The Administration Series: The Rise of the Pre-Pack

Edwin Coe’s Restructuring & Insolvency team has put together a series of blogs on all matters administration related, covering background and insights into the process, technical guidance, case law updates and practical tips.

Please keep an eye out for our upcoming blogs in this series, and do not hesitate to get in touch with a member of our team should you require assistance in relation to a company facing financial difficulty. We are experts in this field and are here to help.

The Rise of the Pre-Pack

Preamble: Powers, purpose and collectiveness

Once appointed, whether by the court or by the out-of-court procedure, administrators have extensive powers, pursuant to the Insolvency Act 1986 (“IA 1986”), to do anything necessary or expedient for the management of the affairs, business and property of the company. The administrators will exercise these powers to achieve one of the three hierarchical statutory objectives at paragraph 3(1) of Schedule B1 of the IA1986, that should result in either the rescue of the company or its business, or the realisation of assets to maximise value in the financially distressed company for the benefit of its creditors.

To promote creditor inclusion in the administration procedure, administrators are required to send their proposals, setting out how they intend to achieve the stated statutory objective, to creditors within eight weeks of their appointment. Paragraph 52 of Schedule B1 provides for three exceptions whereby an administrator may choose not to send the statement of proposals to creditors, which includes circumstances where each creditor will be paid in full; where no distribution would be made to unsecured creditors other than the prescribed part; and where neither the company nor its business can be rescued. The paragraph 52 exceptions are purposefully limited so as to encourage collectiveness in the administration process.

What is a Pre-Pack?

A pre-packaged administration (“pre-pack”) refers to the practice whereby the sale of all or part of a financially distressed company’s business is agreed with a purchaser prior to the appointment of administrators; the sale is subsequently completed by the administrators either immediately upon or very soon after their appointment.

This procedure can be contrasted with a traditional administration, established by the IA 1986 and the Insolvency Rules 1986 (in relation to which, please see our blog: A Short History of Administrations), which generally involves a period of trading the business by the administrators followed by a sale of that business, or the company’s assets on a piecemeal basis, out of the administration.

Whilst the administration procedure is governed by the IA 1986 and now the Insolvency Rules 2016, the pre-pack variant has been established by practitioners organically and in the wake of black-letter law.

Advantages of the Pre-Pack

Pre-packs are a valuable restructuring tool in the insolvency world, offering a number of advantages compared to the traditional sale of a business or company out of an administration. Principally, the pre-pack procedure promotes rescue by prioritising confidentiality of the company’s financial difficulty, thereby preserving goodwill and value in the business or assets and allowing for the survival of trade, employees, as well as other commercial relationships such as with customers and suppliers. Once the terms of a sale have been negotiated and agreed in principle, the process of appointing administrators and completing the sale is comparatively quick. This speed and efficiency, now associated with pre-pack transactions, has the practical benefits of limiting disruption caused to third parties that are engaged with the business and also means that the public’s perception of the business remains relatively unchanged post-sale, thereby retaining the value of the business.

It is not surprising therefore that, over recent years, there has been a steady rise in the use of the pre-pack procedure: with 345 pre-packs having been reported in 2016; and 473 reported in 2019 (representing 26% of the total recorded administrations for both 2016 and 2019 respectively). Post-covid, in 2022, pre-packs represented approximately 29% of the total recorded administrations in England and Wales.

Despite the evident benefits of the pre-pack procedure, they have not found favour with all stakeholders in administrations. For the same reasons that pre-packs have become a vital insolvency tool, they have also received persistent criticism, predominantly by unsecured creditors of distressed companies, who have felt disenfranchised from the process.

Concerns and Criticisms of the Pre-Pack

Transparency

The speed and confidentiality associated with pre-packs is both the blessing and curse of the procedure. Whilst, on one hand, the procedure significantly reduces the risks associated with widespread and public knowledge of the company’s financial difficulty; on the other hand, the limited marketing of the company’s business in a pre-pack, as well as the seeming absence of collectiveness and inclusion of unsecured creditors in the process, has raised significant criticism regarding a lack of transparency.

Such lack of transparency has meant that unsecured creditors are often unaware of the sale of the company’s business until administrators have been appointed and the transaction has completed.

A report prepared by Teresa Graham CBE in 2015 in response to the concerns surrounding pre-packs (the “Graham Review”), revealed that the average return to unsecured creditors as a percentage of the debt owed was 7.22% in pre-packs, compared with 13.06% in traditional administrations.

Connected Persons

Pre-pack sales to connected persons (for example, existing management or family members) generate the greatest concern by unsecured creditors. It is understood that sales to connected parties currently represent around half of all pre-packs.

