Keeping pre-packs afloat

When Teresa Graham published her independent report into pre-pack administrations in June 2014, she concluded that there was, at that time, no need for legislative intervention. Instead, she expressed the hope that the insolvency industry would back her six recommendations on how to improve confidence and transparency in ‘connected party’ pre-packs—broadly, where the former directors or owners are the buyers. Paul Sidle, Rebecca Jarvis, Richard Bussell, Richard Hodgson and Mandip Englund of Linklaters discuss the recommendations.

The recommendations focussed on improving SIP16, notably as regards marketing and valuation, and also promoted the idea of the pre-pack Pool and Viability Statement. The two key recommendations were that in a connected party pre-pack the buyer should seek an opinion from a new Pool on whether the grounds for the proposed pre-pack sale are reasonable; and the buyer should prepare a viability review stating what the buying entity will do differently for the business to survive for at least 12 months from the date of the proposed purchase. The Pool and Viability Statement reforms were introduced from 1 November 2015. Significantly, the measures introduced are entirely voluntary. Changes to SIP16 were duly made, and the Pool and Viability Statement became operational in November 2015.

What is potentially at stake is the continued use of pre-packs as a valuable business rescue tool and way of securing the best economic returns for creditors. The government has the power until May 2020 to regulate further—or even ban—connected party pre-packs. Whether, and if so how, it would exercise that power will likely depend on broad political considerations, but the decision will be strongly influenced by the perceived success of the November 2015 pre-pack reforms.

What impact have those reforms had and what more could the insolvency industry be doing to ensure their success?

The Pool—the story so far

The Pool—the story so far:

  • numbers of referrals—official data is thin, but one recent press report obtained data from the Pool relating to 17 referrals
  • average value of deals referred—according to that same report, the average value of the pre-packs referred to the Pool so far is around £4.2m. Of those 17 transactions, 11 were over £1m
  • opinions—although there may have been at least one qualified opinion, we are not aware of any negative opinions issued by the Pool (see note below)
  • speed—we understand that response times have been swift and within the promised 48 hour turnaround. We are not aware of any transactions suffering delays as a result of a referral

To put those numbers into context, the Graham report used historical data to give an indication of the maximum number of applications to the Pool which might be made. Based on administration levels in 2013 of around 2300, it estimated about a quarter of those would involve pre-pack sales of which around 65% would be to connected parties. On that basis, the report thought 374 cases per annum could go to the Pool. Since then, administration filings have dropped almost 40%—in 2015 there were just over 1400—and the trend continues downwards. Assuming a similar level in 2016, that would mean approximately 225 cases which could go to the Pool this year. Viewed against those projections, a Pool referral rate of somewhere between 10–20% of connected pre-packs is undeniably low.

Although the average size of deal referred to the Pool appears higher than expected—the data used for the Graham report suggested that the average pre-pack consideration was around £100k—it is likely skewed by the recent ill-fated Polestar pre-pack where the consideration for the assets of the Group exceeded £65.9m.

Note re pre-pack Pool opinions

The role of the Pool is simply to express an opinion on whether a pre-pack is an appropriate way to proceed in the circumstances.

The connected party will receive one of three opinions from a member of the pool. The opinion may not be appealed and is non-binding. No reasons for the opinion will be given.

The three types of opinion will state that:

  • nothing has been found to suggest that the grounds for the proposed pre-packaged sale are unreasonable
  • the evidence provided has been limited in some areas, but otherwise nothing has been found to suggest that the grounds for the proposed pre-packaged sale are unreasonable (a qualified opinion)
  • there is a lack of evidence to support a statement that the grounds for the proposed pre-packaged sale are reasonable (a negative opinion)

Success criteria

While noting how many connected party pre-packs could go to the Pool, the Graham report does not actually indicate what proportion of those it would like to see referred to the Pool for it to be considered a success. But, given it is a voluntary process, it would clearly be unrealistic and unreasonable to expect all possible connected party pre-packs to be referred to the Pool.

The Graham report stated that the success criteria for the Pool concept could include:

  • reduced noise around pre-packs—while not necessarily as a result of the Pool, the falling numbers of administrations and pre-packs in general make this far more likely. Further, a number of the deals referred to the Pool have been picked up in the press and received positive treatment. However, the Polestar transaction highlights the continued sensitivities surrounding pre-packs. In that deal, the connected buyer collapsed within weeks of the pre-pack. The deal had been referred to the Pool and received a favourable opinion and the buyer’s Viability Statement promised 2016 would be a transformational year for the business. Things clearly did not turn out as planned
  • operational efficiency—as noted, while referrals are low overall, anecdotally the Pool appears to be operating well when asked
  • full cost recovery—whether the £800 fee covers the Pool’s costs and the time of the Pool member will not become clear until the pre-pack Pool Limited files its first accounts made up to August 2016 due by December 2016, although in general its costs should be low
  • the provision of a ‘seal of approval’ which helps persuade creditors that the pre-pack has been subjected to some form of independent scrutiny—positive news stories where the Pool has been consulted are clearly helpful, although as stated below, care should be taken in this regard
  • a feeling that creditors’ interests and concerns were factored into the early/earliest discussions that anticipated a pre-pack—some of the practical steps identified below should help address this point

Practical steps IPs can take to ensure the success of the Pool and Viability Statement

Under SIP16, IPs are required to ensure that any connected party considering a pre-pack is made aware of their ability to approach the Pool and to prepare a Viability Statement. But, it is a decision for the buyer alone whether to refer the deal to the Pool and prepare a Viability Statement.

