United Kingdom: Core Elements of a Pre-Pack Administration
One of the core differences between pre-pack transactions in the United Kingdom and the United States is not so much the manner in which deals are implemented, but what those deals seek to enact. In the United States, a pre-pack is in essence a prenegotiated plan of reorganisation that is implemented with the benefit of the pre-approval of the requisite creditor groups and generally sees the emergence from bankruptcy of the reorganised debtor. In the United Kingdom, pre-packs are used to describe sale transactions, where the business and assets of the debtor are transferred to a purchaser and creditors are either rolled into the new structure, to the extent that the sale is a share sale and they have structurally senior claims, or left behind. Pre-packs are often combined with pre-agreed arrangements with secured creditors of the business being sold to fund the purchase price through the novation of ‘credit-bidding’ of their debt claims to the purchaser, thereby creating a powerful debt-restructuring tool.
The UK government recently announced plans to reform the United Kingdom’s insolvency and restructuring framework. The proposals, set out in Section 5 of ‘Insolvency and Corporate Governance, Government Response’ published on 26 August 2018, could, if implemented, have wide-reaching consequences for how restructurings are implemented in the future. In particular, the move to introduce a new restructuring plan that is similar to a Scheme of Arrangement but that contains a cross-class cramdown, could feasibly see US-style pre-packs become more common. How those proposals would be implemented into law remains to be seen, and so this chapter will focus on our current restructuring tool – the pre-packaged administration.
A pre-pack administration is an arrangement pursuant to which a plan relating to the business of a distressed company is negotiated and agreed by the requisite stakeholders prior to the appointment of an administrator, and implemented upon the commencement of the administration. The nature of the agreed plan will more often than not result in a going concern sale of all or part of the company’s business and assets. The UK Insolvency Practitioners Association describes the pre-pack as ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator and the administrator effects the sale immediately on, or shortly after, appointment’.
A pre-pack administration combines features of an informal restructuring and a formal administration procedure, allowing for private negotiations to be made in relation to how the financial distress of the company is to be resolved on an informal basis, before subsequently effecting the deal under a formal administration procedure.
Restructuring in England was historically dominated by preventive informal workouts popularly known as the London Approach. The London Approach, which is one of the most prominent examples of a multi-creditor informal restructuring system globally, describes a system where banks in the city of London privately achieved out-of-court restructurings for distressed companies. A private workout offers a number of advantages in the restructuring process. It is flexible and easily adapted to the business of the distressed company. As it does not typically involve courts and regulatory authorities, it can be done in as little time and as privately as possible, thereby preserving the goodwill of the company while seeking efficient ways to keep it alive. The private nature of the negotiations also serves the purpose of limiting negative publicity that would further destabilise the business and potentially lead to a greater loss of value for stakeholders. Overall, private restructurings offer stakeholders a tool for early intervention and opportunity for significant value preservation.
The restructuring scene in England has, over the years, transitioned from informal consensus-based restructurings led by significant bank lenders with extensive control to more formal restructuring mechanisms. One of those formal procedures is the administration procedure, which allows an insolvency practitioner to be appointed to take over the management of a distressed company and rescue the company as a going concern, as long as this produces the best outcome for the creditors as a whole.
The Insolvency Act grants the administrator broad powers of sale but does not explicitly provide for a pre-pack administration. The pre-pack administration is therefore a market tool developed by market actors to achieve a speedy and efficient resolution of financial distress. Changes introduced to the administration procedure by the Enterprise Act of 2002 have made it possible for an administrator to be appointed out of court and this has in turn increased the use of both the administration procedure and pre-pack administrations significantly. In contrast to a pre-packaged plan under the US Chapter 11 procedure, in a pre-pack administration there is no need for the proposed plan to be presented to the different classes of creditors or for creditors to vote on the plan. The deal can be agreed without the knowledge or approval of creditors and the administrator can effect the sale immediately after he or she is appointed without the approval of creditors. These features allow the company to act discretely and quickly. In a broader sense, they allow market actors to continue to reap some of the benefits of a privately negotiated restructuring, making pre-pack administrations an effective restructuring tool in the United Kingdom.
