Pre-Packs: The New Regulations
Pre-packaged administration sales, or “pre-packs”, remain a widely used and useful tool in restructuring, helping to preserve businesses as a going concern. However, their beneﬁts are to be balanced with the need for transparency and the interests of creditors as a whole.
In response to criticism of pre-packs, and following a recent review of existing industry measures, the Government has introduced the Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (the “Regulations”) which aim to provide creditors with reassurance that pre-pack sales to connected parties are fair, appropriate and transparent.
The Regulations came into force on 30 April 2021. In this article we consider the background to the enactment of the Regulations, the Regulations themselves, recent guidance issued in relation to the Regulations by the Insolvency Service and issues that might arise in the future in relation to the application of the Regulations.
The use of pre-pack sales in administration
A pre-pack sale occurs when the sale of all or a substantial part of a company’s business is arranged prior to that company’s entry into administration. The sale is then formally executed shortly after an administrator is appointed.1
Pre-pack sales are not expressly provided for, nor defined, in the Insolvency Act 1986 (the “IA 1986”). However, it is well-established that an administrator may exercise all of his or her statutory powers – including the power to sell the property of the company – without the leave of the Court, or the approval of creditors.2 Indeed, on an application for directions by administrators, the Court will be reluctant to endorse decisions which are simply of a commercial nature (although on an application for an administration order the Court may expressly give an administrator leave to enter into a pre- packaged sale of the company’s business).
There are, potentially, very great advantages to pursuing a pre-pack sale. In particular, the use of a pre-pack may facilitate the rescue of the business, by effecting a swift and smooth transition of ownership to a solvent entity, without the uncertainty (and potential stigma) of remaining in an insolvency process.3</sup It avoids the cost of trading in administration.4 Further, the process is cheaper than pre-insolvency procedures, such as schemes of arrangement.5 It does not require the leave of the Court, or the approval or involvement of creditors. As such, pre-pack sales are an important aspect of the rescue culture that administration promotes. Finally, there is empirical evidence that pre-packed businesses are more likely to succeed than business sales that occur in the context of a trading administration.6
However, critics of pre-pack sales point to numerous potential risks of the process.7 In short, the very features which are pointed to as a strength of pre-packs may also ground criticisms. The absence of any court or creditor involvement has meant that concerns have been raised about the absence of any transparency in the process.
Creditors are not informed of the sale, until it is presented to them as a fait accompli.8 Particular concerns arise where – as is commonly the case – the business and assets are sold to a person who is connected to the insolvent company, such as a director. There is some evidence to indicate that pre-pack sales to connected parties are less likely to lead to a successful ongoing business.9
Past reviews of pre-pack sales
Concern about the use of pre-packs led to a 2010 consultation by the Government which sought to improve the transparency of pre-pack sales.
The outcome of this consultation was a proposal that creditors of an insolvent company ought to be given a period of notice before any pre-pack sale was effected. However, this proposal was not given effect.10
In 2014, Dame Teresa Graham conducted a wide- ranging review of pre-pack sales, and their conomic impact. The Graham Report concluded that whilst there were substantial benefits to pre-pack sales, there were, nevertheless, improvements that ought to be made to the manner in which they were administered. Dame Teresa made various recommendations, many of which were directed at improving the transparency of the process and/or ensuring that the optimum sale price was achieved.
One such recommendation was the establishment of a “pre-pack pool”. This initiative was limited to situations in which the sale was made to a “connected party” – which was defined in broad terms. In short, where a director, shadow director or officer of the insolvent company (or an associate thereof) took on one of those roles in the new company, or exercised control over the new company, the connected person would have the “opportunity”11 to refer a proposed sale to the pre-pack pool.
The members of the pre-pack pool were business people. Upon a referral to the pool, one member would assess the proposed sale, and would issue a statement. The purpose of the pre-pack pool was to “create independent scrutiny of the deal yet retain overall secrecy before the event”.12
Any referral by a connected person was purely voluntary. Moreover, if the pool member issued a negative statement, there was no obstacle to the sale proceeding; rather, the fact of the negative statement would be referred to in the SIP16 statement.
