THE PRE-PACK SALE – AN ENGLISH PERSPECTIVE
The English insolvency landscape
The English insolvency toolbox contains a number of different procedures available
for the purposes of corporate restructuring. In reality, Administration is generally the
insolvency process of choice where pre-pack sales are utilised. In order to contrast
the English approach to pre-pack sales and the US approach, it is necessary to have
a basic understanding of the administration procedure. In particular, it is worth
emphasising (a) the purposes for which administrators are appointed and (b) the
comparatively light judicial touch surrounding administration compared with the level
of judicial intervention that one might see in a US procedure.
Administrators are independent of the management and must be licensed insolvency
practitioners1. They may be appointed by court order or (more commonly) by written
instrument out of court. In the latter case, notice of the appointment has to be filed
with the court and there will be ongoing filing obligations but the court will not play an
active part in the administration unless requested to do so. However, whether
1
Paragraph 6, Schedule B1 Insolvency Act 1986
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administrators are appointed by the court or out of court, the administrator will be an
officer of the court2.
The administrator is required to exercise his powers by reference to a hierarchy of
purposes3.
(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.
Purpose (a) has primacy unless the administrator thinks that it is not reasonably
practicable to achieve that objective or that Purpose (b) will achieve a better result for
the company's creditors as a whole. The administrator is permitted to perform his
objectives to achieve Purpose (c) only if he thinks that it is not reasonably practicable
to achieve either of Purposes (a) or (b) and he does not unnecessarily harm the
interests of the creditors of the company as a whole.
The "traditional" route for an administrator post appointment is to prepare within 8
weeks of his appointment4 a statement setting out his proposals for achieving the
purpose of the administration. That statement of proposals must be sent to the
Registrar of Companies, every creditor of the company of whom he is aware and
every member of the company of whom he is aware. Statements of proposals are
2
3
Paragraph 5, Schedule B1 Insolvency Act 1986
Paragraph 3, Schedule B1 Insolvency Act 1986
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often fairly generic in form and tend to be very short. They bear no resemblance to
the sort of plan that one might customarily see in US proceedings.
The administrator must call an initial creditors' meeting within 10 weeks of his
appointment5. The business at that initial creditors meeting will include the approval
(or not) of the administrator's proposals, the appointment of a creditors' committee
and resolutions with regard to the administrator's costs.
The administrator will not be required to call an initial creditors' meeting (unless
requested to do so by creditors whose debts amount to at least 10% of the total debts
of the company) if the company has sufficient assets to enable all creditors to be paid
in full; if the company has insufficient assets to enable a distribution to be made to
unsecured creditors or if neither of Purposes (a) or (b) can be achieved.
Once appointed, the administrator displaces the management. He has the power to
appoint or remove directors6 and the board cannot exercise any management powers
without the administrator's consent. The administrator's powers are very wide. He
has the power to do anything necessary or expedient for the management of the
affairs, business and property of the company7 and is required to manage the
company's affairs, business and property in accordance with the proposals approved
by the creditors and in accordance with such directions as may be given to him by
court8.
4
Paragraph 49, Schedule B1 Insolvency Act 1986
Paragraph 51, Schedule B1 Insolvency Act 1986
6 Paragraph 61, Schedule B1 Insolvency Act 1986
7 Paragraph 59, Schedule B1 Insolvency Act 1986
8 Paragraph 68, Schedule B1 Insolvency Act 1986
5
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In practice, the administrator may delegate back to the board the day-to-day
management of the company, but strategic issues such as hiring and firing and the
marketing and sale of assets will be within the sole province of the administrator.
Therefore, one might say that a "typical" administration would involve the
appointment, the formulation of proposals, the calling of a meeting of creditors and
the marketing and realisation of the company's assets in that order.
Marketing strategy is a matter for the administrator. There is no court involvement or
set procedure. It is for the administrator to determine the appropriate marketing
strategy having regard to the specific circumstances. Whilst it may prove prudent for
the administrator to consult with creditors if time permits it is the administrator who
has ownership of the process and the administrator who bears responsibility if
something goes awry.
The Pre-Pack sale
A "typical" pre-pack sale will involve a sale negotiation with an identified buyer prior
to the appointment of the administrator. The prospective administrator may play an
active part in the negotiation but the more prudent approach would generally be for
the existing management of the company to conduct the negotiation subject to the
strict supervision of the prospective administrator so that the prospective
administrator can be satisfied that the process is being handled appropriately.
Customarily there will be little or no market testing as to the sale price. There will be
no communication with creditors and no court involvement. The sale will be
completed immediately following the appointment of the administrators such that
creditors will not get to hear of the transaction until after it has occurred.
