Compulsory independent scrutiny of pre-pack sales to connected parties

Out-Law Analysis | 22 Oct 2020 | 3:01 pm | 3 min. read

The UK government has published draft regulations to make independent scrutiny of pre-pack sales to connected parties compulsory, in order to improve transparency.

A pre-pack is an arrangement to sell part or all of a company's business or assets that is negotiated and agreed before the company enters into administration but is completed when or shortly after the administration commences.

Section 8 of the 2020 Corporate Insolvency and Governance Act (CIGA) gives the government until 30 June 2021 to enact the relevant legislation. We understand that the legislation will be laid before parliament early next year, with a view to the new requirements coming into force some time in April 2021.

The legislation will apply to England, Scotland and Wales. Insolvency law is devolved in Northern Ireland.

The rationale for compulsory scrutiny

Pre-pack administration sales are an important rescue tool. However, in recent years they have attracted a significant amount of controversy, especially where the sale is to existing management or another connected party. Although supporters of the pre-pack will argue that sometimes a connected party will provide the best, if not the only, means of rescue for a company, others will argue that a pre-pack sale to a connected party prejudices creditors and often lacks the appropriate transparency.

James Hillman

James Hillman

Senior Associate

Pre-pack administration sales are an important rescue tool. However, in recent years they have attracted a significant amount of controversy.

The 'pre-pack pool' is an independent body of experienced business people, established in 2015 following recommendations made by Teresa Graham in her review of pre-pack administration sales. A purchaser of the business or assets of a connected party by way of a pre-packed administration can apply to the pre-pack pool for an opinion as to whether the terms of the sale are reasonable.

Referrals to the pre-pack pool are voluntary and its decision is not binding. Consequently, the number of referrals to the pre-pack pool is extremely low. According to the pre-pack pool's annual review for the year ending 31 December 2019, out of 260 connected party pre-packs in 2019 only 21, or 8%, were referred to the pool. The pool itself said that this low referral rate meant that its future viability was financially uncertain.

The Insolvency Service recently reviewed the use of pre-pack sales in administration. In its report, it recognised that pre-packs "are a valuable part of the insolvency framework". It said: "We do not therefore think there is a case to prohibit pre-pack sales to connected parties".

However, the government is keen to further increase the transparency of connected party pre-packs and make them subject to independent scrutiny.

The proposed legislation

When the pre-pack pool was created, the 1986 Insolvency Act was amended to allow the secretary of state to introduce regulations for "prohibiting, or imposing requirements or conditions in relation to" connected party pre-pack sales. This provision expired on 26 May 2020, but was resurrected by CIGA.

Under draft regulations (6-page / 143KB PDF) now published by the government, an administrator will not be able to complete a sale of all or a substantial part of a company's assets to a connected party within eight weeks of a company entering administration without obtaining either the approval of creditors; or an independent written report.

The administrators can obtain the creditors' approval for the sale as part of the creditors' approval to the administration proposals. Those proposals will need to set out the administrator's intention to enter into the proposed pre-pack transaction. However, this method is unlikely to be popular given the time it can take for the administrator's proposals to be approved.

The independent report does not necessarily need to be from the existing pre-pack pool, but from someone who "believes that they have the requisite knowledge and experience to provide the report". The qualifying criteria have proved particularly controversial in the industry, with some believing that it opens the door to abuse of the system. However, the administrator, acting in the best interests of the creditors, must have no reason to believe that the person providing the report did not hold this belief.

The report cannot be provided by one of the administrator's associates or by any individual who has provided insolvency or restructuring advice to the company in the 12 months preceding the report. The evaluator must also be independent of the company and the connected party purchaser. Obtaining the report will be the responsibility of the purchaser.

In a significant change to the current position, a copy of the report must be sent to creditors and filed at Companies House. Redactions or exclusions of commercially sensitive information may be made to the copy filed at Companies House.

Interestingly, the purchaser can obtain multiple reports and the administrator can still proceed with the sale even if the report does not support it. However, the administrator must provide a statement justifying their decision to proceed, a copy of which must also be sent to the company's creditors. If multiple reports are obtained a statement is only required if none of the reports support the proposed transaction. If multiple reports are obtained, all of them must be sent to the company's creditors and Companies House.

A note within the government's report suggests that pre-pack sales to a secured lender to the company will not be caught by the regulations. However, the draft regulations do not expressly include any such exemption at this time.

The government will also be working with insolvency regulators to introduce amendments to strengthen Statement of Insolvency Practice 16 (SIP 16) on pre-pack sales in administration. These will include ensuring that there is greater adherence to the principles of marketing.

Co-written by Ryan Edge of Pinsent Masons.