This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.
Summary and implications
On 16 June 2014, the British Government published the findings and recommendations of an independent review into pre-pack administrations (pre-packs), carried out by Teresa Graham CBE.
The review was commissioned by Vince Cable, the Secretary of State for Business, Innovation and Skills, to address continued disquiet about the merits of pre-packs, particularly among unsecured creditor groups.
Despite identifying a number of shortcomings in current pre-pack practices, Graham concluded that pre-packs “definitely have a place in the insolvency arena” and that to outlaw them to eliminate sub-optimal areas of behaviour would be akin to “throwing the baby out with the bathwater”.
Instead of an outright ban on pre-packs, which had been sought by some opponents of the technique, Graham wants to see a “clean-up” involving “major improvements on how [pre-packs] are administered”.
She has proposed that this be achieved through a package of six measures. Two of these measures are directed at pre-packs involving sales to parties connected to the insolvent company (connected party purchasers) – before entering into a pre-pack, Graham wants connected party purchasers voluntarily to:
- approach a “pre-pack pool” of independent and experienced business people, to obtain an opinion on the proposed pre-pack; and
- complete a “viability review”, stating how the purchaser will survive for at least 12 months from the date of the review and what the purchaser will do differently to the insolvent company to avoid a further failure.
The other measures are intended to improve pre-sale marketing and valuations, disclosure of information to creditors after a pre-pack has been executed, and the monitoring of compliance with Statement of Insolvency Practice 16 (SIP 16).
Graham has invited the insolvency industry to adopt her proposed measures voluntarily, without the need for new legislation, but she has asked that the Government consider legislating if her measures are not adopted or fail to have the desired impact.
The Government has welcomed Graham’s report and committed to work with industry and business to fully implement her recommendations. If embraced, the recommendations should go some way to improve transparency and confidence in a valuable business rescue tool.
Below we have summarised Graham’s key findings and her proposed measures. Before this, for those readers who may be less familiar with the technique, we have included a brief explanation of a pre-pack and the current SIP 16.
What is a pre-pack?
Administration is a formal insolvency process in which a licenced insolvency practitioner (the administrator) is appointed to an insolvent company with the tiered objective of:
- rescuing the company as a going concern;
- achieving a better result for the company’s creditors than in an immediate winding-up; or
- realising the company’s property to make a distribution to secured or preferential creditors.
A pre-pack administration is one where a sale of all or part of an insolvent company’s business is arranged before it enters into administration and the sale is executed by the administrator on or shortly after his or her appointment as administrator.
Pre-packs are not provided for in legislation – they are a technique that has been developed by insolvency practitioners to help achieve business rescue and maximise realisations from the sale of an insolvent company’s business where the company cannot be rescued as a going concern.
This is achieved by lining up and executing the business sale before news about the insolvency has broken – news which could, if announced before the sale, lead to a loss of key suppliers, customers or employees, thereby prejudicing the prospects of a seamless business transfer.
In recent years, approximately a quarter of all administrations have involved a pre-pack. Examples include the sales of the businesses of Blacks Leisure and Dreams Plc.
SIP 16
SIP 16 was introduced in January 2009 and updated in November 2013. It requires an administrator who executes a pre-pack to provide creditors, within seven days of the pre-pack, with an explanation and justification of why the pre-pack was undertaken (a SIP 16 statement).
The SIP 16 statement should include information on matters such as the alternatives considered, marketing undertaken, asset valuations obtained, the purchaser and any connection to the insolvent company, and the consideration for the sale.
SIP 16 is a regulatory requirement rather than a legal requirement. Failure to comply with SIP 16 can result in disciplinary action against an administrator by his or her regulatory/professional body.
Graham’s key findings
Graham analysed information and evidence from a variety of sources, including those affected by or otherwise involved in pre-packs (e.g. suppliers, landlords, insolvency practitioners, lawyers) and reports issued in the administrations of a random sample of 499 companies that executed pre-packs in 2010.
Having done so, she identified the following positives about pre-packs:
- Pre-packs preserve jobs. This benefits other creditors by reducing claims against the insolvent company.
- Pre-packs are cheaper than alternative upstream restructuring procedures, such as schemes of arrangement which have more court and creditor involvement.
- Deferred consideration is, by and large, paid, such that creditors are not unduly harmed by the presence of deferred consideration in a pre-pack.
- On average, purchaser companies are more likely to succeed where they have purchased a business in a pre-pack, rather than after a period of trading in an administration. The odds of failure were 2.4 times higher in a purchase from a trading administration than in a pre-pack purchase.
- Pre-packs bring some limited benefit to the overall UK economy from overseas companies relocating to the UK to avail of the pre-pack (i.e. forum shopping).
Graham also identified the following shortcomings:
- Pre-packs lack transparency. Typically unsecured creditors do not find out about the pre-pack until after the event. This leaves them feeling disenfranchised, particularly where the purchaser is a connected party purchaser.