Elements of a pre-pack administration
A pre-pack administration begins with the directors of a distressed company resolving to engage the services of an insolvency practitioner to assess the company’s financial state and advise on the best course of action. The options available to a company that has or may become unable to pay its debts can range from a trading administration to a company voluntary agreement, a scheme of arrangement or liquidation. Pre-pack administrations are commonly used as a strategy for selling a business as a going concern. The sale of the business and its assets is made to a purchaser entity, which may be newly incorporated for that purpose or in operation as an existing business. At the preparatory stage, the insolvency practitioner is engaged in a business advisory role but there is an understanding that he or she will be appointed as the administrator when the company goes into administration, even if for a relatively short time. This indirectly imposes a duty on the insolvency practitioner to be mindful of his or her duties under the Insolvency Act, a duty that is owed to all the creditors of the distressed company and not the proposed purchaser. The statutory objectives of an administration procedure are, therefore, a relevant consideration even at the preparatory stage.
There are different considerations that inform the choice of a sale of the business over other available options. From the insolvency practitioner’s perspective, the most important consideration is whether rescuing the company as a going concern is reasonably practicable and likely to produce the best outcome for creditors. The insolvency practitioner may satisfy himself or herself that a sale is justified where, for example, it would be impossible or inefficient for the company to trade in administration because of limited funds. It could also be that the value of the business would be significantly eroded in an extended trading administration.
The pre-packaged sale is consistent with the broad powers of sale granted to the administrator under the Insolvency Act. In a traditional administration, the Insolvency Act envisages that the administrator will put together a proposal as soon as is reasonably practicable and not longer than eight weeks after appointment, and present this proposal to the creditors to vote upon. The administrator, however, has the power to bypass the requirement for creditors’ approval of the proposal if he or she determines that each creditor will be paid in full or that no distributions will be made to unsecured creditors. Also, in achieving the purpose of the administration, the administrator can sell the assets of the company without the approval of creditors.
This is similar to what occurs in pre-pack administrations, except that the arrangements for the sale are made before the administrator assumes his or her position. Acknowledging that there may be the need to move swiftly to preserve value, English courts have thrown their weight behind the administrator’s ability to sell assets of the company without leave of court or creditor approval. The decision to conclude a sale of the business in advance of or without the creditors’ meeting is left to the judgment of the administrator. However, this does not protect the administrator from a subsequent challenge for breach of duty.
Once a decision is made to complete a pre-packaged sale, the next step is to discretely find a suitable buyer and negotiate the terms of the sale. In some cases, the company’s directors or secured creditors may have already approached potential buyers and loosely agreed terms with them, before engaging the insolvency practitioner. There is a slight risk that trade suppliers, employees and other partners of the distressed company may be reluctant or unwilling to continue to deal with a different company after the sale. To prevent this outcome and ensure that the transition is as seamless as possible, stakeholders that are crucial to the functioning of the business may be involved in the sale process. Particularly, the buy-in of secured creditors can be important, given that they would typically have security rights over all or substantially all of the company’s assets, the sale may, therefore, require their consent.
An important part of the process of finding a purchaser and agreeing terms from the perspective of the insolvency practitioner, is a valuation of the company by an independent valuer for a fair determination of a fair consideration that reflects the value of the company. This is underscored by the duty of the insolvency practitioner to represent the interests of all creditors and ensure that the sale achieves the best result for them. As discussed below, there are regulatory requirements that now impose disclosure requirements, which include the valuation and marketing strategy adopted for the sale.
The concept of a deferred consideration is commonly used in pre-packaged sales in the United Kingdom. Parties agree for payment of the consideration by the purchaser to be spread out over a period of time. Deferred consideration can be useful where there are insufficient funds to immediately cover the purchase price and in the absence of the deferred payment arrangement, the company will end up in a wasteful liquidation or a prolonged formal insolvency process. The deferred consideration arrangement can be structured in different ways including the payment of a proportion of the consideration as down payment combined with the grant of security by the purchaser. Such security may include fixed charges over the assets of the purchaser, retention of title arrangements and personal guarantees from management of the purchaser.
