Government clarifies rules on Pre-packs

In the current economic climate, as more companies fall into insolvency, we are witnessing the rise of pre-pack administration sales and ensuing media attention. The industry has finally received clear guidance from the Government and from the High Court clarifying what is legally permitted and expected.

Firstly, a new Statement of Insolvency Practice 16 (SIP 16) was published on January 1st. Aiming to increase the transparency of pre-pack deals, it requires insolvency practitioners to provide creditors with specific information when carrying out a pre-pack sale in an administration. The new SIP 16 rules were introduced mainly to give unsecured creditors more information than they previously received in pre-packs. For example, the administrator is required to keep detailed records and provide appropriate justification for agreeing to the pre-pack sale and to provide information to creditors detailing the terms of sale, market activities undertaken, valuations obtained for the business and/or its assets, any connections between the purchaser and the directors of the company and any alternative courses of action that the administrator considered.

Further guidance to the industry came on 6th May in the form of a report from the BERR (Department for Business, Enterprise & Regulatory Reform). The Committee Report on the Insolvency Service welcomed the new SIP 16 and stated that where there are good reasons for a pre-pack administration, this needs to be explained clearly and fully and where there is no good reason, this should be quickly exposed.

And most recently, on 15th May, the High Court ruled in a case involving a pre-pack sale. It has brought some welcome additional guidance to those in the insolvency industry with regard to pre-pack administrations, specifically where the administration has taken place by means of a court application.

The company in question in this case was Kayley Vending Limited, which supplied cigarette vending machines to public houses. It ran into financial difficulties as a result of the smoking ban and was unable to pay its debts to HM Revenue & Customs. HMRC applied for a winding-up petition, which led Kayley to apply for an administration order. Kayley's directors and insolvency practitioner had already negotiated a deal with two potential purchasers, the principal competitors of the company, to sell the business. The insolvency practitioner and an asset valuer had both calculated that a much lower value would be realised if the company went into liquidation. The judge was satisfied with this evidence and granted the administration order, allowing the pre-pack sale to go ahead.

In his judgment, the judge outlined the main risks and benefits of pre-packs. Benefits include the business being sold quickly, the retention of employees that might otherwise leave and the continuity of customer and supplier contracts. Risks, he viewed, include the possibility that the best price may not be achieved for assets and that unsecured creditors could be deprived of the opportunity to influence the transaction before it takes place. His judgment was in line with SIP 16 and the BERR report, reflecting the same concerns. And, crucially, it is also an endorsement of the pre-pack process when it is implemented correctly.

His conclusions included the following:

l The court should be aware of the possibility of abuse of the pre-pack process when making an administration order, given the apparent blessing that this may be seen to confer.

l Sufficient information must be provided to the court so that it may judge whether the administration and pre-pack are in the interest of the creditors. In most cases what is required under SIP 16 will suffice.

l If the administration order is sought through a court application, the insolvency practitioner's costs can be included as an expense of the administration provided that the costs benefit the creditors more than any other party.

Of course, these decisions affect only those administrations where appointment is made by the court. These are the minority of administrations and are usually made when a petition for a compulsory winding-up of the company is pending, such as in the case of Kayley Vending. In addition, the judge emphasised that whether his conclusions will apply in other cases will depend on the facts of each case and will be at the discretion of the judge presiding. However, with regard to whether insolvency practitioner negotiation costs should be included as administration expenses, he did add that "in my judgment it is appropriate that the court should continue to follow this practice."

The area of pre-packs has been controversial for a time and is likely to remain so. However, the developments of recent months should serve to provide some welcome definition for the insolvency industry and confirm that pre-pack administrations are appropriate in certain cases.



Pre-pack

A pre-packaged or 'pre-pack' sale is where a deal for the sale of a business and its assets is agreed prior to the company going into administration. Recently pre-pack sales have garnered significant media attention due to a number of high profile examples involving high street chains. Pre-pack deals are seen by administrators, in many cases, as the only viable option to release maximum funds possible for creditors. However, there has been some concern voiced by unsecured creditors, especially in situations where the pre-pack administration sale is back to the existing management of the company.

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