Margaret Kemp, of counsel at Hogan Lovells, examines the challenges in implementing the recommendations in a report on pre-pack insolvencies.
| Margaret Kemp|
of counsel, Hogan Lovells
Pre-packaged insolvencies, or pre-packs as they are known, have come in for their fair share of criticism over the years.
In brief, a pre-pack is where the sale of a company’s assets and business is agreed before the company enters into an insolvency process, and completed by the insolvency practitioner (IP) immediately on his appointment.
Despite evidence that pre-packs can be beneficial for the rescued business, saving more jobs and ensuring continuity of trade, the speed at which the sale is completed, and the fact that creditors often know nothing about the sale until it has happened, has fuelled claims that pre-packs lack transparency.
There are claims that pre-packs allow less than scrupulous shareholders and directors to continue the old business under the guise of a new company, leaving liabilities in the insolvent old company.
However, the pre-pack’s reputation may be about to be rescued. In 2013 Vince Cable, then the secretary of state for business, innovation and skills, commissioned a report from Teresa Graham into pre-pack insolvencies.
The Graham report was published in June 2014. Steps have since been taken to implement some recommendations in the report. Under the Small Business, Enterprise and Employment Act 2015, the government has taken a reserve power allowing it to pass future legislation restricting or prohibiting sales to connected parties out of insolvency.
A dip in the pool
An enhanced SIP16 has been drafted, which will increase the information that has to be provided to creditors about the sale. However, the report’ most interesting aspect is the formation of a “pre-pack pool” whose function would be to police pre-pack sales to “connected” parties – these are sales to companies where the existing management or shareholders are involved.
The pre-pack pool is a completely new idea. Where a pre-pack sale is to be entered into with a connected party, the connected party should approach the pre-pack pool on a voluntary basis for an opinion on the transaction. A negative opinion does not stop the transaction, but the SIP16 report issued by the IP will have to say whether the pool was approached and whether a negative or positive opinion was given.
Although steps have been taken to form the pool, many aspects of its operation remain unclear. A steering committee has been created to form and possibly manage the operation of the pool, and progress has been made in recruiting pool members.
However, applicants don’t need any experience of insolvency to be selected and IPs aren’t eligible.
A lack of prior insolvency experience may be beneficial, allowing pool members to remain impartial when considering the transaction.
However, it could also be the case that pool members without such experience take longer to review the proposed transaction, at a time when speed is essential to ensure value in the business isn’t eroded.
The report suggests pool members should have half a day to review the papers on the pre-pack transaction. This may be enough time for straightforward transactions, but not for more complex cases.
It’s also unclear whether a pool member will be able to raise questions on the transaction before forming their opinion. If a pool member has little time or information, they may feel they have to issue a negative opinion for that reason. Conversely, delaying the pre-pack to allow a pool member time to review it may result in such a reduction in value of the business, there remains little point in proceeding.
Who’s watching the watchmen?
There is little guidance on how quickly the pool member has to come back with an opinion, or on what the opinion should say – will it be a straight yes/no response, or a fuller, more reasoned opinion, with what has been approved and what has raised question marks? What criteria will have to be taken into account?
Finally, there’s the question of who will police the police – how will the performance both of the pool itself and individual pool members be assessed and monitored?
Connected parties are not going to use a system they don’t trust, and confidence in the pool will quickly be eroded if pool members produce flawed opinions. The downside of a market that does not use the pool is that legislation may be passed that bans pre-packs outright.
There’s no doubt the pre-pack process has been open to abuse and greater scrutiny is to be welcomed. Whether the pool redresses the balance remains to be seen.
Will Christopher, partner and civil fraud specialist at Kingsley Napley, explains how a recent decision by the Supreme Court will be a great relief to liquidators and creditors of insolvent companies where directors are under suspicion.
| Will Christopher|
partner and civil fraud specialist, Kingsley Napley
The case of Jetivia v Bilta (2015) concerned a classic alleged VAT carousel fraud where Bilta purchased carbon credits from a Swiss company, Jetivia. The credits were zero-rated for UK VAT because the sales to Bilta were from traders doing business outside the UK.
