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 or prepackaged plan of reorganisation that is often 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.

Pre-pack 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’.^[2]

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.^[3] 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.^[4] In contrast to a prepackaged 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 they are 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 they 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 their 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.^[5] The insolvency practitioner may be satisfied 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 prepackaged sale is consistent with the broad powers of sale granted to the administrator under the Insolvency Act.^[6] 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.^[7] The administrator, however, has the power to bypass the requirement for creditors’ approval of the proposal if they determine that each creditor will be paid in full or that no distributions will be made to unsecured creditors.^[8] Also, in achieving the purpose of the administration, the administrator can sell the assets of the company without the approval of creditors.^[9]

This is similar to what occurs in pre-pack administrations, except that the arrangements for the sale are made before the administrator assumes their 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.^[10] The decision to conclude a sale of the business in advance of or without the creditors’ meeting is left to the judgement of the administrator. However, this does not protect the administrator from a subsequent challenge for breach of duty.^[11]

Once a decision is made to complete a prepackaged 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. The buy-in of secured creditors can be particularly 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 prepackaged sales in the United Kingdom.^[12] 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 where, 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. This 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.^[13] The purchase of a business by a connected party raises some fairness concerns, and therefore 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 prepackaged sales have recently become the subject of regulation and 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 companies, the directors or a qualifying floating charge holder, if there is one.^[14]

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 prepackaged 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.^[15]

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^[16] and, less commonly, a creditors’ voluntary liquidation of the company, a company voluntary arrangement or a scheme of arrangement. To complete the administration process, the administrator will make the necessary filings at Companies House and with the Insolvency Service.^[17]

Challenging a pre-pack administration

In a prepackaged sale, stakeholders such as trade suppliers, creditors^[18] and shareholders^[19] 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. These parties, if given an opportunity and the means, may attempt to challenge the process and seek to produce a different result. In an administration, the options available to discontented creditors include seeking the removal of the administrator^[20] or making an application to challenge the conduct of the administrator.^[21] The main difficulty with challenging a prepackaged 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. In addition, 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 their business judgement.^[22] 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,^[23] the applicants were creditors of VE Interactive who brought a claim against the administrators to challenge the prepackaged 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, 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 their 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 businesses. 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^[24] and relationships with key suppliers maintained. The pre-pack also potentially reduces the cost of the administration.^[25]

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

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 prepackaged sales.^[26] 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 prepackaged sale and in negotiating and arranging the sale. An insolvency practitioner is expected to keep a detailed record of the reasoning behind the prepackaged 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 that routinely monitor compliance with required standards and can take disciplinary action where appropriate.

Sale to connected persons

Sales to connected persons dominate a significant percentage of prepackaged sales in the United Kingdom.^[27] 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.

The United Kingdom has introduced the Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021^[28] to address the unease around purchases by connected persons. As part of this statutory intervention, SIP 16 has been updated to reflect the Regulations. SIP 16 previously included the option for a pre-pack pool to make an independent assessment, for a fee, as to whether the deal was reasonable. The pre-pack pool comprised a group of experts who were to be consulted for an opinion where the proposed purchaser in a prepackaged sale is a connected person. Under the updated version of SIP 16, references to the pre-pack pool have been replaced by the statutory obligation under the Regulations to obtain an independent qualifying report from an evaluator. In practice, the pre-pack pool is likely to step into the role of the evaluator in most cases. By providing improved oversight, the Regulations are set to address the main criticisms surrounding pre-packs, although they potentially throw up practical issues of their own. These issues will become clearer as stakeholders navigate the implementation phase, but the next chapter identifies some of the practical issues that could potentially impact implementation of the Regulations.

Notes