IPs may be liable for misfeasance claim from pre-pack sale if connected person checks not done properly

30 November 2022

By Rupert Darrington:

The new rules for whether a proposed purchaser in a pre-pack situation is a connected person are not clear in many cases, and this could open up IPs to misfeasance claims, or a claim for removal, says David Pollard, barrister at Wilberforce Chambers.

According to Pollard, under the Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 there can be a breach of statutory requirements even if this is inadvertent, or if “reasonable care” has been taken.

“There is no express sanction for a breach in the legislation, but this could be the source for others on the administrator, for example a misfeasance claim, or a claim for removal,” he said.

“Administrators may seek confirmations of status from relevant parties, for example a prospective purchaser, but this may not be conclusive – and may be tricky to get.”

Pollard, who has recently written a book  on the subject, said that “at its extremes, a proposed purchaser company can be a connected person with an insolvent company if there is just one person – perhaps best called a link person – who both is, or was, an associate of the insolvent company or of a director or officer of the company and is, or was, an associate of the purchaser company or of a director or officer of the company.”

According to Pollard, one partial way of checking this is for both sides to prepare a list of their relevant persons – that is their associates and the associates of their directors and officers – and then cross check both lists to see if they have any names in common.

“But often a potential major difficulty here can be not just in identifying the associates of the companies, but also in identifying both the directors (and former directors) and officers (and former officers) of a company and the associates of such persons.”

Pollard said another difficulty is that the definitions of an “associate” are themselves quite wide. “It will often be a practically impossible task for a BidCo, or the administrators of an InsolventCo, to identify all its associates.  It can be very difficult for an individual director or officer to confirm all of his or her associates.”

Under the 2021 rules and the coming into force of para 60A of Schedule B1 to the Insolvency Act 1986, if a substantial disposal is envisaged within the first eight weeks of an administration, the parties need to check if the proposed purchaser is a “connected person” with the company in administration. If it is, then the purchaser usually needs to provide a report from an independent evaluator.

The relevant tests for being a connected person is set out in the legislation: para 60A of Schedule B1 to the Insolvency Act 1986, says Pollard.  But he adds: “The tests are rather complex and use many other concepts, which themselves can be tricky, such as [the meaning of the words] associate, director, and officer.

“All of this points towards a cautious, but potentially more costly, approach of getting an evaluator’s report in all cases unless Bidco is clearly not connected, or the disposal is clearly outside 8 weeks.”

Overview of ‘associate’ under s435 of the Insolvency Act 1986

Source: David Pollard

General points:

• All wholly owned companies in a group are associated with each other.

• Directors are associated with the company on whose board they sit, but not necessarily with its subsidiaries. Similarly, an employee is associated with his or her employer (and vice versa).

• A company is associated with each of its directors, officers and employees.

• Significant shareholders (over one-third voting power) will have ‘control’ and so are associated with the company (and its subsidiaries).

• This can also apply (at the same time) to another person who has a contractual power to exercise the votes (which can include a lender with security over shares).

The definitions of ‘connected’ and ‘associate’ are complex and contain many nuances.  For further analysis, see Pollard ‘Connected and Associated: Insolvency and Pensions Law’ (Bloomsbury Professional, 2021).

Associated persons:       

Relatives:

• A person is an associate of an individual if that person is:

• the individual’s spouse or civil partner;

• a relative of the individual;

• a relative of the individual’s spouse or civil partner;

• the spouse or civil partner of a relative of the individual; or

• the spouse or civil partner of a relative of the individual’s spouse or civil partner.

References to a spouse or civil partner include:

      • a former husband, wife or civil partner and

• a ‘reputed’ husband, wife or civil partner.

A ‘relative’ in relation to a person is that person’s brother, sister, uncle, aunt, nephew, niece, lineal ancestor or lineal descendant.

Partnerships:

A person is an associate of any person with whom he is in partnership and of the husband, wife, civil partner or relative of any individual with whom he is in partnership. A Scottish firm is an associate of any person who is a member of the firm.

Trusts:

A trustee is associated with beneficiaries of the trust (but excluding pension schemes and employees’ share schemes) and vice versa.

Employees:

A person is an associate of any person whom he employs or by whom he is employed.

Directors and officers

Any director or other officer of a company is to be treated as employed by that company and so an associate.  The term “officer” probably includes the company secretary and a “manager”.  The term “manager” means someone who manages (and will depend on the context).

If a person is associated with another person then they are associates of each other.

Companies associated with other companies:

A company is an associate of another company if:

• the same person has control of both or a person has control of one and persons who are his associates, or he and persons who are his associates, have control of the other; or

• a group of two or more persons has control of each company and the groups either consist of the same persons or could be regarded as consisting of the same persons by treating (in one or more cases) a member of either group as replaced by a person of whom he is an associate.

• A company is an associate of another person if that person has control of the company or if that person and persons who are his associates together have control of the company.

There are special rules for members of a limited liability partnership.

Control

A person is to be taken as having control of a company if:

• the directors of the company or of another company that has control of it (or any of them) are accustomed to act in accordance with his directions or instructions; or

• he, she or it is entitled to exercise, or control the exercise of, one-third or more of the voting power at any general meeting of the company or of another company that has control of it.

If two or more persons together satisfy either of the above conditions, they are to be taken as having control of the company.

Control can arise with just one-third of the voting power:

• A person has ‘control’ of a company if he, she or it has (or can control the exercise of) one-third or more of the voting power in the company at any general meeting (or controls an entity that controls the company).

• Such control may be possible through a voting agreement (eg by a lender with a mortgage or charge over the shares).

• It is also possible that separate holdings of separate shareholders can be added together to give joint control (particularly if the shareholders are associated).

1‘Connected and Associated: Insolvency and Pensions Law’ by David Pollard (2021, Bloomsbury Professional)