This article contains a useful re-cap of the changes made to SIP 16 and the introduction of a pre-pack pool in November 2015. It also takes an early look at whether the pre-pack pool is working, citing some statistics on “take-up” since the pool’s inception and some examples of pre-packs to connected parties since the pool was introduced.
What is a “pre-pack”?
A “pre-pack” is a sale of a company’s business and assets by an administrator immediately on, or shortly after, the administrators’ appointment, on terms that have been negotiated and agreed in advance of the company entering administration.
The lack of transparency of pre-pack sales by administrators has long divided opinion, particularly where the purchaser is the existing management team or owners or connected to the selling business. In these cases, creditors often feel that they are left “high and dry” with no visibility or remedy, whilst the management responsible for the failure of the old business, or connected parties, move onto a new, but essentially the same, business, free of legacy creditors.
Conversely, advocates of the process argue that pre-packs preserve going concern value in businesses, which is so often otherwise destroyed during a trading administration or a sale negotiated post-administration. They say that, at its best, the process maximises that going concern value, generating maximum return for creditors and, in the process, saving more jobs and businesses which then continue to contribute to UK plc.
Attempts to address criticism of the process and the Graham Report
Statement of Insolvency Practice 16 (SIP 16) was introduced in January 2009 to address criticism of the pre-pack process. This required administrators of a company to report to creditors on a pre-pack sale. SIP 16 was updated and made more prescriptive in November 2013 to require more information to be provided to creditors regarding, amongst other things, the marketing of the business prior to sale.
These attempts to address criticisms of the process were deemed unsatisfactory and, in 2013, the government commissioned a review of pre-pack administrations. On 16 June 2014, the Insolvency Service published the Graham Report of Pre-Pack Administrations completed by Teresa Graham CBE.
The Review gave a relatively balanced assessment of pre-packs, and proposed voluntary scrutiny of them, rather than new legislation. It made recommendations targeted at sales to “connected parties”, having found that returns to creditors from connected sales were usually worse than from sales to independent third parties, whilst connected purchasers were, statistically, less likely to succeed than unconnected purchasers. These recommendations included further revisions to SIP 16 and the creation of a “pre-pack pool” of experienced business people, who would review sales to connected parties.
On 1 November 2015 a new SIP 16 came into force to coincide with the launch of the pre-pack pool on 2 November 2015.
The revised SIP 16
Under the revised SIP 16, insolvency practitioners must now:
- identify any pre-appointment advisory role they have held prior to appointment and explain the difference between such advisory role and that of an administrator;
- keep a detailed record of the reasons for a pre-pack and all the alternatives that were considered;
- make a prospective connected purchaser aware of its ability (but not duty) to (i) apply for an opinion from the pre-pack pool and/or (ii) to make a “viability statement” to creditors, stating how the purchaser will survive for the next 12 months and what it will do differently to avoid another failure of the business;
- market the business for sale in a way that is proportionate to its nature and size;
- deliver a SIP 16 statement to creditors, with notification of their appointment and within seven days of the pre-pack sale, to include: an explanation and justification for the pre-pack and of the marketing undertaken, an indication as to whether alternatives were considered and explain the marketing undertaken in the SIP 16 statement and, importantly, any opinion given by the pre-pack pool and any viability statement produced by the purchaser.
The pre-pack pool
The pre-pack pool is an independent body of 19 (at the time of writing) experienced business people from a variety of industries, who offer their opinion on a proposed pre-pack to a connected party. The requirement to sit as a pool member includes 10 years at board level as a minimum, with as broad a range of board experience as possible. Practising insolvency practitioners have been excluded from the application process in order to avoid potential conflicts of interest and accusations of tribalism, but retired insolvency practitioners have been accepted.
The pre-pack pool operates exclusively via its website (www.prepackpool.co.uk). Prospective purchaser applicants must submit information electronically and there is no prescribed requirement in format. Cases are allocated on a rota basis to one of the pre-pack pool members. Applications cost £800 plus VAT. The pre-pack pool website states that, usually, responses will be provided within 48 hours.
The designated pool member will issue one of the following three opinions:
- Nothing found to suggest that the grounds for the proposed pre-packaged sale are unreasonable.
- Evidence provided has been limited in some areas but otherwise nothing found to suggest that the sale is unreasonable.
- There is a lack of evidence to support a statement that the grounds for proposed pre-package sale are reasonable.
No reasons are given for the opinion issued and there is no mechanism for an appeal.