Bilta then sold the carbon credits to UK traders incurring a VAT liability. However, the sales net of VAT were for less than the price paid to Jetivia, rendering Bilta insolvent and unable to pay its VAT liability to HMRC. The buyers were able to sell the carbon credits for a profit as a result.
When Bilta was placed into liquidation, (it was unable to pay HMRC debts of some £38m), the liquidators started proceedings in the name of the company against the Bilta directors – one of whom was the sole shareholder. Proceedings also began against the co-conspirators (Jetivia and its director) in the alleged fraudulent scheme. They were accused of dishonestly assisting in the breaches of fi duciary duty on the part of the directors.
The co-conspirators made applications for summary judgment, on the basis that the ‘illegality defence’ applied. They claimed that, as Bilta was also involved in the alleged scheme, the liquidators could not rely on its own illegal acts to bring a claim. This application was refused at first instance and by the Court of Appeal.
The illegality defence
Much of the argument focussed on whether the directors’ alleged acts could be attributed to the company (Bilta), so as to make it a co-conspirator, and make available the illegality defence. On this question, Lord Neuberger summarised the Supreme Court’s decision.
He said: “Where a company has been the victim of wrongdoing by its directors, or of which its directors had notice, then the wrongdoing, or knowledge, of the directors cannot be attributed to the company as a defence to a claim brought against the directors by the company’s liquidator.”
This applies where liquidators bring a claim against the directors, in the name of the liquidated company, due to losses suffered because of the directors’ wrongdoing. This also applies, as Lord Neuberger said, “even where the directors were the only directors and shareholders of the company and even though the knowledge of the directors may be attributed to the company in many other types of proceedings.”
Due to this conclusion, the question of whether the illegality defence was available didn’t arise.
Stone & Rolls
Regarding the illegality defence, there were helpful remarks during the case on the analysis of Stone & Rolls v Moore Stephens  UKHL 39. The majority of the justices concluded that Stone & Rolls should only be authority in that, save for certain limited principles, on the facts of that case, the Court of Appeal was right to find that the illegality defence succeeded.
These principles were that the illegality defence is not available where there are innocent shareholders or directors, and that the defence is available, albeit only on certain facts, where there are no innocent shareholders or directors. Apart from this Lord Neuberger, quoting Lord Denning, said Stone & Rolls “should be put on one side and marked ‘not to be looked at again’”.
Does s213 have extraterritorial effect?
The Supreme Court dealt with this part of the appeal in short order. The appellants (Jeitivia and its director), based in Switzerland and France respectively, contended that the liquidators could not bring claims against them under s213 of the Insolvency Act 1986 for fraudulent trading, as it did not have extra-territorial effect.
In effect they submitted that the words in the section that say the court can make declarations against “any persons”, meant only persons in the UK. The Supreme Court held, unanimously, that s213 does have extraterritorial effect, consistent with the English courts’ worldwide jurisdiction over the assets of the company and their proper distribution, and in common with s238, which the Court of Appeal has previously decided does have extraterritorial effect (In Paramount Airways Ltd (1993) Ch 223).
This judgment will be welcomed by liquidators and creditors of insolvent firms because it hasn’t removed a well-used tool in their armoury to recover losses for creditors and shareholders. It has clarified the law in relation to attribution of unlawful acts.
The trial continues.
Isabella Piasecka, solicitor at Carter-Ruck, welcomes the extension of “no win no fee” availability for insolvency litigation – and makes the case for it to be permanent.
| Isabella Piasecka|
Insolvency litigation has long been recognised as a special category for which “no win no fee” or Conditional Fee Agreements should be available.
The stated rationale is the public interest in assisting creditors to recover losses from rogue company directors or third parties whose actions have caused serious harm to a now insolvent business – sometimes even contributing to its demise – and in deterring wrongful behaviour. The more compelling reason perhaps is the monies it adds to government coffers by way of recouping unpaid tax.
Under the current regime, those acting on a CFA on behalf of an insolvent company can recover from the losing side both the CFA uplift, known as a success fee, as well as premiums for After The Event (“ATE”) insurance, which protects against adverse costs should the action fail. CFAs are therefore an invaluable means of funding litigation: they not only defer the substantial costs of legal action, but make those costs conditional on success. That is obviously a huge advantage for companies which are by definition without money.