The potential purchasers will either be third parties, secured creditors or more commonly, connected parties who are shareholders, directors or other majority investors of the company. Section 249 of the Insolvency Act defines connected parties to include a director, shadow director and associates of the company. The purchase of a business by a connected party raises some fairness concerns and the need for an independent valuation becomes more crucial where the proposed buyers have a connection with the company. Some of the issues raised by the involvement of connected persons in pre-packaged sales are discussed later in this chapter.
After the terms of the sale are agreed and relevant documentation is prepared, the insolvency practitioner is officially appointed as administrator and the sale is concluded immediately or soon after the appointment. The formal appointment of the administrator can be made out of court by any one of the company, the directors or a qualifying floating charge holder, if there is one.
Once the administrator assumes office, the immediate task is to effect the sale on the agreed terms. The administrator distributes the consideration received from the sale of the company to the creditors in the order of priority prescribed for administration procedures by the Insolvency Act. In reality, unsecured creditors are likely to be out of the money and only secured and preferential creditors tend to receive a return from the administration. The sale of the company is completed quickly and the business resumes normal solvent trading thereafter. In the pre-packaged sale of clothing retail store House of Fraser to Sports Direct in 2018, the sale was effected within a few hours of the company going into administration.
Following a pre-pack sale, the selling entity will often be left as a shell, housing only liabilities that were not transferred. The administrator determines what happens with the company. The options include a dissolution of the entity where there are no funds or property to distribute to creditors and, less commonly, a creditors’ voluntary liquidation of the company, a company voluntary arrangement or scheme of arrangement. To complete the administration process, the administrator will make the necessary filings at Companies House and with the Insolvency Service.
Challenging a pre-pack administration
In a pre-packaged sale, stakeholders such as trade suppliers, creditors and shareholders may disagree with many aspects of a pre-pack sale ranging from the choice of insolvency practitioner to the proposed purchaser and, particularly, the consideration received for the sale. Such parties, if given an opportunity and the means, may attempt to challenge the process and seek to produce a different result. The main difficulty with challenging a pre-packaged sale is the fact that creditors often have limited or no visibility on the process, until it has become a done deal. Furthermore, the courts have sanctioned the practice of selling a company’s assets in advance without the approval of creditors, and will typically not overturn commercial arrangements unless a case of fraud or undervalue is clearly made out. Within the administration process, it is often difficult to challenge the conduct of the administration and one of the reasons for this is because the administrator is given significant discretion to exercise his or her business judgement. These factors combined with the potential costs of bringing a challenge, serve as a strong disincentive to aggrieved creditors.
However, creditors who receive information about the proposed sale can successfully challenge aspects of the transaction if there are reasonable grounds to do so. In Ve Vegas Investors LLC & others v. Henry Shinners, Finbarr O’Connell and others the applicants were creditors of VE Interactive who brought a claim against the administrators to challenge the pre-packaged sale of the company to the directors for £1.75 million. The creditors asked for the administrator to be replaced. Without determining whether the proposed sale was legitimate or not, the court found that there was a serious issue for investigation by an independent party into whether the proposed sale was in the best interest of the company and whether the administrator had breached his or her duty in agreeing to the terms of the sale.
Regulation of pre-pack administrations
As the use of the pre-pack administration has grown in the United Kingdom, the process has been recognised for its ability to rescue distressed companies. Value is preserved because of the speed with which pre-packs are concluded. The ability to sell the business as a going concern to a new buyer with minimal or no interruption to the running of the company can avoid much of the value erosion that has been known to attend formal insolvency processes. Jobs can be saved and relationships with key suppliers maintained. The pre-pack also potentially reduces the cost of the administration.
