A statement of intent

The recession has seen a major increase in the use of “pre-pack” administrations. Morgan Bowen explains what local authority lawyers should be looking for if their council is affected.

Statement of Insolvency Practice 16 became effective from 1 January 2009. It sets out guidance notes to insolvency practitioners on the proper conduct of so-called "pre-packs".

A pre-pack is defined in the statement 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 his appointment". As a consequence, administrators now have to make extensive written disclosure to creditors in all cases where there is a "pre-pack".

History

The prevailing view under the old authorities was that permission of the court was needed where an administrator wished to sell prior to the section 24 Insolvency Act 1986 creditors' meeting. At such an application, the company would need to provide independent valuation evidence and evidence that any delay in the sale process would lower the going concern value of the assets being sold.

However, in re T & D Industries Plc [2000] 1 WLR 646, Neuberger J held that permission of the court was not needed for such pre-pack sales. In fact, Neuberger J held that the decision on whether or not a pre-pack sale should occur was a decision best taken by the administrator himself, not the court and that it was inappropriate for the court to be used as "a sort of bomb shelter" for the administrator.

The power of the administrator to sell on a pre-pack basis without the approval of the court survived the introduction by the Enterprise Act 2002 of Schedule B1 to the Insolvency Act 1986.

The problems presented by pre-packs

Notwithstanding the fact that the administrator has the power in law to engage in pre-pack sales without court approval, the creditors of course retain the full panoply of powers laid out in the Insolvency Act post-sale, including the power to apply for an order by the court removing the administrator – this power is contained in para 88 of Schedule B1.

Just such a removal was ordered by the court in the recent case of Clydesdale Financial Services v Smailes [2009] BCC 810 where David Richards J held that, in the specific circumstances of that case, the terms of the contract for the pre-pack sale and the circumstances that led to its promulgation did give rise to a legitimate concern that warranted an investigation by an appropriate office holder and that, as the administrator, Smailes, had been so closely involved with the negotiations that gave rise to the eventual contract, it would be difficult for him to conduct such an independent review, thus necessitating his removal pursuant to para 88 of Schedule B1.

Pre-packs thus represent a veritable minefield for practitioners as they cannot hide behind the approval of the court and yet may find themselves open to attack by creditors. Nevertheless, there are many occasions where pre-packs are the best way of preserving going concern value and the only way of preserving jobs and, in appropriate circumstances, must continue to be used by administrators.

As the recession has bitten and as the number of administrations in general has risen, increasing concerns have been expressed by creditors as to the general practice of pre-packs, particularly where there is a pre-pack sale back to existing management. SIP 16 was issued in this context with the intention of improving in each administration the creditors' understanding of the underlying rationale for the pre-pack. Close compliance with it should definitely assist an administrator in preventing subsequent successful attacks by creditors seeking their removal.

What does SIP 16 say?

The key substantive provisions of the statement relate to disclosure by the administrator to the creditors and are contained in para 9 of the statement. The following information is to be provided by the administrator to all creditors on all pre-packs unless there are exceptional circumstances and, if there are such exceptional circumstances, the reason why the information is not provided should be stated:

• the source of the administrator's initial introduction;
• the extent of his involvement prior to the appointment;
• any marketing activities;
• any valuations;
• any alternative courses of action considered;
• why it was not possible to market the business as a going concern and sell it in the administration;
• what efforts were made to consult with major creditors;
• the identity of the purchaser;
• any connection between the purchaser and the directors or shareholders;
• the names of any directors or former directors who are involved in the management or ownership of the purchaser;
• details of the assets involved and the nature of the transaction;
• the date of the transaction;
• if the sale is part of a wider transaction, a description of other aspects of the transaction;
• the consideration for the transaction and payment terms (including any conditions that could materially affect the consideration;
• any options, buy-back arrangements or similar conditions in the contract of sale;
• details of requests made to potential funders for working capital; and
• details of any guarantees given by any of the directors to any prior financier and whether that financier is financing the new business.

By para 11, unless it is impracticable to do so, the disclosure should be provided with the first notification to creditors and, in any case where there has been a pre-pack, the administrator should hold his initial creditors' meeting as soon as possible after his appointment.

The Insolvency Service's Report on the first six months' operation of SIP 16

The Insolvency Service has subsequently issued its Report on the first six months' operation of SIP 16. In its executive summary, the Service stated that information relating to 370 out of a total of 572 companies in administration was compliant with the disclosure requirements of SIP 16, representing 65% of the total.

The Service stated however that failure to comply with SIP 16 did not imply misconduct in the pre-pack itself. In many cases, apparent non-compliance could be attributed to early differences in interpreting the requirements of the guidance. However, in 17 of the cases reviewed the insolvency practitioners’ conduct was such as to warrant its being referred to their authorising bodies.

The report went on to state that there did remain significant room for improvement in the information provided in a good proportion of cases. In particular there were three areas where improvements in the compliance with SIP 16 was expected going forward.

Firstly, the timing of the statements: given that all the relevant details would usually be known to the insolvency practitioner at the time of appointment, it could ordinarily be expected that the information could be sent to creditors upon completion of the sale.

Secondly, failure to provide full details of a valuation or marketing exercise was a common weakness in the SIP 16 information, and of particular concern. Without details of the value placed on assets, it would usually be very difficult for creditors to determine whether the pre-pack sale was in their interests.

Thirdly, it was highly important that any connection between the insolvent company and the purchaser of its business be fully disclosed. Failure to do so could give rise to the perception that the directors and insolvency practitioner had colluded to withhold this information from creditors, with a consequent loss of confidence in the integrity of the sale and the insolvency regime as a whole.

A further report is expected in the New Year.

Morgan Bowen is a barrister (non-practising) at Moon Beever.