Pre-packaged administration sales (where a sale of key assets is agreed prior to the appointment of administrators and then implemented by the administrators immediately following their appointment), have been a widely-used and highly successful tool to rescue businesses, or parts of businesses, that may otherwise have languished in administration interminably. However, some criticism has been levied against pre-pack sales on the grounds that they provide a possible opportunity for unscrupulous business owners to buy back assets and create so-called "phoenix companies", to the detriment of creditors. In response to recent media coverage and criticism of pre-packaged administration sales along these lines, new legislation has been introduced with a view to increasing transparency and creditor confidence by imposing conditions on pre-packs to persons "connected" to the insolvent company.
The Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (the "Regulations") prevent an administrator from selling a substantial part of a company's assets to persons connected to the company within the first 8 weeks of appointment without certain conditions being satisfied. From 30 April 2021, an administrator must obtain either creditor approval to the disposal or an expert's report confirming that the disposal is reasonable before disposing of the relevant assets.
The concept of "connected persons" will be familiar to restructuring professionals from the Insolvency Act 1986. For the purpose of the Regulations, "connected persons" include directors and shareholders of more than a third of the voting capital of the insolvent company, as well as entities which are controlled or owned by those directors and shareholders.
Lenders to an insolvent company will not be "connected" by virtue of the Regulations, unless they also control more than a third of the voting rights.
Either of the two conditions must be satisfied if a disposal to a "connected person" is to be completed within 8 weeks of the administrator being appointed:
The administrator obtains creditor approval to the disposal through a qualifying decision procedure before completing the disposal. This requires approval of more than 50% in value of creditors holding unsecured claims. Such approval would be ineffective if more than 50% of such creditors who are unconnected to the company vote against the proposals.
The Regulations specify that the decision must be included with the administrator's proposals, which requires that creditors receive at least 14 days' prior notice before approval can be granted. As the administrator has no authority to issue the proposals prior to appointment, there doesn't appear to be any route to avoid a significant delay to the disposal (at least 14 days if the proposals are delivered immediately upon appointment) and, accordingly, adopting this route will negate the typical benefit in a pre-pack of minimising disruption to the business and diminution of value.
It will be interesting to see how often this route is used in practice, as the notice requirements will cause a significant increase in risk to the administrators – both through a lengthy period of trading in administration and likely an adoption of any employment contracts. Moreover, in addition to the necessary support of secured creditors to a disposal, this route will also require active unsecured creditor engagement; their willingness to engage in the approval process (and in a timely fashion) cannot be guaranteed, particularly in circumstances where expected returns are minimal. As a result, the alternative – the expert's report - is most likely to become the favoured and more realistic route in a pre-pack scenario.
Instead of obtaining creditor approval to the disposal, the connected prospective purchaser may instead obtain a written "qualifying" report from an independent individual with "sufficient knowledge and experience" (the "Evaluator"). The Regulations prescribe the contents of the report, which must include a statement that the Evaluator is either satisfied or not satisfied that the consideration for the disposal is reasonable in the circumstances, the basis for their belief and a summary of the evidence relied upon.
The Regulations do not provide any clarity as to what constitutes "sufficient knowledge and experience", but the Evaluator must self-certify that they meet these requirements (and the administrator is not required to verify the adequacy of the Evaluator's knowledge or experience). The Evaluator must also have the benefit of professional indemnity insurance, which specifically covers potential liabilities arising from statements made in the report.
It is unclear as to who will act as an Evaluator but the "Pre-Pack Pool" (which was the precursor to, and has been superseded by, the Regulations) have confirmed they can fulfil the role. The requirement for sufficient experience, together with the necessity for suitable professional indemnity insurance, suggests qualified insolvency practitioners would be the most likely alternative candidates – but the pool of viable options will be much broader given the absence of any specific requirements in terms of minimum qualifications.
An administrator is not bound by the conclusions in the Evaluator's report and an unfavourable report does not prevent the disposal from being made, although the administrator must explain his decision to proceed (notwithstanding the conclusions) in the report to creditors.
In addition, whilst the Regulations require any previous expert reports obtained by the proposed purchaser to be disclosed, there are no restrictions on the number of expert reports that can be obtained. One would expect that market reputation (and the cost and time involved in obtaining several reports) would deter purchasers from such a course of action but there is nothing to stop a prospective purchaser from shopping around in the hope of getting a (more) favourable opinion.
It is also important to note that the report(s) must be sent to all creditors and registered at Companies House, however the administrator can remove any information that they consider confidential or commercially sensitive.
As currently drafted, the Regulations will apply to any sale by an administrator within 8 weeks of their appointment meaning that the Regulations will not just apply to traditional "pre-packs" but to all disposals to connected parties within this period. Presumably, the rationale being that, by allowing for such an extended period, other prospective buyers may become aware of the process, put forward alternative offers, possibly increasing the ultimate returns to creditors. While officeholders should already be performing thorough valuation and marketing exercises as part of the disposal process, the presence of external scrutiny should ensure that these practices are suitably comprehensive.
There are no exclusions from the Regulations on the basis of size of company and, with a significant number of pre-packs to connected persons occurring in the SME market, it seems likely this is where the Regulations will have the most impact. Nevertheless, the Regulations will add an additional layer of complexity, time and cost to any pre-packs where the purchaser is connected to the seller. This may cause issues in certain restructurings, particularly debt-for-equity swaps where a debtholder already has a substantial equity state in the target company.
Ultimately, whether the Regulations achieve their aim of increasing stakeholder confidence and transparency in an often controversial but valuable restructuring tool remains to be seen.