SIP16 also requires the IP to state that it is has requested a copy of the Pool opinion (where applicable) and attach it, along with any Viability Statement, to the SIP16 statement if received. If a Viability Statement has been requested but not provided, the administrator must notify creditors.

Clearly, SIP16 does not impose a heavy burden on IPs as regards the Pool and Viability Statement, so full compliance is vital. There are a number of practical steps IPs could take to discharge their SIP16 obligations—and their broader role in improving stakeholder confidence—without, importantly, compromising their essential duties owed to creditors:

  • ensure early awareness—it would be sensible for IPs to write to the proposed connected party buyer, or at least have a written record of any other steps taken, to ensure that they are aware of their ability to approach the Pool and prepare a Viability Statement. Rather than wait until a connected party buyer has made a firm offer which is accepted, it may even be helpful to inform bidders of this at an earlier stage in the process—eg when requesting offers or in response to requests for information about the business
  • highlight benefits—it may be appropriate for IPs to highlight specific reasons why a referral to the Pool and/or preparation of a Viability Statement would be beneficial, eg it may help persuade existing customers and suppliers to support the buyer. Ultimately, however, this is a question for the purchaser and its advisers to address
  • ask for early indication of approach—in light of an IP’s duty to achieve the best offer reasonably available in the circumstances, it would not be appropriate to make a referral to the Pool or preparation of a Viability Statement a condition to accepting a bid from a connected party buyer. But, IPs could nevertheless ask prospective connected party buyers to indicate in their offer what their intentions are in this regard. A connected buyer’s intention to approach the Pool or prepare a Viability Statement may not, on its own, be a significant factor when assessing the offer. However, it could be relevant if there were competing connected party bidders with similar offers or where an offer is going to involve a degree of deferred consideration (as the IP will want to be able to assess the prospects of payment)
  • provide appropriate support—if a connected buyer decides to approach the Pool and/or prepare a Viability Statement, they may request information from the IP (eg in order to complete the Pool application form). As the Pool Q&A point out, the IP has no relationship with the Pool and the Pool will not seek any third party verification of facts or presumed intentions of relevant parties engaged in the sale. Further, the proposed administrator cannot give advice to the connected buyer and will not share with it the independent valuation obtained. However, IPs should generally be comfortable with supplying background information to help show why a pre-pack is an appropriate method of disposal in the circumstances (which is what the Pool is tasked with looking at)
  • encourage provision of Pool opinions—when highlighting the ability to approach the Pool, IPs could take the simple step of highlighting that the Pool application form has a box which can be ticked asking the Pool to send a copy of the opinion to the IP
  • ask buyer to explain reasons—if a connected party has decided not to approach the Pool, IPs could consider whether to ask the proposed buyer to explain its reasons. It might be, for example, that the connected party pre-pack forms only a small part of a series of transactions where the main sale is to an unconnected buyer. In the pre-pack of the Parabis business, the connected party chose not to approach the pool and in a letter sent to the administrators and attached to the SIP16 report, stated that while it recognised the advantages of the Pool in certain circumstances, it saw little advantage in referring the deal to the Pool. It highlighted, in particular, the robust market testing which had taken place over a period of months, involving a competitive bid process, and the fact that its offer represented the best offer for the business which had been accepted as such by the (then) proposed administrators
  • ensure appropriate publicity—IPs and connected buyers are likely to want to publicise the fact that the Pool was approached and/or a Viability Statement was produced. At the same time, however, IPs should be careful not to misstate the function of the Pool. Some of the press reports about the Pool relating to recent connected party pre-packs have described its role as ‘backing’, ‘approving’ or giving the green light to such deals. The opinion of the Pool concerns, strictly, only whether a pre-pack is an appropriate way to proceed in the circumstances—not whether it is a good deal, that remains the task of the IP. The blurred distinction may be understandable – even the Graham report refers to the Pool providing a ‘seal of approval’—but overplaying the role of the Pool and Viability Statement could also have a downside (eg if the buyer subsequently fails)

Beyond the Pool—measuring the success of the 2015 reforms

We think that the success of the 2015 reforms should not simply be measured by reference to the number of referrals made to the Pool or the number of Viability Statements which are prepared. Referrals are voluntary and are made by the buyer who may have many legitimate reasons for not wanting to approach the Pool.

In assessing the success of the November 2015 reforms, the government should also look beyond the Pool and the Viability Statement and at the other changes made—in particular, the enhanced requirements relating to marketing and valuation forming part of the revised SIP16.

It is worth highlighting that in its final review of SIP16 compliance before handing over responsibility to the RPBs, the Insolvency Service reported that for the period January to October 2015:

  • 96% of all SIP16 statements were fully compliant or contained only minor breaches, and
  • only 1% of all complaints received by the Complaints Gateway related to SIP16 statements/pre-pack administrations

While it remains to be seen what emphasis the government will put on the Pool, these figures are helpful at showing the level of stakeholder confidence in pre-packs generally even before the reforms. Provided the levels of SIP16 compliance and the number of complaints are similar for the period after November 2015, there should be no empirical reason for the government to exercise its reserve powers.

It is worth remembering that the research used to support the Graham report was based on a sample of 500 pre-packs from 2010. Practice has changed significantly since then, in large part due to the issue of SIP16 (which had only been in place for one year at the time of the research). Insolvency levels have also fallen significantly, as have accordingly the number of connected party pre-packs. Of those, there may of course be some which pollute the waters but that should not warrant government intervention. Rather, they should be investigated and appropriate action taken.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Further reading

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First published by Linklaters and on LexisPSL Restructuring and Insolvency

 

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