All of the recommendations made by Dame Teresa were voluntary measures, and all were implemented by the industry in 2015. None required legislation. However, the Small Business Enterprise and Employment Act 2015 created, in section 129, a reserve power for the Secretary of State to legislate in respect of pre-packs – but subject to a sunset provision, which (after extension) was due to expire in June 2021. The purpose of the reserve power was to enable the Government to take legislative steps if voluntary measures proved ineffective.
The 2020 Report, and the background to the Regulations
In October 2020, the Insolvency Service published a Report reviewing the effectiveness of the measures that had been introduced in 2015 as a result of the Graham review. It was noted that although there had been improvements in the marketing of businesses that were to be the subject of a pre-pack sale, there was nevertheless ongoing concern about the transparency of pre-packs, and “whether they are always in the best interests of creditors”.13 Again, it was observed that concerns were particularly acute in respect of sales to connected parties, which were noted to be about half of all pre-pack sales. The report also observed that there was a particular need to protect creditors because of the foreshadowed increase in company insolvencies as a result of the COVID-19 pandemic.
The Explanatory Memorandum to the Regulations noted that the use of the pre-pack pool was disappointingly low – in 2019, there were 260 pre-pack sales to connected parties, but only 23 referrals were made to the pre-pack pool.14 Further “non-legislative measures” were considered to be inappropriate, because referral to the pre-pack pool was already available on a voluntary basis.15
The October 2020 Report16, which included the results of a survey of insolvency practitioners, indicated that the most commonly cited reason for not using the pool was that the purchaser of the business saw no benefit in making a referral to the pool. The cost was also cited as a factor – which was £950 plus VAT. However, it was generally agreed that the pool functioned well. Moreover, various stakeholders expressed disappointment that it was not more frequently used.
As consequence of these ongoing concerns the Regulations (drafts of which were published with the October 2020 Report) were enacted on 29 March 2021 and came into force on 30 April 2021.
We summarise the Regulations below.
The Regulations provide (regulation 3) that an administrator cannot execute a “substantial disposal” with a “connected person” during the period of 8 weeks beginning with the day on which the company enters into administration unless either one of the following two conditions is met:
- the prior approval of the company’s creditors has been obtained; or
- a “qualifying report” in respect of that disposal has been obtained (i.e. a report from an “evaluator”, as described further below).
The Regulations operate only in relation to administrations which commence on or after 30 April 2021.
What is a substantial disposal?
Regulation 3(3)(a) defines the term “substantial disposal” as “the disposal, hiring out or sale to one or more connected persons, during the period of 8 weeks beginning with the day on which the company enters administration, of what is, in the administrator’s opinion, all or a substantial part of the company’s business or assets”.
As the Regulations are engaged in relation any substantial disposals made to a connected person within the period of 8 weeks of commencement of the administrations, they will catch not only traditional pre-packs negotiated and arranged before the company goes into administration but also disposals to a connected person arranged after the commencement of the administration and effected within 8 weeks.
The Regulations do not define the term “disposal” other than by referring to “a disposal, hiring out or sale” (regulation 3). The term is likely to be interpreted broadly. It will include, for example, a situation where a connected person holding security over the company’s assets purchases the business or assets to reduce their level of debt in the administration.17
Whilst yet untested, an attempt to flout the Regulations by agreeing a sale but deferring completion to beyond the expiry of the eight week period within which disposals are caught by the Regulations appears unlikely to be successful because the contract will likely give rise to the creation of an equitable interest sufficient to constitute a “disposal”.
To fall within the scope of the Regulations, the disposal must be a disposal of what, in the administrator’s opinion, is all or a substantial part of the company’s business or assets. Establishing whether a disposal is substantial will, therefore, likely include the administrator considering but is not limited to: (i) the value of either the business, assets or both involved in the disposal; (ii) how much of the business is being disposed of; and (iii) whether the trading style and good will of the business forms part of the disposal.18
The expression “all or a substantial part of the company’s business or assets” is not defined but is similar to the term used (and equally not defined) in relation to the definition of the holder of a qualifying floating charge in paragraph 14 of Schedule B1 to the IA 1986 (“Schedule B1”).
Where there is doubt as to whether a disposal involves “all or a substantial part of the company’s business or assets” it seems likely the Court will give an administrator some latitude (the Regulations leaving it up to the administrator’s “opinion” whether the disposal involves such a part of the company’s assets).
