A new Statement of Insolvency Practice (SIP16) is expected to be published in March 2015, aimed at improving the framework and operation of pre-pack administrations. This follows the Graham Review, and its report published in June 2014. In this article, we explore the existing pre-pack structure, its shortcomings and how the changes expected might affect insolvency practitioners and their insurers.

Background

Of approximately 20,000 businesses that are the subject of an insolvency procedure every year, around 600 to 700 involve pre-pack administrations. In those instances, and usually before the creditors are aware of its failure, the administrator sells the business on, often to the existing owners or directors that have overseen its demise. It is small wonder then that pre-pack administrations are often treated with suspicion and have long been criticised in numerous respects, many of which were recognised in the Graham Review. These criticisms include:

  • A lack of transparency around pre-pack administrations
  • Insufficient, and in many instances non-existent, marketing
  • Inadequate assessment of the viability of the new business with 29 per cent of connected sale pre-packs failing within 3 years, although that number falls to 16 per cent where the sale is unconnected
  • Weak control and regulation of professionals in the conduct of pre-pack administrations

However, it is also important to recognise that pre-packs can often be the most favourable outcome for a business, its owners or directors, employees and its creditors. They are quicker and cheaper than a formal insolvency procedure and aim to keep a business trading with minimal, if any, interruption. They are also part of a flexible insolvency framework, arguably bringing a benefit to the UK economy by attracting foreign companies and investment, which encourages restructuring in times of difficulty. Further, many of the perceived disadvantages outlined above can also work to practitioners’, and the struggling company’s, advantage. Overall, therefore, pre-packs are usually seen as a positive aspect of UK company law.

The Graham Review

The Graham Review suggested a number of changes to the way in which pre-pack administrations are carried out which it incorporated in an amended draft SIP16. Whether, and to what extent, the final statement will adopt those changes is currently open to conjecture but, the Graham Review having been commissioned by Vince Cable, the Secretary of State for Business, Innovation and Skills, it seems likely that any differences will be limited. The Graham Review’s key recommendations include:

  • The creation of an independent pre-pack pool, where connected parties disclose details of a proposed deal to an allocated member of the pool to review the documents and provide comment
  • A viability review by connected parties on the new company, stating how it will survive for at least 12 months following the pre-pack
  • The marketing of businesses in accordance with certain principles, and where marketing is not thought to be desirable, an explanation from the administrator as to why
  • The appointment of an independent valuer with professional indemnity insurance to undertake a valuation of a pre-pack business
  • Moving the task of monitoring SIP16 statements from the Insolvency Service to the recognised professional bodies

Comment

The aims of the Graham Review, and of the anticipated updated SIP16, are clear: to rectify as many of the problems and criticisms of the existing pre-pack procedure as possible. The hope is that this will in time ensure greater confidence from creditors, directors and insolvency professionals and that pre-packed businesses will be more successful trading propositions going forward. But what will be the effect on practitioners if the Graham Review achieves its objectives?

There will certainly be more work required in pre-pack administrations. In addition, greater opportunities for professionals in the pre-pack pool (the industry is hopeful the pool will be operational by the end of March) and those who specialise in valuing failed businesses also arise. An increased willingness to intervene by regulatory professional bodies may also be a feature, but the better-organised practitioner should have nothing to fear there.

Isurers will be keen to establish whether the new regime will mean fewer claims arising out of the conduct of a pre-pack administration. Having to justify a marketing strategy, or lack of one, independent valuations and a more stringent approach in determining the survival prospects of a pre-packed business should in time mean that claims are less likely, provided the decisions taken are reasonable in the circumstances and are supported by sound judgement. However, if a claim is made, there is a concern that the standards to which practitioners are to be subject will be considered higher, making them harder to defend.

There is bound to be uncertainty while the new regime gets up and running, particularly if it follows the recommendations of the Graham Review. With the thinly veiled threat of asking the government to consider legislation to formally enact the proposed changes where practitioners do not accept them, the industry would do well to familiarise itself with the new SIP16 and act accordingly.

On balance, it is probably fair to say that practitioners, their regulatory bodies and their insurers have been presented with an opportunity to create an improved system of pre-pack administrations that will suit their own needs, as well as the interests of the businesses, directors, creditors and employees concerned.