Unsurprisingly, a lot of criticism has also been levelled at pre-pack administrations and the manner in which they are conducted. At the core of the criticisms of pre-pack administrations is the lack of transparency, lack of inclusivity and resulting prejudice to certain creditor groups, especially unsecured creditors. As previously noted, the deal is often completed without the knowledge and approval of unsecured creditors. The concern around lack of visibility and transparency is heightened when the purchaser is connected to the insolvent business, for example, the management or previous owners. Consequently, pre-packs have been accused of enabling an abuse of the system by creating an avenue for management or investors to freely transfer the assets of a distressed company, dump the debts and leave behind merely a shell of tax liabilities, pension deficits, supplier and other debts.
Statement of Insolvency Practice 16
These fairness concerns and criticisms have inspired some light-touch regulatory changes in the United Kingdom. In January 2009, the Joint Insolvency Committee issued the Statement of Insolvency Practice 16 (SIP 16) to provide some guidance to practitioners on best practices for pre-packaged sales. SIP 16 recommends that an insolvency practitioner acting in a pre-pack administration should be able to demonstrate that the duties of an administrator under the Insolvency Act have been met. As discussed above, there is an expectation that the insolvency practitioner will consider whether a pre-pack sale produces the best outcome for creditors and the other alternatives are likely to result in a liquidation of the company. SIP 16 emphasises the need for insolvency practitioners to act as independently as possible in making the decision to effect a pre-packaged sale and in negotiating and arranging the sale. An insolvency practitioner is expected to keep a detailed record of the reasoning behind the pre-packaged sale and all the alternatives that were considered before deciding to settle for the pre-pack option. In a detailed document called the SIP 16 Statement, the insolvency practitioner is expected to provide the creditors with information about the justification for the pre-pack, marketing strategy and other specific information about the deal, within seven days of the sale transaction. SIP 16 also recommends an independent valuation and robust marketing of the business to ensure that the best possible value is obtained for the creditors as a whole. The SIP report is filed upon completion of the sale with the Insolvency Service.
The SIP 16 Statement aims to address the lack of transparency around the pre-pack process but it is not intended to provide creditors with any decision-making powers for what is essentially a fait accompli. Beyond providing information to creditors and other stakeholders, SIP 16 also seeks to elicit some accountability on the part of the insolvency practitioner. Failure to comply with SIP 16 does not invalidate a sale or automatically result in a finding of misconduct by the insolvency practitioner. Insolvency practitioners are, however, regulated by recognised bodies who routinely monitor compliance with required standards and can take disciplinary action where appropriate.
Sale to connected persons – the pre-pack pool
Sales to connected persons dominate a significant percentage of pre-packaged sales in the United Kingdom. Finance for funding a trading administration can be difficult to source and where the only available buyers are persons with a connection to the company, this may be the only chance at saving the business. Further, a sale to connected persons, particularly directors who are familiar with the business and have the required expertise to run it, can be beneficial to the continued survival of the company. However, for all the benefits it may offer, a sale to connected persons adds an extra layer of criticism to a process that is already viewed as obscure and lacking accountability. The process becomes more vulnerable to challenges as to whether a fair price has been paid and whether disenfranchised creditors have not been unfairly prejudiced by the deal.
To address the unease around purchase by connected persons, the concept of the pre-pack pool was introduced in the United Kingdom in 2015. The pre-pack pool consists of a group of experts who are to be consulted for an opinion where the proposed purchaser in a pre-packaged sale is a connected person. The function of the pre-pack pool here is to make an independent assessment, for a fee, as to whether the deal is reasonable or not. The opinion is included in the SIP 16 report and available to creditors and recognised professional regulators, as part of the post-transaction disclosure requirements. The role of the pre-pack pool is to provide additional reassurance to creditors, and reference to the pre-pack pool is entirely voluntary. From its inception in 2015 to the end of 2018, the pre-pack pool reviewed 24 applications in relation to proposed connected party sales. Out of 24, the pre-pack pool concluded that 18 cases presented a reasonable case for a pre-packaged sale. This statistic contrasts widely with the data on the number of pre-packaged sales that occurred in the same period. In 2018 alone, there were 450 pre-packs, 241 of which were connected party sales.
