Andrew Watling, a Managing Director in our Southampton office, provides an insight into the background of pre-packs and changes to legislation that are to be introduced from 30 April 2021 in answer to longstanding concerns surrounding their use.

There is no legal definition of what a “pre-pack” is but it is widely acknowledged as a reference to a sale of a business and assets by Administrators of a Company, which has been negotiated by them prior to but completed immediately, or very shortly, after their appointment.

Pre-packs have been a part of an Insolvency Practitioner’s toolkit for a long time. They are often attractive to us as a way to rescue a viable business, save jobs and increase the value of assets in instances where there might be a lack of available funding, regulatory barriers or unacceptable risks to trading a business, even for a short time, while a sale of the business is sought. Other benefits might be a reduction in the administration costs and the preservation of relationships with suppliers and customers which might be adversely affected if news of the company’s plight became widely known before the sale.

During his tenure in the coalition Government, Vince Cable became aware of concerns surrounding pre-packs and commissioned a report to consider their full economic impact and to make recommendations for their reform if necessary. As a result, the Graham Report established that pre-packs had a place in the market and did bring benefits to the insolvency framework but that they needed some reform and increased transparency.

The report’s recommendations for an independent assessment of pre-packs by an authorised (but not regulated) pool of professionals were enacted in 2015 in the expectation that this would improve creditor confidence in the process.

Pre-packs and their place in insolvency

To understand the strength of feeling against pre-packs, it is important to understand where they sit in the insolvency space. Between 2016 and 2019, there were

  • over 68,000 company insolvencies in England and Wales.
  • Administrations made up less than 10% of appointments
  • The 1,600-odd pre-packs in that time made up just over a quarter of administrations.
  • Connected party pre-packs accounted for 53% of pre-packs, less than 15% of administrations and just over 1% of corporate insolvencies

So, if pre-packs account for such a small portion of insolvency numbers, why has there been so much noise and ill-feeling surrounding them?

Unlike liquidation, administrations are classed as “Rescue Procedures” and the Administrators’ primary objective is to achieve the survival of the company as a going concern, failing which they need to achieve a better return to creditors or simply to distribute funds to any class of creditors. As a result, there is often a successor business coming out of the sale and therefore a continuing reminder that business owners and managers have used a legal process to shed debt and gained an unfair advantage over bill-paying, solvent competitors. It is also a perception that connected party pre-packs were transacted behind closed doors at an artificially low value that benefitted the purchaser and prejudiced creditors. Because these transactions often occurred before many stakeholders became aware of the business’ insolvency and with limited exposure to the market, creditors feel they have been presented with a fait accompli and feel powerless to influence the process.

The Graham Report intended to provide greater disclosure from Administrators on the thought process behind the transaction and independent scrutiny from the Pre-Pack Pool.

The 2020 review and new reforms

A 2020 review of the impact of the market since the Graham Report’s reforms were brought in and showed that although there has been some improvement in the information provided to creditors by Administrators following the pre-pack and increased exposure of the pre-packed businesses to the market, often via dedicated websites, the concerns around transparency and their effect on creditors remained and resulted in further regulations being introduced, but only where pre-packs were completed to connected persons.

These new Regulations prevent Administrators from selling a business and assets to a connected party during the first eight weeks of Administration - so not just pre-packs - unless certain conditions are met.

A major failing of previous reform has been the lack of utilisation of the pre-pack pool – the body that was designed to assess the validity of the pre-pack. Engagement with the pool was to be encouraged by the Administrator, but was ultimately voluntary and between 2016 and 2019, only 12% of connected party pre-packs were referred to the pool, with the main reasons for lack of engagement being that the purchaser saw no benefit in referring the transaction and that it was not required.

The new regulations

  • All pre-packs now require the connected purchaser to obtain an independent opinion from an “Evaluator” on the terms of the sale, unless creditors have approved it, which would require disclosure to and engagement with creditors on the details of the sale.
  • The Evaluator must confirm that they are satisfied that the amount to be paid for the business and assets, and the grounds for the sale by the Administrator, are reasonable in the circumstances and they must give reasons for reaching their conclusion.
  • The Administrator may still complete a transaction that the Evaluator assesses as unreasonable, but they will need to provide a very clear explanation why they chose to do so.

Looking ahead

By its own admission, the Government acknowledges that the new measures will affect less than 2% of corporate insolvencies each year and there are no such requirements for pre-pack sales to unconnected parties, so the impact of these new reforms is not likely to be widely felt by many more than the purchaser and Administrator and it will be interesting to see whether these compulsory requirements have the desired effect of increasing creditor confidence.