Over recent years I have been astounded that certain professionals, including accountants, insolvency practitioners (IPs) and solicitors, appear unable to recognise a conflict of interest if it were to stand up and slap them in the face.
Cynically, one could suggest that the blinkers have been on because it serves the interests of the professional concerned. Ignoring a conflict of interest is a fundamental breach of professional ethics, not something that can be brushed under the table for pure personal financial gain.
The case of VE Vegas Investors IV LLC and others v Shinners and others is of interest in highlighting where things can go wrong.
Conflict of interest
The Solicitors Regulation Authority (SRA) specify within the Solicitors Code of Conduct (Rule 3.01) that there is a conflict of interest if:
- You owe, or your firm owes, separate duties to act in the best interests of two or more clients in relation to the same or related matters, and those duties conflict, or there is a significant risk that those duties may conflict, or
- Your duty to act in the best interests of any client in relation to a matter conflicts, or there is a significant risk that it may conflict, with your own interests in relation to that or a related matter.
The SRA rule is a good starting point. It makes it clear there are two elements to conflict of interest. The first, a client conflict i.e. where the interests of two or more clients may be in conflict. It is this area where people often concentrate, however the second element is equally as important. An own interest conflict, i.e. where the interests of the client conflict with the interests of the practitioner.
A ‘pre-pack’ is a process where a company is placed into administration and the administrator sells the business and assets of the company within a short period of time following appointment. Clearly there has been provision of advice to the company, and its directors, and the consideration, negotiation, and preparation of documents prior to the administrators’ appointment. This enables the sale to be completed immediately following appointment. Such advice will be provided, frequently, by members of the turnaround profession, often either IPs or lawyers, if not both. One needs to carefully consider the basis on which that advice has been provided.
The more contentious pre-packs are those where the purchasing vehicle is a company, or other entity, controlled by those, or some of those, who previously controlled the company which has just entered into administration. Commonly referred to as a ‘phoenix’, the new vehicle emerges from the ashes of the old, freed of debts of and/or detrimental contractual obligations of, the old entity.
Due to the concerns expressed by certain people around transactions of such a nature, protections have been imposed, including professional guidelines on IPs (within SIP16) requiring their observance of standards around marketing of the business and assets of the distressed company, and the need to provide transparency around the IP’s actions.
Vegas Investors IV LLC and others v Shinners and others
The judgment in VE Vegas Investors IV LLC and others v Shinners and others drives home how turnaround professionals must take off their blinkers and be fully aware of the possibilities of conflict of interest or suffer the consequences which can flow from their actions.
In this case a well known firm in the insolvency industry were appointed to advise the company (‘V’) concerning a possible pre-pack. Despite failing to obtain sufficient financial information or clarity over the extent of V’s assets and liabilities from V and its directors, information received being far below that sufficient for an arm’s length purchaser to consider whether to acquire the business and assets of V, two practitioners from the insolvency firm accepted an appointment as administrators.
The newly appointed administrators completed a prepackaged sale, to a new company formed by V’s directors, the day following their appointment. Various creditors of V sought removal of the administrators, on the ground that they had a conflict of interest. The conflict of interest prevented the administrators investigating whether the sale they had effected, was at a value below market value, and prevented them from investigating whether they, in their capacity as administrators, had breached their duties to creditors in effecting the sale. The creditors’ claims were upheld.
The court commented that:
- Where a firm of IPs is retained by management of a company to give advice on insolvency options prior to an administration
- The management pursue a purchase of the company’s business and/or assets, and
- The administrators appointed to effect the sale are members of that same IP firm
then there is an unavoidable conflict from the date of the administrators’ appointment. This is because (quoting the words of Mr Registrar Jones, delivering the judgement of the Companies Court) the administrators are ‘inextricably bound up in the process by reason of their [IP firm’s] contractual retainer… This is not technical legal analysis. It is obvious.’
The judgement is not in itself the end of an IP giving pre-appointment advice, but it is clear that such an IP must be clear as to who that advice is given, and must be fully aware of the principles of conflict of interest.
Merits of a pre-pack sale
The court made clear that it did not comment on the merits of a pre-pack sale. Having been involved in numerous pre-packs I can argue their merits, whilst often there may also be merits to a pre-pack in favour of vehicle controlled by former management/owners. This case, however, may go some way to opening the eyes of professionals to potential conflict of interest and hopefully give creditors the confidence to seek to challenge those who remain blinkered, ignore own interest conflict and seek financial gain ahead of professional ethics.