Evaluating pre-packs: An uneasy compromise
06 April 2021
Despite their benefits to businesses, despite saving a large number of jobs, and despite making up just 3% of corporate insolvencies in England and Wales in 2019, pre-pack administrations are often the target of negative attention.
In recent years, a number of high-profile companies have undergone a pre-pack, attracting voluminous press coverage. Creditors, and media and political commentators, sometimes criticise pre-packs for being less transparent than other kinds of corporate insolvency.
In response to this criticism, pre-packs have been the subject of a programme of reform over the last few years, with the aim of improving public confidence in the process.
The 2021 pre-pack regulations
The most recent stage of these reforms saw the Government announce that - as of 30 April - all sales of businesses or substantial assets of an insolvent company to a connected party, such as a director or company owner, which take place within eight weeks of the beginning of the administration process, will be subject to a new step in the procedure.
Under the new legislation (The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021, such sales to a connected party must now either receive approval from the company's creditors prior to the sale, or the connected party purchaser must supply a written opinion as to whether the sale is fair and reasonable to creditors, provided by an 'Evaluator'.
Although the new regulations permit an administrator to proceed with a sale to a connected party or parties in situations where the Evaluator's qualifying report states a case is not made for the support of the substantial disposal, they must provide a statement which explains their reasons for doing so.
A new role and new requirement
The Evaluator is a new role, created by these regulations. It is loosely defined by the Government, with only a few stipulations: the Evaluator must believe that they hold suitable knowledge and experience to be able to review a potential sale; they must be covered by a valid professional indemnity policy; they must be independent of all parties involved in the sale; and they must not be excluded from acting as an Evaluator, for example due to a prior conviction for an offence involving dishonesty or deception.
There is also a new requirement placed on administrators under the regulations, which requires them to be "satisfied that the individual making that report [the Evaluator] had sufficient relevant knowledge and experience to make a qualifying report."
This requirement effectively charges administrators with ascertaining the suitability of individual Evaluators. This is not a problem in theory, as administrators are likely to have the experience and resources to establish this point, but it is worth noting the regulations make no reference to the scenario in which an Evaluator may be purposely and successfully misleading about their qualifications or suitability for the role.
Given there is no central register of Evaluators, to whom should administrators complain to if they have been misled? How can inappropriate Evaluators be reported? And to whom should they be reported? We are still awaiting answers to these questions.
Room for improvement
While we understand the approach the Government has taken with these reforms - and the rationale behind them - we firmly believe these reforms would achieve their objective more rapidly and more effectively if the Government were to oversee who can take up a position as an Evaluator.
Were the Government to agree to maintain a list of approved Evaluators, rather than leaving the regulation of this position to the market (by insurance companies who will have to take steps to correctly price professional indemnity cover for the Evaluators, and by the administrators as noted above), it would give stakeholders greater confidence in the robustness of the reforms - a result which might have made the additional administrative burden on the Government easier to bear.
We also have some issues with requirements for the Evaluator role, namely that they could have been more strictly defined. In their current form, the listed requirements risk falling between two stools: they may well not be enough to assuage creditor concerns around connected party pre-packs, while simultaneously adding extra cost and complexity into the process, and potentially making business rescue a trickier prospect.
Strong regulation in place
Insolvency and restructuring professionals are highly regulated, and are well aware of their duty to the creditor body as a whole to achieve the best possible outcome. With pre-packs attracting a high level of scrutiny from regulators, insolvency practitioners will only undertake one if they are convinced it will give the highest level of return possible to those owed debts by the insolvent company. Employees whose jobs are transferred over smoothly to the new entity, with no break in service, also stand to benefit from a procedure that has been developed within the UK's corporate insolvency framework as a way to rescue businesses.
While we understand why concerns around connected party sales exist, it is often a connected party, such as a director, who has the relevant knowledge to be best-placed to give the new entity its greatest chance of success. If entrepreneurship and risk-taking were discouraged following one setback, many profitable UK companies would not exist, something that the Government recognised when, last October, it announced it would not ban outright all connected party sales in administrations.
With its new regulations, the Government has tried to find a balance between assuaging creditors' concerns around transparency, and allowing entrepreneurs a second chance. Once they come into force, we will be able to judge whether or not the Government's chosen solution has been successful - and with business rescue and renewal likely to be high on the agenda as the economy begins to recover from the pandemic, we hope the path they have chosen is the right one.
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