- Marketing of businesses is insufficient. For more than a third of the companies surveyed there was no clear evidence as to when marketing was carried out and for how long. Too often only limited marketing was undertaken and the evidence showed that where no marketing was carried out, returns to creditors were lower.
- Explanations of valuations are insufficient. Although an independent valuation was conducted in the majority of cases surveyed (91 per cent), many were simply desk- top valuations and the valuation did not include all of the available assets, e.g. intellectual property or goodwill.
- There is insufficient attention to the viability of the purchaser company. This is a particular concern for both transferring and new suppliers, but it is not a primary concern of the administrator because his duties lie principally towards the creditors of the insolvent seller company.
- The regulation of pre-packs and the monitoring of that regulation could be better. In particular, more can be done in relation to SIP 16 to discourage bad practices.
Of the 499 pre-packs surveyed by Graham, almost two thirds involved connected party purchasers. Pre-pack sales to connected party purchasers typically attract a higher level of criticism than pre-pack sales to unconnected parties because of the perception that it is the same directors “driving the same Rolls Royce through the factory gates”.
The evidence showed that 29 per cent of connected party purchasers subsequently failed within three years, compared to only 16 per cent of unconnected party purchasers. This is likely one of the reasons why Graham chose to focus two of her six measures on pre-packs involving connected party purchasers.
Graham’s recommendations
Graham has recommended the following measures to improve pre-packs.
1. Pre-pack pool
On a voluntary basis, connected party purchasers should approach a “pre-pack pool” before the pre-pack and disclose details of the proposed deal for the pool member to opine on for a fee to be paid by the connected party purchaser.
The pool member should be an experienced businessperson, selected from a wide range of industries and disciplines and possibly nominated by an organisation such as the CBI.
Graham envisages a small secretariat being established to administer the pool and that cases be allocated on a strict rotation basis.
If the pool member issues a negative statement the pre-pack can still proceed, but the negative statement should be disclosed in the SIP 16 statement.
The proposal is aimed at achieving some independent scrutiny of the pre-pack deal before it is executed, but without news breaking more widely in a way that could damage the business before it is sold.
This measure is aimed solely at sales to connected party purchasers. It does not apply to sales to unconnected parties.
2. Viability report
On a voluntary basis, connected party purchasers should prepare a “viability review” of the purchaser, stating how the purchaser will survive for at least 12 months from the date of the statement and what the purchaser will do differently from the insolvent company to avoid a further failure.
The viability report should be attached to the SIP 16 statement. The administrator will not be expected to comment or express an opinion on the review. Where the connected party has not completed a review, the administrator should state that he or she has asked for one but it has not been provided.
As for the “pre-pack pool”, this measure is aimed solely at sales to connected party purchasers. It does not apply to sales to unconnected parties.
3. Revised SIP 16
The Joint Insolvency Committee (made up of representatives of the recognised professional bodies for insolvency practitioners) should consider adopting a reinforced version of SIP 16 at the earliest opportunity.
Graham sees SIP 16 as a vehicle for delivering her package of measures and she has prepared a re-draft of the 2013 version of SIP 16 to take into account her recommendations.
4. Marketing
All marketing of businesses prior to a pre-pack should comply with six principles of good marketing and any deviation from these principles should be brought to the attention of creditors in the revised SIP 16 statement.
Graham proposes the following marketing principles:
- Broadcast rather than narrowcast – the business should be marketed as widely as possible, proportionately to the nature and size of the company.
- Justify the media used – the SIP 16 statement should fully explain the reasons for the marketing and media strategy adopted.
- Ensure independence – the insolvency practitioner should satisfy himself or herself as to the adequacy of the marketing that has been undertaken and not simply rely on marketing conducted prior to their instruction as a proxy to avoid further marketing.
- Publicise rather than simply publish – marketing should be undertaken for an appropriate length of time, sufficient for the insolvency practitioner to satisfy himself or herself that the best deal has been sought.
- Connectivity – online marketing should be used alongside other media by default. Where the internet has not been used to market, the administrator should justify why it has not been used.
- Comply or explain – the administrator must fully explain his or her marketing strategy and how it achieved the best outcome for all creditors, particularly where the sale is to a connected party purchaser.
5. Valuation
SIP 16 should be amended to require valuations to be carried out by valuers who hold professional indemnity insurance. Where this is not the case, the administrator should explain his or her reasons for choosing a valuer without such insurance.
The reason behind this recommendation is that insurers place their own stringent checks on those who apply for cover, so creditors can be more satisfied that a valuation from an insured valuer will represent a fair value.
6. Monitoring SIP 16
The Insolvency Service should withdraw from monitoring SIP 16 statements and the monitoring should be picked up by the recognised professional bodies.
Graham considers that the recognised professional bodies are better placed to scrutinise compliance with SIP 16 given the level of their practical experience.
For those who would like to read more, Graham’s full report can be found at: https://www.gov.uk/government/publications/graham-review-into-pre-pack-administration.