A disposal can only be a substantial disposal, and so within the scope of the Regulations, if it is a disposal to one or more “connected persons” and takes place during the period of 8 weeks from the date the company enters into administration.
A series of connected transactions may constitute a substantial disposal (regulation 3(3)(b)).
Who is a connected person?
The Regulations are only engaged where the disposal is to “one or more connected persons”. For these purposes, the definition of “connected person” used in paragraph 60A(3) of Schedule B1 is adopted.
The analysis of connectedness under paragraph 60A(3) of Schedule B1 (which relies to some extent on section 435 of the IA 1986) in any given case may be complex. It is the responsibility of the administrator to establish if a party is connected to the company.
Connected persons include: (a) a director or other officer of the company; (b) a shadow director of the company; (c) a “non-employee associate” (being an associate as defined in section 435 of the IA 1986, but excluding someone who is an associate only by reason of an employment relationship) of a director, other officer or shadow director; and (d) companies connected with such persons.
The full definition is set out in paragraphs 60A(3) to (6) of Schedule B1 and will require careful consideration in particular cases.
The obligations imposed on an administrator under the Regulations apply irrespective of the administrator’s knowledge of whether the buyer is, in fact, a connected person. Where there is any doubt as whether or not a person is connected it is likely to be necessary, therefore, for an administrator to conduct appropriate investigations and/or to obtain legal advice.
The Regulations allow a disposal that would otherwise be prohibited in two circumstances. First, a substantial disposal to a connected person is permitted where the approval of the company’s creditors is obtained before the disposal is made. Secondly, such a disposal is permitted where the administrator has obtained a “qualifying report” and complies with the relevant notification requirements. Each of these two categories of permitted disposal are considered below.
Approval of the company’s creditors
This option requires the administrator to (regulation 4):
- Include proposals for making the disposal (“disposal proposals”) in the statement of the administrator’s proposals for achieving the purpose of the administration under paragraph 49 of Schedule B1; and
- Seek the creditors’ approval of the disposal proposals before the disposal
The administrator may only proceed with the disposal once the creditors have approved the disposal proposals, either as initially proposed or as modified with the administrator’s consent.
The Regulations are silent as to the details of the disposal required to be included in the disposal proposals. However, it seems likely that the information requirements set out in SIP 16 will provide a useful reference point as to the detail to be provided.19
Approval of the disposal proposals will be decided by creditors at the same time as they decide on whether to approve the administrator’s proposals under paragraph 51 of Schedule B1. Given this, the option of obtaining creditors’ approval is likely to prove impractical in many cases in which pre- packs would traditionally be carried out, because of the delay that would be associated with obtaining such approval.
The creditors’ decision is made in accordance with section 246ZE of the IA 1986. It appears that the decision can be made using them deemed consent procedure under section 246ZF. There are circumstances in which approval of the administrator’s proposals is not required under paragraph 51 of Schedule B1 to the IA 1986 – namely, where the administrator has made a statement under paragraph 52(1). However, in these circumstances, approval of the disposal proposals is nevertheless still required, and accordingly a decision procedure (which may include deemed consent) must still be undertaken in relation to the disposal proposals.
Obtaining a qualifying report
If the administrator proceeds on the basis of an evaluator’s report (rather than creditor approval), the administrator must obtain a copy of the report, which is commissioned and paid for by the connected person, before effecting the disposal. The administrator must also comply with notification requirements in relation to the report. An evaluator’s report will be a “qualifying report” if the statutory requirements around both its process and content are met.
Critically the qualifying report must contain a statement, with reasons, that either: (i) the evaluator is satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances; or (ii) the evaluator is not satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances (a “case not made opinion”) (regulation 7(h)).
In addition, the report must contain:
- A statement as to what relevant knowledge and experience the evaluator has to make the report.
- Details of the professional indemnity insurance that the evaluator carries.
- Details as to any previous report that the connected person has obtained, where known to the evaluator
- Identification of the property being disposed of and the consideration for the disposal.
