Pre-pack reforms: R3’s response to the latest Government proposals

24 November 2020

In October, the Government announced the outcome of its review into the 2015 industry reforms to pre-packs: it would be bringing in new regulations to require independent scrutiny of connected party pre-pack administration sales. Alongside a policy report, the Government also published the draft regulations that would give effect to its proposed measures. Our full response to these regulations can be found here, while a summary of our response is included below.

Background

Following a Government-commissioned review into pre-packs and the regulatory framework around them in 2014, a number of reforms were introduced through the Small Business Enterprise and Employment Act 2015 (SBEE Act), with the aim of increasing transparency and improving stakeholder confidence in the procedure, including improvements to the marketing and valuing of a company’s business and assets ahead of a pre-pack.

One of these reforms included the creation of the Pre-Pack Pool, an independent body of experienced business professionals. The Pool would offer an independent opinion where a pre-pack was proposed, and parties connected to the company were intending to purchase the company’s business or assets, in order to provide independent assurance that the case for the purchase had been made.

The reforms also introduced a review power through the SBEE Act which gave the Government the ability to review the effectiveness of these measures by a later date (May 2020) and to introduce further regulations – or indeed to ban connected party pre-pack sales altogether – if deemed necessary.

The Government was unable to publish the outcome of its review by the deadline in May, due to the disruption caused by COVID-19 and the push to quickly introduce corporate insolvency framework reforms. However, following prompting from Peers during the Corporate Insolvency and Governance Act 2020 debates, the power was reintroduced through the Act with a new deadline of June 2021 – giving the Government additional time to progress with the review.

Overview

We have broadly welcomed the reforms, as they could help to improve confidence in pre-packs. Pre-packs have attracted considerable attention and scrutiny over recent years, but they are an important business rescue tool that can help protect the value of an insolvent company’s business or assets for creditors. They are often less costly than other insolvency procedures – meaning more money can get back to creditors – and they can save jobs by allowing businesses to recover from financial difficulties. In order to be used, an administrator must show that pre-packs generate a better return for creditors than any alternative. Administrators also have to fulfil a range of other regulatory requirements in order for pre-packs to be used.

That said, our response highlights two very significant issues with the proposals: the qualifying criteria of the ‘Evaluator’ and the scope of the proposals. If left unresolved, these issues may hurt rather than enhance confidence in pre-packs – and therefore risk undermining the very purpose of the reforms.

Qualifying criteria of the ‘Evaluator’

An important development in the new regulations is the introduction of an ‘Evaluator’ in connected party pre-pack sales. The Evaluator’s role will be to provide an independent opinion as to whether connected party pre-pack sales are fair and appropriate. Under the proposals, a company’s business or assets will only be able to be sold to a connected party if creditor approval or a report from the Evaluator is obtained, up to a period of eight weeks.

The Government is proposing that an individual will be qualified to act as an Evaluator if “the individual believes that they have the requisite knowledge and experience to provide the report.” This means that simply through deeming themselves to be sufficiently knowledgeable, unqualified and inappropriate opinion providers could be allowed to act in this role. This risks further damaging the perception of pre-packs, while bringing the wider regulatory framework into disrepute – undermining the entire point of the new regulations.

The Pre-Pack Pool has carried out a similar role, albeit on a voluntary basis, to the proposed Evaluator, since its creation in 2015 – when it was established for the very purpose of supplying such opinions. The crucial difference is that it will now be mandatory to obtain an Evaluator’s opinion for these sales to go ahead (or alternatively to seek creditor approval), whereas previously, consulting the Pool had been optional. The Pool has a track record of delivering opinions quickly and efficiently, but it is a private limited company which means the Government cannot mandate in legislation that it should be the sole source of these opinions under the proposed mandatory basis, something that R3 would support.

A solution to this issue could be for the Insolvency Service to maintain a list of approved opinion providers, approved by the Secretary of State, which could include Pre-Pack Pool members. The Pool’s current role would be maintained, and unsuitable individuals would be barred from carrying out the Evaluator role.

We are suggesting that at the very least, the Evaluator should be required to possess Professional Indemnity (PI) insurance. This type of insurance is obtained by individuals whose jobs involve advising clients, handling data or intellectual property, or who offer a professional service. It covers costs when mistakes which cause clients financial or reputational loss are made, and is required by certain regulatory bodies. Successfully obtaining this cover would suggest that an individual Evaluator was at least involved in advising clients and handling sensitive information on a serious and legitimate basis.

Scope of the proposals

One difficulty the Insolvency Service has faced in drafting these regulations is that there is no statutory definition of a pre-pack. This makes it difficult for Government to introduce regulations that apply only to this particular insolvency tool. The SBEE Act therefore allows the Government to impose requirements or conditions in respect of connected party administration sales as a whole, rather than just connected party pre-pack administration sales. Under the Government’s proposed measures, connected party sales agreed after the company goes into administration, up to a period of eight weeks, will be impacted by the reforms.

We have suggested to Government that a clear distinction should be made in the regulations between connected party sales in administration as a whole and connected party pre-pack administrations. While there is value to creditors and stakeholders in the regulations applying to connected party pre-pack sales, we do not believe the case has been made for applying these measures to all connected party administration sales.

Connected party sales in administration normally take place after the appointment of an administrator, by which time creditors are aware of the company’s entry into an insolvency procedure. When the insolvency of a company is known, some connected parties may view this as an opportunity to bid for certain elements and/or assets of a company. Again, at this stage, creditors will be aware of the situation. The profession’s Statement of Insolvency Practice (SIP) 13, ‘Disposal of Assets to Connected Parties in an Insolvency Process’, also requires insolvency practitioners to report to creditors on this type of transaction. As a result, concerns around the perceived lack of transparency in connected party pre-pack sales do not apply to those connected party sales that take place in administrations more generally. 

Next steps

We will be discussing the contents of our submission with Insolvency Service officials in the coming weeks, and are keen to work with officials to ensure that confidence in the regulatory framework for pre-packs is enhanced, rather than undermined. The recommendations we have put forward could play a key role in achieving this objective.