How will pre-pack administrations fare in the current climate?

As the UK tax office chases outstanding amounts from the lockdown months, the number of administrations is rising. Amid this, restructuring expert Paul Reeves examines whether the phenomenon of the pre-pack administration may be due for an unexpected revival.

Since the administration process became the key business rescue process over twenty years ago, the pre-pack administration has suffered a tarnished reputation. However, in recent times, legislation has been introduced to tighter control the process especially where the pre-pack sale is to a connected party. This has led to many people asking the question; is the pre-pack destined for the bin or will it play a pivotal role in restructuring organisations?

Unlike a trading administration, a pre-pack is a process whereby a sale of the assets of an insolvent business is agreed prior to the commencing of administration. On the appointment of an Administrator, the pre-agreed deal is concluded. It is not uncommon for the sale to be approved without the business being advertised.

By choosing not to advertise, the organisation is able to safeguard the goodwill of the business, reduce administration expenses and ensure their relationship with customers and employers remains strong. In order to minimise potential trouble, the pre-pack is often given to a purchaser that is connected or involved with the insolvent business and who has a keen interest in its survival. These linked parties are often best placed to advance the business and represent the best possibility to obtain maximum value for the entity’s assets. Consequently, it is often the most worthwhile outcome for creditors.

The implementation of new legislation 

Recently announced legislation has transformed the manner in which a sale for a business can be conducted, via a pre-pack, to connected parties. Certain conditions must now be fulfilled before an administrator can dispose of company assets to a connected party during the first eight weeks of a business entering administration. So, what are these conditions that need to be satisfied?

Administrators are faced with two options.

They either;

1. Seek the prior approval of creditors who can sanction the proposed pre-pack deal

or

1. Enlist a report from an independent evaluator that must conclude that the proposed deal is in the best interest of creditors.

The task at hand to seek creditor approval

Seeking the approval of creditors prior to concluding a pre-pack sale of the assets of a business seems to have positive merits. It delivers complete transparency and avoids finger-pointing further down the line. Yet, the seeking of creditor approval could down the process fairly drastically. Furthermore, administrators could be put into a challenging position if approval is not forthcoming. As a result, they could be left trading a business with all the resultant risks that could follow.

Essentially, this is likely to be the way forward in most pre-pack scenarios. Prior to a connected party transaction taking place, an administrator will engage with a person who has relevant understanding and familiarity, together with suitable professional indemnity cover. This evaluator has the task of evaluating the planned transaction and must be ultimately satisfied that the consideration proposed for the business assets and the grounds for the disposal are rational given the situation they’re in. Whilst the Administrator is not bound by the concluding judgement of the evaluator, the administrator will need to deliver a report to creditors and the Registrar of Companies setting out their basis for proceeding with the disposal. It will be a brave Administrator who proceeds with a pre-pack transaction where it conflicts with the evaluator’s belief, even though the opinion is not binding.

It cannot be binding as the Administrator has their own duties and obligations which includes acting in the best interests of creditors as a whole.

Pre-pack administrations are the way forward

It makes sense that legislation has been introduced recently that seeks to provide increased transparency around pre-pack deals. Creditors have often felt that they have been put into a situation where a business sale has occurred without their say. Whilst the new legislation doesn’t necessarily give creditors with the increased input that they may desire, it should at least provide the comfort that dealings have been scrutinised, at some level, prior to completion.

The past 2 years have been tough for businesses battling the wrath of Covid-19. However, there is clearly a crucial role for pre-pack administrations in helping the UK recover from the dramatic impact of the pandemic, and it would be a shame if the legislative changes prove to be a hindrance to the process. Hopefully, that will not be the case.

Paul Reeves is a Managing Director in Restructuring Advisory with global professional services firm Kroll.