The connected person is responsible for providing information to an evaluator to complete their report. The connected person should obviously expect to be asked for information about the company entering administration, the recipient of the assets and the substantial disposal. A viability statement or business plan (or both) may well be requested where a disposal involves deferred consideration.20
In order for a report to constitute a “qualifying report” its contents must have been considered by the administrator (regulation 5(a)). The report must be obtained by a connected person and given to the administrator. The report must be in writing, dated and authenticated by the evaluator (regulation 6).
An administrator does not have to be appointed at the time the report is obtained. For obvious reasons it would not be possible to carry out a pre-pack sale in many cases were that not the case. Instead, the report may be obtained before the company enters administration so that the sale can be finalised as soon as possible by the administrator following appointment.21
Who can act as evaluator?
In order for a person to be able to act an evaluator, the administrator must be satisfied that the person has sufficient relevant knowledge and experience to make the report (regulation 6(1)(a)(ii) and 6(2)). The evaluator must be satisfied that their own relevant knowledge and experience is sufficient for the purposes of making a qualifying report (regulation 10(a)).
As described in the Insolvency Service’s Guidance in relation to the Regulations,22 there are certain professions that are more likely to have the relevant knowledge and skills required to act as an evaluator. These include accountants, surveyors, lawyers with a corporate background and insolvency practitioners. However, it is not necessary for an evaluator to have insolvency experience. The selection of an evaluator may depend on the nature of the business for sale and someone with specialist knowledge of the business may be more suitable.
In addition, the evaluator:
- Must have professional indemnity insurance in place to cover possible liabilities to the administrator, the connected person, creditors or any other person (regulation 11).
- Must be independent.
As to independence, an individual will meet this requirement unless they (regulation 12):
- are connected (within the meaning of section 249 of the IA 1986) with the company in administration or the connected person;
- are an associate (within the meaning of section 435 of the IA 1986) of the connected person;
- know or have reason to believe that they have a conflict of interest (being a financial or other interest which is likely to affect prejudicially their independence in providing a qualifying report); or
- have within the previous 12 months, provided advice to, and in respect of, the company (i) in connection with, or in anticipation of, the commencement of an insolvency procedure or (ii) in relation to corporate rescue or
In addition, Regulation 13 excludes a number of persons for acting as an evaluator including:
- the administrator, any associate of the administrator and any person connected with a company with which the administrator is connected;
- persons with unspent convictions for offences involving dishonesty or deception; and
- persons who are subject to insolvency proceedings or are disqualified under the Company Directors Disqualification Act 1986
What happens if the report states a case not made opinion?
Where the evaluator produces a case not made opinion, an administrator will still be able to proceed with the sale to the connected person but will need to provide an explanation to creditors of why the administrator has proceeded nevertheless (regulation 9). The administrator is, therefore, obliged to consider the evaluator’s report but is not required to follow it.
Accordingly, an administrator can proceed with a disposal even where an evaluator has stated they are not satisfied that the disposal is reasonable. For example, if the evaluator’s report contains a case not made opinion, but no other potential purchasers are found following a properly run sales process, the administrator may well be justified in allowing the sale to take place in any event.
“the ways in which connected persons may attempt to circumvent the disclosure requirements, remain problematic”
However, good reasons as to why it said that the administrator considers that it would be in the best interests of creditors to enter into the disposal (notwithstanding the evaluator’s view) are likely to be required. If an administrator simply states that the disposal is justified without any sufficient explanation, then it may be difficult for them to show that they have complied with the requirements under the Regulations to consider the contents of the report and/or their fiduciary and other duties to the company.
The administrator must provide a copy of the report, and where applicable, a statement of reasons for proceeding with the disposal, to creditors and to Companies House at the same time as sending them a copy of his or her statement of proposals for the administration under paragraph 49 of Schedule B1 (that is, as soon as reasonably practicable and in any event within eight weeks of the start of the administration) (regulation 9(5)).
There are two circumstances in which an administrator must do more than merely send a copy of the report to creditors and Companies House. In each such case, the administrator must provide a statement of reasons for proceeding with the disposal. The circumstances are: (i) where the evaluator has given a case not made opinion; and (ii) where the evaluator has included in the qualifying report details of any previous report where the person making that earlier report was satisfied that the grounds for the disposal were not reasonable in the circumstances or the consideration to be provided for the disposal was not reasonable in the circumstances.
