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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:
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.
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:
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:
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:
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:
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.
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First published by Linklaters and on LexisPSL Restructuring and Insolvency
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