Although the pre-pack pool potentially introduces some oversight and accountability into the pre-pack process, the data suggests that the pool is significantly underused. This has prompted further deliberations on the shortcomings of the mechanism and measures to improve its use and efficiency. A common view is that the pre-pack pool suffers a design challenge – the fact that it is voluntary. It has, therefore, been debated whether statutory intervention is needed to ensure that all stakeholders recognise the pre-pack pool as an essential part of the pre-pack process.
1 Jacqueline Ingram is a partner and Damilola Odetola is an associate at Milbank LLP.
2 Part 26 of the Companies Act 2006.
3 Statement of Insolvency Practice 16.
4 Schedule 1, Paragraph 2 and Schedule B1 of the Insolvency Act.
5 Sandra Frisby, ‘A Preliminary Analysis of Pre-Packaged Administrations’ Report to the Association of Business Recovery Professionals (2007).
6 Schedule 1, Paragraph 2 and Schedule B1 of the Insolvency Act.
7 Schedule B1, Paragraph 49(5).
8 Schedule B1, Paragraph 52, Insolvency Act.
9 Where the sale relates to assets over which there is a fixed charge, the permission of the court is required to discharge the fixed charge. Where subject to a floating charge, the administrator can sell without the permission of the creditor and the court. In both cases, the secured creditor retains priority over the proceeds of the sale. Schedule B1, Paragraphs 70 and 71, Insolvency Act.
10 Re T&D Industries  1 BCLC 471; DKLL Solicitors v HMRC  EWHC 2067 (Ch).
11 Re Transbus International  EWHC 932 (Ch);  2 BCLC 550.
12 Statistics from empirical research finds that out of 500 pre-packs completed in 2010, over half of all sales included an element of deferred consideration. Graham Review into Pre-Pack Administration (2014) https://www.gov.uk/government/publications/graham-review-into-pre-pack-administration.
13 Associate is broadly defined in Section 435 of the Act to include partners, employees, persons who have control of the company, among others.
14 Schedule B1, Paragraphs 14 and 22.
16 Schedule B1, Paragraph 78.
17 The Insolvency Service is a government agency in the UK Department for Business, Energy and Industrial Strategy. The agency administers issues relating to insolvency and financial distress and performs a range of functions which include providing information to the public and prosecuting breaches of legislation. https://www.gov.uk/government/organisations/insolvency-service/about.
18 Ve Vegas Investors LLC & others v. Henry Shinners, Finbarr O’Connell and others  EWHC 186 (Ch).
19 Re Meem SL Limited (In Administration)  EWHC 2688 (Ch).
20 Schedule B1, Paragraph 74 provides for a challenge of the administrator’s conduct of the administrator but is not well used.
21  EWHC 186 (Ch).
22 A study of SIP16 Reports relating to pre-packs completed in 2010 showed that majority of pre-packs preserve 100 per cent of employment.
23 Note, however, that while some of the costs may be reduced as a result of the speed with which pre-packs tend to be completed, under the insolvency rules, insolvency practitioners can claim pre-appointment fees as an expense of the administration. IR 1986 r2.67A.
24 The statement has been revised twice since it was first introduced. The recent version became effective from 1 November 2015 https://www.r3.org.uk/what-we-do/publications/professional/statements-of-insolvency-practice/e-and-w/sip-16-list.
25 In the empirical research commissioned by the Graham Review in 2014, it was found that in a sample of 500 pre-packs, almost two-thirds of purchasers were connected to the distressed company.
26 Pre-Pack Pool Annual Report 2018, https://www.prepackpool.co.uk/uploads/files/files/Pre%20pack%20pool%20%202018%20Annual%20report%20v3%20NC%20edits.pdf.
27 Statistics from Insolvency Service, https://www.prepackpool.co.uk/uploads/files/files/Pre%20pack%20pool%20%202018%20Annual%20report%20v3%20NC%20edits.pdf.