The enactment of the Insolvency Act 1986 “the Act” introduced the concept of administration for a company, a process designed to save the entity, either in whole or in part, and thereby preserve both jobs and an economic activity.  Generally speaking, this was seen as the replacement for receivership, and preferable to liquidation which tends to be seen as the end of the line.

In order to preserve economic activity, a way had to be found to allow the sale of an existing business and history has shown that such a transaction is often to a connected party e.g. the directors of the failed entity.  What is now known as a pre-pack administration quickly gained popularity because it allowed the administrator to transfer a business activity immediately upon appointment and thereby save jobs, preserve a supply chain, and respect the rescue culture.

However disquiet began to arise when creditors thought that assets were being sold too cheaply, particularly to connected parties. Accordingly, the various insolvency regulatory bodies created Statement of Insolvency Practice 16 “SIP 16”.

Protocols were introduced in order to provide assurance that a pre-pack sale was appropriate and at fair value.  Research by the government suggests that administrators were not using the pre-pack pool (a group of experienced and independent individuals who could provide comment upon the fair value of the transaction before it occurred), that the marketing procedures required by SIP 16 were not being followed as comprehensively as the government anticipated, or that the purchaser failed to provide a viability report to show that there was sufficient funding in place for the new entity to operate for at least twelve months following a business transfer.  A viability report is seen as important because, for example, it demonstrates that the purchaser is not simply asset stripping on the basis that a subsequent sale has been organised at a higher price, with the profit thereon being retained by the directors.

In order to address some of the issues, the government published a review of its industry reform review last month (www.gov.uk/government/publications/pre-pack-sales-in-administration).

The draft regulations propose, for example, to stop an administrator from selling any of the company’s property to a person connected with that company within the first eight weeks of his appointment without obtaining either prior approval from creditors or an independent written report.  The connected party purchaser is required to obtain the written opinion. Further, the administrator will be obliged to consider such opinion before acting and be satisfied that the provider of the opinion is demonstrably independent of the purchaser.

This approach may well be designed to stop a pre-pack sale to a connected party when administration occurs, but one obvious problem facing an administrator will be how to finance ongoing trading for a period of at least eight weeks whilst a buyer is found. Will the connected party purchaser be content to fund the administrator in the hope that a pre-pack sale proceeds as intended, whilst accepting the risk that another party may emerge and pay a higher price? Depending upon the type of industry and financial support available, will the challenge of ongoing trading prove insurmountable?

Often, the benefit of a pre-pack sale is the ability to obtain a higher value than might be obtained if the business is marketed widely for a period of weeks e.g. a premium is paid in order to ring-fence the business rather than allow parts of it to dissipate.  When competitors realise that a company is in administration and available for sale, it is possible that they will try to “take” the business by approaching known customers directly and place pressure on suppliers to cease deliveries and thereby thwart a sale to a connected party.

It is difficult to envisage that, particularly for larger entities, a wholly independent buyer will be in a position to organise a realistic offer within eight weeks.  Further, experience suggests that when the business is of fairly modest size, competitors are less minded to purchase the entity from an administrator but be thankful that it has failed and hope that it merely removes someone from the market.

In general terms, there is nothing wrong with transparency of action. After all, the administrator did not cause the insolvency, but one wonders why he should risk liability and asset impairment because he is required to continue a trading activity for a period of at least eight weeks when the business has already hit the financial rocks.

Time will tell if the proposals find their way to the statute book without amendment and, if they do, whether another change to the insolvency landscape will impact positively upon the rescue culture.

The views in this article are those of Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, chartered accountants, Aberdeen.  They do not purport to represent those of the firm in general.