Pre-packaged administrations

“Pre-pack” is the term used to describe the sale of an insolvent business by an IP appointed as the Administrator of the insolvent company under the Insolvency Act 1986 (as amended by the Enterprise Act 2002) on the basis of an agreement negotiated before the Administrator is appointed.

The sale, which is sometimes, though not always, made to the previous directors or managers of the insolvent business, is then rapidly executed by the Administrator without the business being offered on the open market and without prior consultation with the full body of creditors. During 2006 there was a lively debate within the insolvency profession and outside on whether pre-packs, the use of which appears to be increasing, were sometimes being resorted to where they were not justified.

There is a wide consensus between insolvency practitioners, their regulators and creditors’ representatives that the pre-pack is a necessary and useful tool for saving a business where any delay in selling the business or the process of marketing it are likely to destroy or reduce its realisable value (an example is where the sole assets of the insolvent company are its staff). The IPC shares this view. However, two concerns about the way in which pre-packs are operated were also expressed in the debate.

The first is that in some cases pre-packs are being used when the business could and should have been marketed more widely, even for a short period of time, to see whether any higher offers were forthcoming. The second is that serious conflicts of interest can arise if an IP, who has been acting as an adviser to the original company, to its directors or managers or to an interested third party, is subsequently appointed as the Administrator to execute a sale, on which he or she may have previously given advice to one or more of the interested parties.

The Administrator is required to have regard to the interests of all the creditors (including the unsecured creditors) in deciding what should be done with the insolvent company or its business in accordance with the priorities set out in the Enterprise Act 2002.

He or she also has to consider whether the conduct of the directors of the insolvent company has been appropriate in the period preceding the insolvency and to report on this to the Secretary of State. If the IP appointed as Administrator has previously been advising the original company, its directors or managers or a connected third party on the company’s future, he or she will face a risk of “self review”, i.e. having to assess the appropriateness of his/her own previous advice. In these circumstances the IP needs to consider whether he or she will be seen as sufficiently independent to accept the appointment as Administrator.

We understand that the Insolvency Service is preparing (secondary) legislation, which would require Administrators who have executed a pre-pack to make a full report to all the creditors explaining why a prepack was used in the particular case. (The legislation would also enable fees earned by an IP prior to the appointment of an Administrator to be recovered [subject to the creditors’ approval] from the proceeds of the sale of the business through a pre-pack). The IPC welcomes this proposal.

We think it is essential that the Administrator should be required to include in his/her report to creditors a specific explanation of why the business was not offered on the open market, even for a short period of time, and why doing so would have been detrimental to the value of the business. A mere assertion that the pre-pack offer produces a higher price than a valuer has estimated for a hypothetical sale should not be regarded as a sufficient justification for setting aside the presumption that putting the business up for sale on the open market would normally be the surest way of maximizing the return to creditors.

The IPC also considers that further action is needed to ensure that IPs are seen to deal appropriately with the conflicts of interests described above.

Arguments have been put to us that the conflict of interest can be discounted without detriment, because the IP can reasonably be expected to have been giving consistent “seamless” advice both pre- and postappointment as Administrator. It is also argued that the need for an independent administrator is lessened, because normally in a pre-pack there is no money left over for the unsecured creditors.

We do not find these arguments persuasive. The first ignores the fact that the conflict of interest test, as stated in the DTI’s “Guidance to Professional Conduct and Ethics for persons authorised by the Secretary of State as Insolvency Practitioners", is whether “the objectivity of the IP in carrying out a subsequent insolvency appointment might be, or be seen to be, impaired” (emphasis added).

The second argument begs the question as to whether an open market sale of the business might have produced a better price. In any case, when there is no money left for the unsecured creditors the need for an independent report on the conduct of the directors is more than usually important for them, particularly where the business is being sold back to directors.

Recommendations
We recommend that the Insolvency Service should require Administrators, when reporting on a prepack to the full body of creditors, to give a prompt reasoned explanation of why they decided against putting the business up for sale on the open market even for a short period and why doing so would have been detrimental to obtaining a better price for the sale of the business.

As regards conflicts of interest in relation to potential pre-packs, the RPBs should draw their IPs’ attention to the existing ethical requirement on IPs to consider, before taking any appointment as an office-holder of an insolvent business, whether any previous material business connection they may have had with the insolvent company, its directors, managers or other connected third parties may put in question, or be seen by other parties to put in question, the independence and objectivity the officeholder needs to have. We further recommend that the RPBs consider whether any more detailed guidance should be given to the profession on this matter.

We also recommend that the RPBs should monitor how Administrators have handled potential conflicts of interest in pre-pack cases. To facilitate monitoring, IPs who accept appointments as Administrators in pre-pack cases having previously been involved in advising the company, its directors or managers or other connected third parties on the option of a pre-pack sale, should disclose this connection in their report to the full body of creditors and explain how they have handled the potential conflict of interest.

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