Applications are confidential, but applicants are asked to consent to the opinion being sent to the prospective administrator who will, in compliance with SIP 16, wish to include it in the SIP 16 statement to creditors following any pre-pack sale.
Crucially, applications to the pre-pack pool are not compulsory. Insolvency practitioners merely need make prospective connected purchasers aware of the pre-pack pool and the potential for enhanced stakeholder confidence if a positive pool opinion is issued. The decision to apply rests with the buyer.
Will the pre-pack pool work?
From its inception, there has been a good deal of scepticism about the operation of the pre-pack pool amongst restructuring and insolvency professionals and commentators. That scepticism seems to stem from the fact that use of the pool is optional for connected purchasers. It is felt that, whilst references to the pool remain discretionary, only well-funded connected purchasers and those beyond reproach will be inclined to use it. Even they may be reluctant to do so given that it doesn’t bestow any protection from challenge or criticism. Once a deal is agreed, at which point an application might be made, time is usually of the essence and (often tight) resources are directed at due diligence and legal negotiations. Time and effort spent on a pre-pack pool application may not be high on the agenda. Indeed, if funding headroom is tight, it is unlikely to be considered a critical cost.
Certainly those connected purchasers with a potential question mark over their pre-pack offer, and therefore those that the new regime is designed to catch, are likely to avoid it completely for fear of an adverse opinion.
Are connected purchasers using the pre-pack pool?
Given the confidentiality of pre-pack pool applications, it will take some time for academics and commentators to get a firm sense of the impact of the pool process. However, statistics as to use of the pool to date and anecdotal evidence from insolvency practitioners can give us an early indication.
At the time of writing this article (4 months after its launch), the pre-pack pool had received 8 applications. In all cases the designated pool member opined that there was “no reason not to proceed” or “no reason not to proceed, but with minor limitations in evidence provided”. No negative opinions had been issued.
How does 8 applications in 4 months compare with the number of pre-pack sales to connected parties during the same period?
It is impossible to know how many pre-pack sales to connected parties were completed between November 2015 and February 2016, but it is possible to formulate an estimate, based on historic statistics.
According to the Graham Report, the Insolvency Service estimated that, in 2011, 25 per cent of 2,808 administrations gave rise to a pre-pack sale and that nearly 80 per cent of those pre-pack sales were to connected parties. The most recent Insolvency Service statistics recorded that 363 companies entered administration in Q3 of 2015. That averages out (crudely, it is acknowledged) to 121 administrations each month, suggesting there were approximately 480 administrations between 1 November 2015 and 29 February 2016. If the Insolvency Service estimates from 2011 are applied, 25% (120) of those administration would have given rise to pre-packs sales, and 80% (96) of those pre-pack sales would have been to connected parties.
The authors acknowledge that this estimate necessarily applies a number of assumptions and is, ultimately, an unsophisticated calculation. However, historic data would suggest that it is in the right “ball-park”. If one accepts that premise, 8 pre-pack pool referrals in 4 months does not appear to represent a promising strike-rate.
Anecdotally, in the high-profile, pre-pack sale of elements of the Parabis Group to a team including some original Parabis founders (i.e. a connected purchaser), the purchaser declined to use the pre-pack pool and the sales completed regardless. In the Parabis SIP 16 note, the administrators appended a letter from the connected purchaser explaining that it had declined to use the pre-pack pool on the basis that the business had been marketed robustly, and the proposed price was the best on offer. It is hard to argue with the logic of that argument, but it does seem to bear witness to some of the rationale for scepticism about transparency referred to earlier in this note.
A concluding thought
With the introduction of the revised SIP 16 and pre-pack pool, the government has given the insolvency and restructuring profession an opportunity voluntarily to improve creditor confidence in pre-pack sales and to prove that they are a valuable tool for saving businesses and preserving employment. However, the profession is reliant on connected purchasers to help dispel the myths and promote the merits of pre-pack sales, by using the pre-pack pool. Evidence to date suggests that connected purchasers are not playing ball, although more time is needed to assess the full impact of the pool. If the pool does prove to be a damp squib, there is a real risk that the government will look again at statutory regulation, which will no doubt be more onerous for insolvency practitioners and, worse still, could dilute the value of pre-pack sales. That said, with insolvencies at an all-time low and pre-pack sales in decline has government concern and public criticism dwindled, and with it the need for the use of the ‘pre-pack’ pool and any further regulation?