The administrator may, in providing a copy of the qualifying report, exclude any information that, in the administrator’s opinion, is confidential or commercially sensitive.
The administrator is not required to fulfil the notification requirements before proceeding with the disposal.
Issues for the future
Whilst the Regulations represent an important development in the regulation of pre-pack sales they are likely to engender issues which will require careful consideration, including by the court.
We highlight three such issues below.
There is nothing to prevent a connected person from obtaining more than one report if it does not like what arises from the first one. If an evaluator becomes aware that a previous report has been obtained, the evaluator’s qualifying report must include a copy
or details of it, if they are available to the evaluator. Alternatively, the
qualifying report must state that that report or details of it have not been made available to the evaluator, and provide details of why the evaluator did not obtain it, and any steps that they took to obtain it (regulation 8).
The ability of the connected person to “opinion shop” has been the subject of criticism by commentators, and the extent to which evaluators must investigate, and the ways in which connected persons may attempt to circumvent the disclosure requirements, remain problematic. There is plainly scope for mischief.
Sanctions for non-compliance
The Regulations are silent on any consequences of non-compliance. There is no suggestion in the Regulations that the disposal itself could be undone. Instead, it seems likely that a failure by an administrator to comply with the Regulations may constitute a matter relevant to a court in determining whether the actions of the administrator are open to challenge under paragraph 74 of Schedule B1 (unfair harm), or whether the administrator has been guilty of misfeasance under paragraph 75 of Schedule B1. By contrast, where an administrator has complied with the Regulations and a positive evaluator’s report has been obtained, that may well make a claim against an administrator in respect of pre-pack sale more difficult.
The duties owed by the evaluator to other parties
It is also not clear in what circumstances the creditors, the administrator or the connected party might have some form of recourse against the evaluator in the event that there is some shortcoming in the report. The regulations provide that the evaluator must have professional indemnity insurance to meet potential liabilities to “the administrator, the connected person, creditors or any other person” (regulation 11). However, the regulations identify only the requisite content of the qualifying report (regulation 7); they do not identify what investigation (if any) the evaluator must undertake of the circumstances of the disposal, or the process by which the port ought to be prepared. Moreover, as noted above, the evaluator will usually be commissioned and paid by the connected person, but their report must be considered by the administrator (regulation 5) and provided to creditors (regulation 9(5)). If there is some dispute as to the accuracy or reliability of the evaluator’s conclusions, then it is uncertain (1) to whom the evaluator would owe a duty, and (2) the scope of any such duty.
The Regulations represent an important development in the regulation of pre-pack sales. However, political interest in pre- pack sales will remain high. It remains to be seen whether the Regulations will quell the calls for further transparency in relation to pre-packs and whether further legislative intervention will be necessary in the future.
1 See the definition in the Graham Report, [5.15].
2 Re T & D Industries plc  1 WLR 646.
3 See Trower et al, Corporate Administrations and Rescue Procedures (4th ed, 2017) [10.4].
4 The Insolvency Service, Pre-pack sales in administration report, 8 October 2020, Executive Summary
5 Graham Report, [3.5].
6 Graham Report, [6.1].
7 Graham Report, [6.1].
8 Graham Report, [7.25].
9 Graham Report, [9.3].
10 Graham Report, [5.1].
11Graham Report, [9.7].
12 Graham Report, [9.7].
13The Insolvency Service, Pre-pack sales in administration report, 8 October 2020.
14 Explanatory Memorandum, [7.4].
15 Explanatory Memorandum, [7.4].
16 The Insolvency Service, Pre-pack sales in administration report, 8 October 2020.
17 Paragraph 4 of the Insolvency Services’ Guidance in relation to the Regulations.
18 Paragraph 4 of the Insolvency Services’ Guidance in relation to the Regulations.
19 Both SIP 16 (Pre- packaged Sales in Administrations) and SIP 13 (Disposals of Assets to Connected Parties in an Insolvency Process) have been updated as of 30 April 2021 to take into account the changes made by the Regulations.
20 Paragraph 7 of the Insolvency Services’ Guidance in relation to the Regulations.
21 Paragraph 6 of the Insolvency Services’ Guidance in relation to the Regulations.
22 At paragraph 7