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A few good men – the pre-pack problem

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.

Posted on 16th June 2015 by Fred Crawley

 

 

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