This article considers the forthcoming changes to SIP 16 and the Insolvency Service’s review of the current regime for pre-packs, in light of continued creditor concerns. It first appeared in Corporate Rescue Insolvency journal, December 2012 (2013) 6 CRI 178).
- In 2012, the government dropped controversial proposals for draft legislation aimed at improving transparency and confidence in pre-packaged sales in administration.
- Since then, some creditor groups have continued to lobby for change.
- SIP 16 has been revised, and the Insolvency Service has opened a review of the current regulatory regime, to assess the long term impact of pre-packs.
Pre-packaged administration sales continue to be the subject of much debate. Supporters argue that the speed at which the transaction is completed preserves valuable goodwill in the business. Valuations of assets on a going concern basis are invariably higher than in a firesale/liquidation scenario. Key employees, suppliers and customers are often retained by the new owner. The risk of trading the business passes to the buyer on completion of the sale, thus avoiding the problem of funding the business during a period of administration.
However, there has been much criticism of pre-packs amongst certain creditor groups, despite the introduction of Statement of Insolvency Practice 16 (“SIP 16”) in 2009. This dissatisfaction has been widely reported in the press, resulting in reputational damage both to the process of pre-packs, and to the insolvency industry itself.
SIP 16 requires administrators to submit a report explaining why a pre-pack was chosen as the best course of action for creditors. However, as a pre-packaged sale is agreed in confidential negotiations before the administrator is appointed, creditors have no opportunity to vote on or approve the proposed sale, and much of the criticism of the procedure hinges around this perceived lack of transparency and accountability. Creditors have complained that they cannot be sure that the sale was in their best interests - as the business was never exposed to the market, how can the administrator be sure that the price paid reflected its true market value? Of course, these concerns are even stronger where the business has been sold back to its existing directors or management, and the public perception is that the directors have simply set up a phoenix company to continue the same business, whilst leaving its creditors behind.
In 2011, the government proposed amendments to the legislation to improve the transparency of pre-packaged sales, including the introduction of a requirement to give creditors three days’ notice of the terms of a proposed sale to a connected or associated party, where there had been no open marketing of the company’s assets. The aim was to enable creditors to consider their position, and possibly make higher offers, or where necessary apply for an injunction to prevent the sale taking place.
However, very few of the interested parties believed these proposals would work. Many of those in favour of creditors being given notice (eg. unsecured creditors, landlords, HMRC) thought the three day period was too short. Bodies representing insolvency practitioners (IPs) felt strongly that it was too long, would cause unnecessary disruption and delay to creditors, and, rather than fostering the rescue culture, would result in increased numbers of firesales via liquidation, with the associated erosion of asset values.
As a result, the government withdrew the proposals early in 2012, and commissioned a review to assess ways in which the existing regulatory framework could be used to encourage transparency and confidence in the use of pre-packs in restructuring.
The Insolvency Service’s annual Review of Insolvency Practitioner Regulation for 2012 reports that, in that year, the Insolvency Service was notified of 728 pre-packs by IPs. During the first six months of 2012, 69% of pre-pack cases were sold to a connected party (compared to 80% during the comparable period in 2011). Marketing activities were carried out by the administrator in 60% of pre-packs during this period (compared to 48% during the comparable period in 2011). Following SIP 16 monitoring during 2102, the Insolvency Service reported 34 IPs to their authorising bodies, so that their SIP 16 disclosures could be considered from a regulatory and disciplinary perspective. In most of the non-compliant cases, the main issues were with insufficient provision of information regarding the valuation and marketing of assets, and apportionment of the sale consideration.
Although IPs can be fined for non-compliance, there has been criticism that the fines are not of a level adequate to act as a deterrent. A BIS Select Committee review into the Insolvency Service, published in February 2013, concluded that there need to be tougher sanctions for IPs who fail to comply with the guidelines set out in SIP 16. The Insolvency Service has agreed that there should be stronger penalties and higher fines for non-compliance. It is also changing its feedback methods to give feedback to each IP and their regulating body where a SIP 16 report is found to be non-compliant.
So, the debate on pre-packs rumbles on, and creditors continue to lobby for tighter controls.
Issues raised by creditors, and referred to in the preamble to the Insolvency Service pre-pack review, continue to include:
- that businesses are being sold at an undervalue, especially where the sale is to the previous owner or management with no open market valuation;
- that there are possible conflicts of interest for administrators where they have previously worked closely with the directors, or where they have been appointed by the floating chargeholder;
- the perceived detriment to unsecured creditors who only find out about the sale after it has occurred;
- the role of advertising targeted at directors of companies in distress;
- that allowing the company to leave behind its unwanted debts gives an unfair market advantage; and
- that there may be longer term economic harm caused by allowing inefficient businesses to continue trading.
