The government has published new draft regulations1 under which connected persons who buy a business from an administrator will first have to obtain either an independent opinion on the transaction, or creditor approval. This move follows the release of the government's long-awaited report on the 2015 industry reforms2 to pre-pack sales in administration. The report highlights continuing concerns about the potential for abuse of the pre-pack process and the need for further creditor protection, particularly if the rush of insolvencies predicted to arise as a result of the Covid pandemic materialises. Consequently, the government has decided to legislate.
Which deals will the regulations affect?
Disposals, leases or sales of all or a substantial part of a company's business or assets to a connected person within the first 8 weeks of an administration. Notably, this will not just apply to what we ordinarily think of as pre-pack sales (ie. sales which complete immediately after the administrators' appointment), but all connected person sales completed within the first 8 weeks of the administration.
The definition of connected person in the draft regulations is broader than under the existing voluntary regime3, which expressly excludes from scope sales to secured lenders who hold security (with related voting rights) over more than one third of the company's shares. However, there is no equivalent exclusion from the definition of 'connected person' in the new draft regulations. It is unclear at this stage whether this change is intentional or an oversight. If the regulations remain as currently drafted, a secured lender will be a 'connected person' if it is entitled to exercise or control the exercise of over one third of the voting at a general meeting of the company. Secured lenders pursuing a 'loan-to-own' strategy via an administration sale will need to carefully consider the provisions in their security documents regarding the assumption of control over voting rights in order to avoid falling within this definition. Given the wider consequences of a secured lender being 'connected' (or 'associated')4, protections against this should already be built into security documents, but it will be important that this point is not overlooked in the planning for a pre-pack sale.
What do the regulations require?
Where an administration sale falls within the regulations, before completing the sale, the connected purchaser will have to obtain an independent written opinion from an evaluator or, alternatively, the administrator can obtain creditor approval. Typically, the evaluator opinion option will be much quicker and therefore preferable.
The provider of the independent opinion (known as the 'evaluator') must state that either the case is made for the sale (i.e. that the consideration payable is reasonable) or it is not, with reasons for their conclusion. This opinion goes further than the one provided under the existing voluntary regime by the Pre-Pack Pool. Where the evaluator finds that the case is not made for the sale, the administrator will still be able to proceed with the sale as long as they set out the reasons for doing so. Copies of the independent opinion (and administrators' reasons for proceeding despite a 'case not made' opinion) will have to be sent to all creditors and Companies House, achieving the transparency aims which are key to this reform.
Who is the 'evaluator'?
While certain stakeholders recommended that referrals to the Pre-Pack Pool itself be made mandatory, the draft regulations permit a wider category of persons to perform the evaluator role provided that they are independent of the connected purchaser, the company and the administrator, and meet certain eligibility requirements. The qualification requirements for the evaluator seem lightweight, requiring only that the evaluator believes that they have the requisite knowledge and experience to provide the report, and that the administrator has no reason to believe that they do not. In the vast majority of cases, this ought to be sufficient, but it does leave open some opportunity for abuse. It remains to be seen whether the Pre-Pack Pool will continue to be the main opinion provider, or whether referrals to independent accountants, valuers or other professionals will be found to be more flexible and cost-effective.
What happens next?
The regulations are still in draft form, and the Insolvency Service has said that the government will seek to bring forward the regulations as soon as Parliamentary time allows before June 2021.
In the meantime, the Insolvency Service has stated its intention to work with the industry and the regulators to prepare guidance to accompany the regulations and to update and strengthen Statement of Insolvency Practice 16 to improve the quality of information provided to creditors.
Ashurst comment
This development has been anticipated for some while, and although it will add an additional step (and commensurate time and cost) to pre-pack administration sales to connected persons, in large scale cases this need not be disproportionate and can probably be worked out in the economics of the transaction as a whole. The greater impact is likely to be felt in the SME market, as for the higher value and more complex transactions, we have seen insolvency practitioners insist upon the referral to the Pre-Pack Pool as a condition to their appointment since its inception and despite its voluntary nature.
There are still some drafting and other wrinkles to be worked out: for example it is unclear what duty of care (if any) the evaluator might have to the wider creditor body of the insolvent company and whether this risk can be covered by professional liability insurance. It is hoped that these points can be addressed before the draft regulations become law.
1. Proposed draft regulations to require scrutiny of pre-pack sales to connected parties.
2. The 2015 pre-pack reforms included the creation of the Pre-Pack Pool, an independent body set up to provide opinions on pre-pack transactions, and changes to Statement of Insolvency Practice 16, which provided for connected party purchasers in a pre-pack administration sale to voluntarily refer the transaction to the Pre-Pack Pool for an independent opinion, and to provide a viability report on the future of the purchaser. In December 2017, the government announced its review of the 2015 pre-pack reforms. That review eventually led to the response and new draft regulations published on 8 October 2020 and reported on in this update. Statement of Insolvency Practice 16
3. The current voluntary regime is set out in Statement of Insolvency Practice 16 on pre-packaged sales in administrations, which provides best practice guidance to administrators engaged in such transactions.
4. For example, the risk of becoming subject to a contribution notice under the Pensions Act 2004.
Co-author: Rebecca James, Expertise Lawyer
