than the Pre-Pack Pool?

The legislation seeks to improve confidence in the pre-pack process

But does it? Without any real “teeth”, it is difficult to describe the Evaluator role as anything other than a box ticking exercise, potentially at a cost to the estate (if the connected party reduces their offer to allow for the costs of the Evaluator’s report and there is no credible alternative purchaser). Without a directory of approved, independent Evaluators, it is unlikely to increase confidence in the pre-pack process.

In Conclusion

Administrators, as licensed Insolvency Practitioners, are answerable to their respective regulatory bodies and are required to meet stringent timeframes under the legislation and Statement of Insolvency Practice 16 when conducting pre-pack transactions. Pre-packs (whether to connected or unconnected parties) should play a role in helping the UK to recover from the effects of the pandemic. At a time when businesses have needed, and will likely to continue to need, unprecedented support, making these changes may prove to be more of a hindrance than a help.