Revision of SIP 16
Following a consultation in the spring of 2013, the Joint Insolvency Committee (“JIC”) has published a revised SIP 16, which will come into force on 1 November 2013.
The revisions remind IPs that the particular nature of an IP’s position in a pre-pack renders transparency in all dealings of primary importance. Administrators are already required to keep a detailed record of the reasoning behind the decision to undertake a pre-packaged sale, and to demonstrate that they have acted with due regard for the interests of creditors, as is required by legislation.
The revisions add to the list of information which should be included in the administrator’s explanation of a pre-packaged sale. These revisions are clearly in response to creditor concerns. The additions require disclosure of details of any marketing activities undertaken and valuations obtained by the administrator for the business, or if no marketing/valuation exercise was undertaken, an explanation of why not, and of how the administrator was able to satisfy himself as to the value of the assets.
The revisions also require more detailed disclosure of how the sale consideration was split under broad asset categories, and between fixed and floating realisations. In transactions affecting a group of companies, the administrator will have to ensure that his disclosure is sufficient to enable a transparent explanation, for example of allocation of the consideration within the group.
Administrators will also have to disclose if the business or business assets have been acquired from an IP within the previous 24 months, or longer if the administrator deems that relevant to creditors’ understanding. The administrator will have to disclose the details of the previous transaction, and whether he or his firm or associates were involved.
The administrator’s explanation of the pre-pack will have to be given with the first notification to creditors, and in any event within seven calendar days of the sale.
Although many of the responses to the JIC consultation on the revisions to SIP 16 were positive, there were dissenting voices. Notably, the Road Haulage Association (“RHA”)’s response stated that, despite the revision to SIP 16, it believes that insufficient importance was and still is being placed on the impact of a pre-pack on competitor businesses. Its view is that, within the road haulage sector, pre-packs do not protect jobs, rather they “undermine quality jobs offered by operators trading sustainably for economic rates, within the rules, and following best practice”. The RHA states that in its industry, there is little concern about preserving jobs, since the sector is highly competitive, and in the case of business failure, rival companies simply take on the work and redundant employees from the failed business. Its fundamental issue with the current pre-pack system is that it gives information only after the event. Despite the introduction of the seven day time limit for disclosure, this remains information received after the event, which leaves the pre-pack system open to abuse, and creditors with a lack of confidence in the operation of the entire system. They point out that many creditors, who are already running businesses on tight margins, are unlikely to challenge a pre-packaged sale, due to the time and cost involved.
Insolvency Service review
The Insolvency Service’s review of the present regulatory regime is also now underway, and the report is expected to be published in the spring of 2014. There has been some criticism that the money spent on funding this review would be better spent on increasing funding to enable the Insolvency Service, which has faced funding cuts, to properly investigate the few cases in which the pre-pack procedure is being abused, and pursue disqualification proceedings where appropriate.
Although the announcement of the review led to some speculation that the proposal to give creditors’ three days’ notice of a pre-packaged sale would be revived, this seems unlikely, given previous resistance.
R3, the body representing insolvency professionals, has suggested further measures in order to increase transparency and confidence in the pre-pack procedure, such as requiring all administrations involving connected party pre-packs to exit into liquidation, giving creditors the right to appoint an independent liquidator to examine the sale, and tackle any wrongdoing. However, this investigatory work would again need funding.
It is accepted that there are cases in which unscrupulous directors or IPs abuse the pre-pack procedure, and it is hoped that the revised SIP 16 and stronger penalties for non-compliance will go some way to preventing this. There are also procedures within the insolvency legislation to deal with situations in which the procedure has been abused. Although there are associated costs, directors can be disqualified, or actions brought for misfeasance or wrongdoing, and creditors can challenge the conduct of an administrator via the court.
It is important to bear in mind the fact that, in most cases of insolvency, unsecured creditors would probably lose out, regardless of the pre-packaged sale. In many cases some creditors may wish to continue to trade with the new business, and the pre-pack sale is a preferable option to liquidation and the death of the business. In addition, allowing directors ‘another go’ if they are not guilty of any misfeasance or misconduct is an important part of the enterprise and rescue culture promoted in the UK.