3 November 2021

The pre-pack regs: sales to a secured creditor funded newco as a sale to “connected persons”

In our previous commentary, we concluded that the ‘The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021’ (Regulations) had enacted a tick-box exercise for experienced market participants.

This conclusion has not changed on a review of how the market has interacted with the Regulations, despite the issuance of additional statutory guidance on 30 April 2021 (Guidance), and some earlier nervousness amongst advisors that secured creditor funded / credit bid style pre-pack purchases might be caught as sales to “connected person(s)” under the Regulations where they involve the management of the OldCo going forward. The Guidance is available here.

REGULATIONS NEED NOT RESULT IN TRANSACTION TIMING SLIPPAGE

If the evaluator's report is obtained in good time, the completion of a pre-pack (immediate sale upon entry into administration) need not be delayed by the Regulations:

“An administrator does not have to be appointed at the time the report is obtained. For example, a pre-pack sale in administration is where the sale is arranged prior to a company entering administration and completed on or very shortly after the appointment of the administrator. In those circumstances, the report should be obtained before the company enters administration so that the sale can be finalised as soon as possible by the appointed administrator.”

This works to re-inforce our assessment: the Regulations and Guidance have ultimately created a tick-box exercise for experienced market participants – especially where the report is only to be circulated to known creditors at the same time as the Administrators' proposals (i.e. at some time after the sale).

POINTS OF PRACTICE TO NOTE FROM THE GUIDANCE

The Insolvency Service issued the Guidance on the date the Regulations came into force. The Guidance considers the role of the evaluator and details the criteria (including the information the evaluator is likely to need) for taking on this role. It goes on to set-out the what the evaluator' report must include.

The majority of the Guidance in this respect flows naturally from the Regulations themselves. Certain points of practice are worth noting however – each of which should pose no difficulty for market professionals:

proposed administrator to be satisfied as to the calibre of evaluator and scope of their insurance: “the administrator must be satisfied that the evaluator has sufficient knowledge and skills to provide the report and is eligible to act. They will also want to be satisfied that the [evaluator's] professional indemnity insurance provides a reasonable level of cover and extends to the individual for acting as an evaluator and providing the report”;
evaluator should be proactive in chasing down the information they need: “… the connected person should provide information and supporting documents that are requested by the evaluator... Where the connected person cannot provide information which the evaluator reasonably requires then the evaluator can ask the connected person to take steps to get that information from the relevant people (e.g. from the proposed administrator or the company in the case of a pre-pack). Alternatively, the evaluator may choose to approach those people directly … It is unlikely that an evaluator would be able to satisfy themselves that a disposal was reasonable without having been provided with at least the information listed above.”;
the evaluator may not be able to obtain commercially sensitive information straight away and should work with the proposed administrator to find a workaround: “Evaluators should bear in mind that certain individuals, for example, the insolvency practitioner, may refuse to share commercially-sensitive information. That might be the case where, for example, the information would compromise a bidding process. Where an evaluator considers that such information is needed for their report then they should discuss this with the insolvency practitioner in an attempt to find a resolution.” Despite the Guidance on point, it is difficult to envisage a situation in proper practice where an administrator in a pre-pack scenario would not be aligned with the evaluator, management, and the prospective purchaser on the use of a market-standard non-disclosure agreement to bridge this gap. Nonetheless, “Insolvency practitioners are not required to disclose commercially-sensitive information”.
48-hour turnaround maximum for a report expected (where sufficient information has been provided to an evaluator): in a pre-pack, the report will be provided pre-appointment in any event; and
the proposed administrator must be satisfied as to the inclusion of all necessary content in the report and that the evaluator meets the requirements to act: regardless of the report’s conclusions, it will not be a “valid” report unless all necessary content is included. Whilst a proposed administrator could in theory be carefree as to what the report concludes, they cannot be carefree as to the substance and form of the report or its author.

NEWCO AS A “CONNECTED PERSON”: SECURED CREDITOR / CREDIT-BID STYLE PRE-PACK SALES

There has been some discussion in the market concerning the situation where a secured creditor of the company in distress establishes a NewCo to purchase the assets of the distressed company out of administration (perhaps by way of a non-cash credit bid of their debt: agreeing to reduce their debt claims in the amount of the value of the assets being transferred).