On 1st April 2015, a two-year exemption for insolvency litigation from the general end of recoverability was expected to come to a close, leaving clients (and lawyers) exposed to potentially significant costs.
Just weeks before the deadline however, the Government confirmed it would extend the exemption “for the time being”, with further details of the “appropriate way forward” to follow later this year.
A 2014 report commissioned by R3, which is lobbying for a permanent exemption, says ending it could cost creditors more than £150m a year, which is the amount R3 estimates is currently realised by CFA-backed insolvency litigation. Of that, an estimated £50-70m relates to monies owed to HMRC. It is self-evident that, without the ability fully to recover costs, legal action to reclaim debts will simply be unaffordable in the majority of cases, not least for lower value claims.
Before it announced the extended reprieve, the Government had urged insolvency practitioners to explore funding alternatives, including third-party funding and Damages Based Agreements, or DBAs, which were introduced at the same time as the exemption in 2013.
Under a DBA, the costs payable by the client in the event of a win are calculated as a percentage of the damages recovered. These are capped at 50% of the total damages, and the costs recoverable from the losing side are restricted by the percentage payable under the DBA fee, as well as by the amount that would have been recoverable on a standard, hourly-rate basis, whichever is lower.
They are then a good option for the client, where the claim is high-value and speculative, and for the lawyer, where the matter will likely be quickly resolved. They remain for the most part however, unattractive, and the take-up of DBAs has so far been weak, particularly in the context of insolvency litigation. With the future of the exemption still uncertain, and unless DBAs are considerably amended, insolvent companies and their advisers looking to sue would do well to secure a CFA promptly.
Julie Palmer, regional managing partner at Begbies Traynor, explains why the general election – whatever the result – could be a challenge for the credit sector.
| Julie Palmer|
regional managing partner, Begbies Traynor
As the coalition government approaches the final few weeks of its life, there is sure to be an intense debate among historians and political pundits alike over the government’s legacy.
For a start, the actual existence of a coalition government is a rare event in Britain, while financial challenges on the scale faced over the past few years are thankfully rarer. But perhaps for the lending industry, the defining legacy of the past five years – and more – is cheap credit.
The phenomenon has been great for consumers, if not for savers, particularly in austere times, and with the recent dip into negative inflation, pay packets have started to stretch further than they have for a while.
But for businesses that have struggled to turn a profit through the economic downturn, cheap credit has been nothing short of a lifeline.
Indeed, Begbies Traynor’s research into corporate financial distress has shown there are more than 430,000 businesses dependent on credit for their survival. On the flip side of this, the phrase ‘zombie company’ has become a familiar refrain amongst financial journalists.
At the beginning of the recession it was a combination of forbearance from creditors, “time to pay” arrangements from HMRC, the financial crisis and low interest rates that allowed these highly-geared, break-even businesses to survive.
And while the recession could have been much deeper had so-called zombie companies been allowed to fail, there is now a growing argument they could actively hamper the recovery. Keeping zombie companies alive might well hold back more successful businesses which need the additional turnover to continue their development. Instead, they are piling up cash.
But this, perhaps, is a debate for another day.
Given its work in business rescue and recovery, Begbies Traynor is very much interested in what happens next with regard to the cost of credit. Whilst those historians and pundits get on with debating the past, our sector will be very much looking to the future.
A combination of a recovering economy and a five-year gap before the next general election surely means the next government will struggle to resist a small interest rate rise, if only to gauge the impact of such a thing. Therefore our advice to businesses is to take action now in order to avoid the effects of more expensive credit.
Yet for many of those 430,000 zombie companies, a rate rise might spell disaster. It would almost certainly mean an unfortunate reversal in the declining trend for insolvencies, as seen in the ONS figures for October to December 2014.
In general, the upcoming election should be something of a red alert for the credit sector. A rate rise is something for which we will all have to plan – and innovative solutions for highly-geared, marginally profitable companies will be required if we’re to maintain the momentum of the recovery.