The Graham Review highlighted two key reasons for creditor concern regarding sales to connected persons: first, as at the date of the Graham Review, the average return to unsecured creditors fell to 6.07% in sales to connected persons, compared to an average return of 8.82% where the business was sold to an unconnected person; secondly, statistics show that pre-packs to connected persons are much more likely to fail within three years, as compared to an unconnected sale.

To address these concerns, the Graham Review recommended that the insolvency industry implement a package of voluntary measures including:

1. The establishment of a group of experienced business people to give an independent review of a pre-pack sale, which became known as the Pre-Pack Pool;
2. Improvements to marketing and valuation requirements; and
3. Improvements to the information to be provided to creditors.

Pre-Pack Pool (the “PPP”)

The PPP is an independent body of experienced business people with relevant expertise who can be approached to offer an opinion on the purchase of a business by connected parties where a company is going into administration and where a pre-packaged sale is proposed. The process is entirely voluntary and relies on the connected purchaser referring the case to the PPP for its opinion.

Despite the number of pre-packs continuing to increase, the proportion of those referred to the PPP have been steadily reducing, with less than 10% of pre-pack sales being referred from 2018.

Whilst the PPP continues to exist, following the implementation of new regulations in April 2021, the pool members now conduct their role and prepare reports under the revised guise of an “evaluator”, as detailed further below.

SIP 16

In January 2009, the Insolvency Service issued Statement of Insolvency Practice 16 (“SIP 16”), which is a guidance note that requires administrators to disclose certain information to unsecured creditors. In particular, they are required to justify why the pre-pack process was appropriate and the alternative options that were considered.

A subsequent review of SIP 16 statements found that there was an increase in the number of businesses being marketed and the quality of marketing being undertaken. Whilst some stakeholders have, nonetheless, continued to express concerns about businesses being sold for less than market value, the Government has recognised that there are valid reasons for accepting such deals. It acknowledges that in some situation, the administrator has the responsibility to accept an offer that, although possibly below market value, delivers the best possible outcome for creditors in the given circumstances.

SIP 16 was adopted by each of the Recognised Professional Bodies (“RPBs”), which are responsible for monitoring the SIP 16 disclosure statements. Similarly to the volume of pre-pack administrations, recent data obtained from SIP 16 statements received by the RPBs shows a stark increase in the number of sales to connected persons from 106 in 2021 to 201 in 2022.

The effect of SIP 16 was to provide self-regulation by the officeholder to address the transparency and connected persons concerns around pre-pack deals. Whilst a breach of SIP 16 does not carry with it a legal penalty, the relevant RPB (of which the administrator is a member) can take disciplinary action, if appropriate.

The Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (the “2021 Regulations”)

Where the voluntary approach of making a referral to the PPP had failed, the Government was required to instead consider a mandatory-based approach.

To this end, the 2021 Regulations came into effect on 30 April 2021 and prohibit an administrator from making a substantial disposal of the company’s assets to connected persons within eight weeks of commencement of the administration, unless they have received either pre-disposal approval from creditors or a qualifying report from an evaluator. It is for the administrator to determine whether a person is a connected person, or whether a transaction should be designated a substantial disposal.

The evaluator provides either a “case made” or “case-not-made” opinion. A case is made where the evaluator states that they are satisfied that the consideration to be provided and the grounds for the substantial disposal are reasonable.

Whilst the evaluator’s report must be obtained by the connected person and the report must be presented to the administrator who must consider it and satisfy themselves that the individual making the report met all of the criteria, controversially, the administrator is not however obliged to follow the evaluator’s report.

Will Pre-Packs Prevail?

Despite facing significant criticism, pre-packs persist as a resilient and indispensable tool in the insolvency arsenal. The efforts of the Government to address concerns surrounding pre-packs by enhancing transparency, while upholding their integrity, will no doubt be a continuing requirement.

The introduction of a mandatory evaluator exercise, as prescribed by the 2021 Regulations, represents an important step towards mitigating negative perceptions by providing a degree of reassurance where sales are to connected parties. However, it is essential to recognise the limitations of the 2021 Regulations: whilst the aim of the 2021 Regulations was to prevent unfavourable deals, administrators retain discretion over whether to proceed despite a negative evaluator report.

In striving to balance and accommodate diverse stakeholder interests, the Government faces an ongoing challenge and whilst unsecured creditors may have a different agenda to other stakeholders, the imperative remains to continually refine and improve the pre-pack framework. In the (abridged) words of John Lydgate: “You can please some of the people all of the time…but you can’t please all of the people all of the time.”

Our Restructuring and Insolvency team has considerable experience in advising businesses, directors and individuals facing financial distress. Should you require any assistance, please contact any member of the Restructuring & Insolvency team. We are experts in this field and are here to help.

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