Government gets previous on pre-packs

THE PRACTICE developed by insolvency practitioners of agreeing in advance of administration the sale of a troubled company’s business or assets often to a connected party (usually the current directors) without the knowledge of unsecured creditors, has always been controversial.

At a time when use of this controversial pre-pack procedure is on the increase its future is uncertain. With the stated aim of improving the transparency of, and confidence in, pre-pack sales, the government published draft regulations in June 2011.

The difficult task before the draftsmen was to retain the acknowledged benefit of pre-packs whilst tackling the perception of unfairness (when a management team can ‘dump’ its debts and carry on in business at the expense of trade creditors and to the detriment of its more scrupulous market rivals and in the process creating market distortions and perhaps even job losses elsewhere).

The initial draft regulations were a fairly blunt instrument and were met with widespread objections from the legal and insolvency profession. As a result, the government has decided not to introduce the legislation this autumn but instead the draftsmen have gone back to the drawing board with further draft regulations expected in January 2012.

The initial draft rules proposed that administrators be required to give creditors three days’ notice of the pre-pack where sale to a connected party is proposed and where the business or assets have not been openly marked. This was intended to give creditors an opportunity to apply to court to stop the sale where abuse is suspected or to make a better offer for the assets.

In addition to this, there were provisions requiring the administrator to file detailed SIP 16 type disclosure at Companies House as well as certify that he is satisfied that the pre-pack sale offers a better outcome than any alternative.

A chief objection to these proposals is the risk that notifying creditors will allow even those who do not stand to receive a dividend to make mischief and hold up pre-packs whilst the value in the business seeps away.

In practice though, creditors who have lost out in the administration are unlikely to incur the expense of bringing a doomed court application and if they do, adverse costs decisions are likely to discourage future actions.

Nevertheless the risk remains that notification of creditors will increase the likelihood of customers cancelling contracts and suppliers withholding their goods.

While groups representing creditors welcomed the draft rules they called for an extension of the notice period to seven days to allow creditors time to raise finance to mount their own bid.

If the notification requirement survives the next draft of the regulations it is likely to be modified to include some or all of the following:
a provision that the requirement only applies to small and medium transactions (the perception of abuse appears to be greatest at the lower end of the market);
exclusion of those connected to secured creditors from the current definition of connected parties;
clarification of the definition of open marketing;
a provision that the requirement only apply in more circumscribed scenarios such as where in the IP’s opinion there are unsecured creditors who are likely to be adversely affected by the pre-pack sale as against alternative insolvency procedures;
court power to disapply the notice requirement in circumstances where the IP can show that notice would be likely to prejudice the creditors as a whole.

The courts have indicated a disinclination to interfere with an administrator’s commercial assessment where pre-packs are concerned.

This suggests that even if the notice period is introduced, the courts are likely to be reluctant to strike down a pre-pack proposal except in the most clear cut cases of abuse.

Without introducing a notice requirement, the objective of protecting creditors’ interests and preventing abuse ought to be satisfied by (i) the obligation on IPs to make a proper assessment as to whether the proposed sale is in the interests of creditors as a whole and (ii) the machinery already in place in the insolvency legislation for creditors to challenge an administrator’s decision after the event.

Ruth Jordan is an insolvency barrister at Serle Court

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