Often critical to the commercials of a pre-pack of this nature would be the continued / transition role for management in operating the business (sometimes twinned with a management incentive plan). Further, for many institutional lenders there will be concerns around holding shares in any such NewCo and they may prefer to allow management (and possibly other investors) to take the equity or a proportion of it, with the lender remaining as arm’s length debt investors into NewCo.

The Guidance makes it clear however that a director of the company in distress, or a company that is controlled by such persons, will be considered to be a “connected person” for the purpose of the Regulations in these types of situations. The definition of connected person (in paragraph 60A(3) of Schedule B1 to the Insolvency Act 1986) includes directors, shadow directors or other officers of the company, as well as "connected companies". The definition of 'connected person' could also capture sales to lenders who hold security (with related voting rights) over more than one third of the company's shares.

In the classic credit-bid style cases detailed above:

if the directors of the distressed company (or any one of them) are directors, shadow directors, secretaries or "non-employee associates" (including a spouse, ex-spouse, parent, child, sibling or business partner of a director or any other officer) of the purchasing NewCo – the NewCo will be a “connected person” and an evaluator’s report will be needed;
if either the distressed company or its directors (alone or together) are entitled to exercise, or control the exercise of, one-third or more of the voting power at any general meeting of the purchasing NewCo or of another company that has control of it – the NewCo will be a “connected person” and an evaluator’s report will be needed; and
conversely, if the NewCo purchasing entity has control over the company (for example, being entitled to exercise, or control the exercise of one third or more of the voting rights at a general meeting of the company or another company which has control of it) - the NewCo will be a “connected person” and an evaluator’s report will be needed.

The above examples are not exhaustive and the Insolvency Act’s “connected person” regime under paragraph 60A(3) can be a trap for the unwary. It may be that a structuring solution lies in pushing management’s directorships, equity stakes or other business relationships ‘down the group’, being careful to avoid any sustainable allegations of shadow or de facto directorship at NewCo level or above.

Something which remains to be settled is the approach to be taken towards a transaction whereby a NewCo (or for that matter, any purchasing entity), wholly unconnected at the completion of the pre-pack sale (and as such, not obliged to secure an evaluator's report), becomes "connected" post-completion by appointing the distressed company's board to lead the newly-acquired business.

In practice, if there is ever a niggling concern in the mind of the an administrator about whether the purchaser is a connected person, the prudent approach is to ask the purchaser to secure an evaluator’s report (at the time of writing, the pre-pack pool will provide an evaluator's report for a relatively modest fixed cost of £1,500, although the purchaser is at liberty to form their own view about where to go for a report).

Ultimately, an unfavourable report from the evaluator cannot block the pre-pack sale - the only practical consequence is that the administrator must share with creditors the reasons for proceeding with the sale despite the unfavourable report. By contrast, if the administrator completes the pre-pack sale having wrongly determined that the purchaser was not "connected", the administrator could face sanctions for non-compliance.

STILL JUST A TICK BOX EXERCISE?

Our view, set out in our previous update, remains: the Regulations may come to operate as a tick-box exercise for experienced market participants given that:

pre-pack sales to a secured creditor funded / credit bid ‘NewCo’ structure that comes to involve management may be capable of being structured to evade the Regulations. And, if you cannot so structure (or prefer not to) – it may be simpler to secure an evaluator’s report;
the administrator need not have been appointed at the time the report is obtained (but in practical terms, the report must be sourced at an advanced stage in sale negotiations - because any material change to the terms may require a new report);
the connected person(s) is to choose the evaluator (who need not be a regulated individual), with the blessing of the Administrator. For now, we expect the pre-pack pool to be the evaluator of choice, given its familiarity with the process and relative certainty of timing (although we are aware of a number of former insolvency practitioners providing this service independently);
the evaluator's report, no matter its conclusion (even where it contains a "case not made" opinion) cannot block the sale; and
the Administrator should always be content that the sale delivers the best value in the circumstances (given their pre-existing statutory duties to the creditor body as a whole), so as to minimise the likelihood of a 'case not made' opinion from the evaluator. If however, following a properly run sales process, there are no other suitable buyers, the sale is likely to take place (in line with the purpose of the Administration) irrespective of the evaluator's opinion.