Where the insolvency profession can add value and provide assistance is by advising businesses on how to become more sustainable while continuing to deliver for clients. This might involve reviewing assets; for example, does a business need to operate over two sites? Perhaps there is a technological solution that could allow staff to work from home? For some company owners this might be difficult to contemplate, but staff can often be more productive when not being disturbed by ringing phones and queries from colleagues. That’s got to be better for business.
There are also more difficult solutions such as reducing your workforce. But never assume that every single member of staff wants to stay with you – they certainly don’t love your business as much as you do, and may even be looking to part ways. For firms that opt for a programme of redundancies, financial assistance might be available from the Insolvency Service’s Redundancy Payments Office.
If the sector pools its knowledge and expertise, then we’re sure to achieve better outcomes for heavily indebted businesses. After all, the more companies that find themselves unable to service credit agreements, the more perilous life becomes for lenders – as we learned in 2008.
Julie will be speaking on the topic Distressed, survival businesses and reluctant borrowers: What advice is available?, at the Commercial Finance Conference at this year’s Credit Summit, to be held at the QEII conference centre in London on 26 March.
While the mainstream press covers the parts of the wide ranging Small Business, Enterprise and Employment Bill that impact the type of ale that can be sold by pubs up and down the country, restructuring advisors have been more focussed on the sections that deal with insolvency reform, say Andrew Wilkinson and Linton Bloomberg of law firm Weil, Gotshal & Manges
Following the Graham Report on pre-pack administration sales, the Bill includes a reserve power for the government to enact regulations restricting sales by administrators to connected persons. This is despite the report recommending that legislation should be introduced as a last resort, and that, instead, it is preferable for the insolvency industry to embrace the suggested measures on a voluntary basis.
It is good to see that the report recognises some of a pre-pack sale’s key benefits, including enabling a company to keep trading without the damage to goodwill which could be caused by a protracted insolvency process.
The report also highlights the criticism levelled against pre-pack sales in recent years as a result of a perceived lack of transparency and deals being negotiated behind closed doors with limited marketing and valuations being carried out. Whilst any attempt to increase confidence in the procedure is welcomed, the criticism unfortunately seems to be at the process as a whole, rather than targeted at specific deals.
The report identifies potential reforms to make pre-packs more transparent. One recommendation is that any connected party that proposes to buy a business through a pre-pack could, on a voluntary basis, obtain ‘consent’ from a pool of around 30 experienced business people (who do not necessarily have any insolvency experience) who would then issue a statement (interestingly, given the aims of the reforms, on an anonymous basis) on the proposed sale. Although it remains to be seen how this will work in practice, any advisor in a complex restructuring, which involves a connected pre-pack, will face an interesting dilemma:
• Approach the pool – this runs the risk that the pool issues a negative statement, possibly because they have not had sufficient time in the half-day allocated to carry out a comprehensive analysis, something understandable perhaps in a complex cross-border restructuring. Following a negative statement, it would be a brave administrator who proceeds with a sale however much they thought it was in creditors’ best interests. Being naturally cautious individuals and with very little to be gained by having their conduct investigated, a negative statement could kill off any proposed pre-pack sale – possibly leading to a failed restructuring; or
• Not approach the pool – this runs the risk that the administrator could be criticised for not ensuring that the option of having voluntary independent scrutiny of the deal is taken up but at least avoids getting an answer that may not be wanted.
It may be unfair to criticise the pool before we see how it works in practice, however a recent poll suggests that over half of those asked thought that the pool may be unworkable in practice.
The pre-pack sale process is used successfully in connection with the implementation of corporate restructurings and there are questions regarding the viability of the pool approach and whether it is really necessary. The High Court has become much more adept at approving restructuring pre-packs as a number of Court decisions, including the recent decision in the ATU restructuring, illustrate.
In effect, restructuring advisors already have the ability to seek sanction for a sale. Rather than taking a risk in seeking the view of the pool (which will not have the consistency of decision, fair process or option to appeal) and contrary to the desire of the Graham Report, restructuring advisors may prefer to continue to seek the safety of the Court.