Protecting creditors from Pre-Packs: when a company must disclose its secret plans
Pre-Pack administrations can allow an insolvent company to sell off its business and assets free of debt without notice to its creditors. Sometimes the sale is to the same people who ran the company into the ground. Creditors often feel short changed. If the company has to apply to Court to enter administration, there is a protection from Pre-Packs, but creditors have to be alert.
When a creditor petitions to wind up a company that owes an undisputed debt, the ideal result is that the startled company pays up immediately. When that doesn’t happen however, the creditor faces vying with the other unsecured creditors for the insolvent company’s assets as they are realised and distributed. They very rarely recover the full debt.
If the company’s directors come and say to the creditor “we can’t pay you now, but if we go into administration for some time, we really believe we’ll get out of trouble and be able to pay our debts in full”, then the attraction for the creditor is obvious.
In normal circumstances, a company can enter administration by its own motion by filing a notice of appointment with accompanying documents with the Court – this is known as the “out-of-Court-route.”
However, where a winding up petition has been presented, the company cannot enter administration unless a Court makes an Administration Order (as provided by paragraph 25(a) of Schedule B1 to the Insolvency Act 1986). If the company is going to apply for an Administration Order, it will have to give notice to the creditor and stay the winding up petition. The company will also usually identify a proposed administrator.
When deciding whether to order that a company should enter administration (and therefore prevent its being wound up) the Court follows Schedule B1 to the Insolvency Act 1986:
Paragraph 11 of Schedule B1 provides:
The court may make an administration order in relation to a company only if satisfied—
(a) that the company is or is likely to become unable to pay its debts, and
(b) that the administration order is reasonably likely to achieve the purpose of administration.
The purpose of administration is set out at para 3(1) of Schedule B1:
(a) rescuing the company as a going concern, or
(b) achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration), or
(c) realising property in order to make a distribution to one or more secured or preferential creditors.
In the circumstances described above, a creditor may be happy to agree to the appointment of the administrator, believing administration to offer their best chance of recovering all of their debt. The Judge deciding the application may take the same view, especially where the petitioning creditor (and any other creditors who attend the application) have consented.
The Pre Pack surprise
However, if unbeknownst to the creditor a pre –packaged sale (“Pre-Pack”) has already been arranged, joy can turn swiftly to anger. Over the last decade or so, creditors have increasingly had to watch as upon his or her appointment the Administrator immediately sells the business and assets of the company to a prearranged purchaser—often the same people who ran the company into insolvency— for a discount. The buyer can carry on with the company’s business, free of all debts.
The creditor is left with nothing but a share of whatever payment was agreed under the Pre-Pack.
While legal, Pre-Packs have proved controversial to say the least. It is a legitimate defence of these schemes to say that they can rescue a business (and its employees’ jobs) which would sink in the face of the negative publicity surrounding a sale in insolvency. They are quick, and it is not necessarily the case that the company’s unsecured creditors will receive less than if the business and assets of the company were sold following a winding up.
Set against those positives is the fundamental lack of transparency involved in a Pre Pack. Creditors often feel like the victims of a conspiracy—and never more so than when they see that the business and assets of the company are still in the hands of the people who, in their eyes, ran up the company’s debts. The fact that the administrators fees come out of the sale price serves in increase the impression of collusion.
These frustrations filtered through to the insolvency regulatory bodies, wand in 2009 they produced official guidance for Administrators who find themselves arranging Pre Packs for a company before it has entered administration.
Version 3 of ‘Statement of Insolvency Practice 16’ came into force from 1st November 2015. It sets out the steps that an Insolvency Practitioner acting as Administrator in a Pre-Pack must follow. In summary, the Administrator must:
• Be clear that his or her duty is to the company rather than the directors
• Bear in mind the interests of and duties towards creditors
• Obtain proper valuations of assets and retain records of all steps taken
• Unless another approach is clearly preferable, undertake “proper marketing” before the sale
• As soon as possible after the sale, provide creditors with a detailed narrative explanation and justification of the decision to carry out the Pre Pack (“the SIP 16 Statement”)
• Provide additional information where the sale will be to a “connected party”
The appendix to SIP 16 sets out the minimum requirements for ‘proper marketing’, and prescribes certain information and documentation which must be provided by the Administrator to the creditors in the SIP 16 Statement.
If provided properly, the information in SIP 16 Statement is sufficient to provide creditors with an understanding of the Pre-Pack, particularly in terms of who bought the assets and for how much. It should also provide an explanation of how Administrator satisfied him or herself that the Pre-Pack was actually in the company’s and the creditors’ best interests.
But how far does this actually help a creditor?
For unsecured creditors of company’s whose Pre-Packs followed the out-of-Court route for administration, the first they will hear about the administration, leave alone the Pre-Pack, will be when the administrator provides first notification of the administration. That notification is required as soon as reasonably practicable. Paragraph 17 of SIP 16 requires notification of the pre-pack to be given to creditors within seven calendar days after the pre-pack sale regardless of practicalities.
Given that the sale will already have taken place, this is too late for creditors who would have opposed the sale to do anything about it. They are left with the option of a claim against an Administrator if they believe he or she has breached their duty. But in respect of the assets of the company which owed the debt, the ship has already sailed. So long as pre-packs remain legal, the trail will run cold here.
Where the Court has to be involved, there is authority providing that a company cannot apply for an Administration Order with a pre-pack in mind unless it discloses the full details of the proposed sale to the Court and any creditors concerned with that application.
The company’s directors will not be allowed simply to pick and choose what details it gives to the Court when they seek an Administration Order. In Re Bowen Travel Ltd  EWHC 3405 (Ch), HHJ Simon Barker QC said in this context that:
“it is, in my judgment, essential that the evidence presented to the court is reliable. Implicit in the noun "reliable" in this context is not only that it is accurate evidence and true insofar as it is factual, but also that a clear account is given of all potentially relevant facts and circumstances.” (Paragraph 19)
Creditors who have issued winding up petition will be even better served by reference to the now ageing but still valid case of Re Kayley Vending Limited  EWHC 904 (Ch). In that case, HHJ David Cooke considered the disclosure requirements on an application for an Administration Order where a Pre-Pack was envisaged. SIP 16 was still in its early days, but the Judge clearly approved of the transparency that it was aimed at providing. His Judgment provides that the matters covered in SIP 16 should in most cases be the minimum details disclosed in the original application:
“While it is primarily a matter for the applicant to identify what information is likely to assist the court, and that information may not be limited to the matters identified in SIP 16, it seems to me likely that in most cases the information required by SIP 16, insofar as known or ascertainable at the date of application would fall within the requirement I have referred to and so ought to be included in the application.” (Paragraph 24)
It follows that, in principle at least, a creditor who has taken the step of issuing a winding up petition should never be caught unawares by a pre-pack sale. Of course, in the real world, company directors are not always as thorough as they should be.
As the law stands, where a company enters administration via the out-of-Court route, it is permissible for a Pre-Pack sale to be agreed and immediately executed without reference to the creditors. This is not the case however where a Court order is required.
Whenever a creditor in a winding up petition discovers that the company has responded by making an application for an Administration Order, they should not assume that they will be given the full picture. As early as possible, both the company and the proposed administrator should be reminded that the details of any proposed pre-pack, at least those required for a SIP 16 Statement, must be placed before the Court. It’s possible that this would not deter some directors from keeping their plans secret, but it must be hoped that Insolvency Practitioners would not jeopardise themselves by ignoring such a warning.