To encourage compliance, the government inserted a “sunset clause” into the Insolvency Act 1986 giving it the power to ban or regulate pre-pack sales to connected parties within the next five years. When that power expired in May 2020 many thought it was the end for pre-pack reform.
However, it was revived by this year’s Corporate Insolvency and Governance Act and extended to June 2021. In a report published today, the Insolvency Service has announced that the power should be exercised to require an independent opinion to be provided on any pre-pack sale in administration to a connected person.
Why has the government now decided to regulate pre-packs?
Following a review, the government has concluded that connected party pre-packs remain a cause for concern for those affected by them and there is still the perception that they are not always in the best interests of creditors. There is, in the government’s words, “still room for further transparency”.
It was also recognised that more companies may become insolvent as a result of the COVID-19 pandemic. Indeed, since the start of the pandemic, we have seen pre-pack sales by several major brands in both the retail and leisure sectors. This gives rise to concerns about the need to protect the interests of creditors as well as promote company rescue, and the Insolvency Service has concluded that further regulation is justified to ensure that pre-pack sales are subject to a measure of independent scrutiny.
What is a pre-pack sale?
A pre-pack sale takes place when the sale of all or a substantial part of a company’s business is arranged prior to the company entering administration, and then completed by the administrator after they are appointed, usually on day one of the administration.
An independent review led by the now Dame Teresa Graham CBE in 2014 highlighted the lack of transparency around pre-pack sales for unsecured creditors, leaving them feeling aggrieved. One of its key recommendations was the establishment of a group of experienced business people which could be approached, on a voluntary basis, to offer an opinion on any pre-pack sale to a connected party. The Pre-Pack Pool (the Pool) was formed to provide such an opinion.
What were the government’s findings?
Despite the number of connected party pre-packs increasing since 2016, there has not been a corresponding rise in the number of referrals to the Pool. The number of pre-pack sales to connected parties increased year on year from 163 in 2016 to 260 in 2019. Remarkably, however, the number of referrals fell in the same period from 36 (22%) in 2016 to just 23 (9%) in 2019.
The reason given for this poor take up rate was that the purchaser saw no benefit in making a referral. Administrators have no ability to request an independent opinion from the Pool, so referrals are entirely dependent on the willingness of potential purchasers to make one. Further, administrators are only required to make connected party purchasers aware of their ability to approach the Pool; they are not required to recommend that the Pool be approached.
In light of this, stakeholders including insolvency industry trade body R3 and the British Property Federation supported the establishment of a statutory mechanism for making referral to the Pool mandatory.
What has the government decided?
The government does not propose banning connected party pre-pack sales altogether. In many circumstances it was felt that a pre-pack sale provides the best outcome for creditors.
Instead, the government will bring regulations into force before June 2021 preventing an administrator from disposing of company property to a connected party within the first eight weeks of the administration without either the approval of the creditors or an independent written opinion. The opinion provider, who must meet certain eligibility requirements, will provide a written report to state that either the case is made for the disposal or not made. Whilst the administrator can proceed with the disposal if the case is not made, the administrator will be required to provide a statement setting out the reasons for doing so. The administrator must in all cases provide a copy of the opinion to the creditors and Companies House.
Today’s announcement on pre-packs will be no doubt be welcome news for landlords, who may feel that the government’s response so far to COVID-19 has been decidedly debtor friendly and undermined their interests as creditors. Whilst the Insolvency Service does not mandate that written opinions must be sought from the Pool, as the established operator in the market it does appear likely that referrals to the Pool will increase dramatically from their current low levels.
A copy of the report can be found here.
Authored by Mathew Ditchburn