Wed, 25 May 2022 | BUSINESS NEWS
Despite proving a popular option when it comes to business rescues, pre-pack administrations have often been regarded with some wariness. The foremost concern has been in relation to pre-pack deals in which the business is acquired by a connected party.
In such situations, the deal is usually done without creditor input and often happens without creditors event being informed. This opens up the risk that pre-pack acquisitions may not represent the best deal for those owed money by the company. An example of a notable pre-pack deal in recent years was when JD Sports placed Go Outdoors into administration, before buying it back (free of some significant rental burdens) just a week later.
In response to such concerns, new regulations governing pre-pack administrations were introduced last year to tighten control over situations in which businesses are acquired by connected parties. However, with these new rules in place, it’s important to consider whether the pre-pack process still has a central role in UK business restructurings?
What does a pre-pack administration involve?
A pre-pack administration differs from other forms of administration in that a deal to acquire the company or its assets is agreed prior to it entering administration. When an administrator is appointed, the sale will then be completed.
Typically, a deal will be agreed without the business even being advertised, a factor that helps to secure a quick sale (which can be incredibly valuable for a distressed business), preserves the business’ goodwill, maintains key relationships and minimises the costs of the administration process. The business not being advertised can also naturally lend itself to a situation in which it is acquired from administration by a connected party.
A quick sale to a connected party helps to minimise disruption to the business’ operation and can ensure it is taken on, free of some liabilities, by an owner with an interest in its recovery and success. If the connected party is genuinely the best option for the business going forward, then this can also help to ensure the best returns for the business’ creditors.
However, concerns have persisted over the possibility that a connected party, given their potentially high level of control over the process, could position themselves as the preferred bidder and use the deal to simply free themselves of liabilities, to the detriment of creditors.
The new legislation
Introduced in 2021, new rules have come into force for pre-pack sales to connected parties. These rules mean that some conditions have to be satisfied before administrators can sell a company or its assets to a connected party within eight weeks of it entering administration.
The rules stipulate two options, administrators either seek creditor approval for a proposed pre-pack sale, or they engage an independent evaluator to produce a report, which should conclude that the deal genuinely represents the best deal for the business’ creditors.
However, the question now becomes whether these rules rob pre-pack deals of their central benefit: the ability to secure a quick sale to a committed buyer that helps minimise disruption and gives the business the best chance of survival and future success.
Seeking creditor approval
Creditor approval might, on paper, seem like the best method of securing a pre-pack sale in a way that ensures creditors are protected. Crucially, it offers transparency, which can be valuable in the even of later disputes.
However, going through the process of seeking creditor approval, particularly in complex cases where a business may have numerous creditors, can severely slow down the process, potentially at the cost of the key benefits of a pre-pack deal. There is also a risk that creditors may not approve, leaving administrators trading an insolvent business with diminished rescue prospects.
Independent evaluation
Given the risks and potential detriments of gaining creditor approval, most pre-pack administrations under new legislation are likely to involve administrators engaging the services of an independent evaluator. This evaluator will be a professional with relevant knowledge and experience of these kinds of deals and companies, as well as professional indemnity cover.
The administrator will task the evaluator with assessing the proposed deal and the evaluator must be satisfied that both the consideration being offered and the grounds for disposal of the assets are reasonable in the circumstances.
Crucially, the administrator’s duties and obligations mean that they are not legally bound by recommendations made in the evaluator’s report. However, the administrator will need to present their rationale for going ahead with a pre-pack deal to both the Registrar of Companies and the business’ creditors, meaning it would be unusual to go against the evaluator’s opinion.
Where do the new rules leave pre-pack administrations?
Given the concerns that creditors have historically felt regarding pre-pack administrations and the risk that such deals may not work in their best interests, the introduction of new rules was hardly surprising.
Although the legislation may not always lead to more direct creditor input into the pre-pack process, it does at least ensure that a degree of scrutiny is being placed on transactions before they go through.
When done correctly, pre-pack administrations can be of huge help in enabling businesses to survive and set themselves up for future success (especially in a trading environment so heavily impacted by supply chain issues, rising prices and the continuing effects of COVID-19 and Brexit.) However, it remains to be seen whether the new rules mean that pre-pack deals are no longer seen as a viable option.
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