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It is not uncommon for the business to be sold back to its original stakeholders –
often with the original bank finance being "rolled over" into the new acquisition
vehicle by way of a loan to the new vehicle to repay (in full or in part) the loan to the
old company. The arrangements may also provide for part of the secured creditors
claims to equitised by way of the creditors being given equity / warrants in the new
acquisition vehicle. It is also very common for at least part of the consideration to be
deferred. The effect of such an arrangement is that the original stakeholders remain
in control, the secured creditors remain secured over the delevered company (and/or
have an equity stake in it) but the company leaves behind its unsecured creditors.
There had originally been some academic debate as to whether administrators had
the power to dispose of the company's assets prior to obtaining the approval of their
proposals without, at the very least, a direction from the court. That particular issue
was resolved by the High Court in the case of Re Transbus International Limited9. In
that case the High Court confirmed that administrators were permitted to sell the
assets of the company in advance of their proposals being approved by creditors and
that they were only required to comply with the directions of the court if the court
gave such directions (which in the ordinary course it would not – given that no
application would be made to it).
In the later case of DKLL Solicitors v Her Majesty's Revenue and Customs10 the court
was faced with the position of a majority creditor actually hostile to a proposed prepack sale. The matter came before the court on the application to appoint the
administrators. Evidence before the court from the prospective administrators
indicated that an immediate sale post appointment was likely to lead to the greatest
9
[2004] 2 BCLC 550. See also T&D Industries Plc, Re T&D Automotive Limited [2000] 1 BCLC 471
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realisation for the benefit of creditors. HMRC who were the majority creditor sought
to oppose the appointment on the basis that (amongst other things) a pre-pack sale
should not be given tacit approval by the court in the light of the hostility of the major
creditor who would be in a position to vote down the administrator's proposals at the
initial creditors' meeting. The court appointed the administrators and rejected
HMRC's submissions. It concluded that a majority creditor did not have a right of
veto on the implementation of the administrator's proposals because even if rejected
by creditors, an administrator had the ability to apply to court for those proposals to
be implemented11.
The use of pre-packs has attracted a high level of negative press comment. They
have been portrayed as a new invention which permits "evil management" to make
off with the assets at the expense of "innocent creditors". In fact, there is nothing
new with regard to pre-pack sales as they have been around for many years.
However, they were previously seen as being appropriate with regard to businesses
where the asset realisation process was time critical – typically people businesses
where there was a severe risk of employees being poached by competitors before
creditors' meetings could be held. The recent change has been the more widespread
use of pre-packs for virtually any type of business. Statistical research undertaken by
the Insolvency Service has indicated that approximately 29% of all administrations
involve a pre-pack sale12.
10
[2007] EWHC 2067 (CH)
See also Re Structures & Computers Limited [1998] 1 BCLC 292
12 Report on the Operation of Statement of Insolvency Practice 16, July-December 2009, the Insolvency Service
11
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The same research also identified that 76% of pre-pack sales were to parties
originally connected to the insolvent company and an element of the purchase price
was deferred in 69% of cases.
Justification
Typically, pre-packs are justified on grounds that the inherent delay in a typical
administration would be value destructive for the business. Whether that justification
bears scrutiny in all cases is debateable.
Another factor frequently prayed in aid of pre-packs is that there is an absence of
funding to enable the company to continue trading during the administration period.
Whilst it is true that England does not enjoy DIP financing in a form that would be
recognised by US practitioners, there are means by which funding can be made
available. In a traditional administration the secured creditor will normally make a
credit line available to the administrators, such credit line to be treated as an
administration expense and thus enjoying super priority.
Therefore, the secured creditor is in an advantageous position in determining the
route taken by the company. If the secured creditor perceives that its interests are
best served by a pre-pack sale, it can procure that by declining to make post
administration funding available and/or declining to permit the administrator to seek
secured funding elsewhere (by sitting on its security rights). The administrator will
then be able to say fairly that a pre-pack sale was the only option open to him.
The transference of risk
It is important to emphasise that whilst a pre-pack sale may be negotiated pre
administration, the ultimate commercial decision as to whether to complete the
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transaction rests with the administrators. Rarely can one obtain judicial approval to a
sale. Traditionally, English Judges are reluctant to offer guidance or approval on
matters of commercial judgement.
Whilst the administrators bear the risks attached to a pre-pack sale they derive no
particular benefit from them. It is normally the directors and secured creditors as the
interested stakeholders who drive them. The risks to the administrator can be
significant. They may be liable to account financially in the event that they sell the
business at an undervalue. Pre-pack sales also carry substantial regulatory and
reputational risk. During 2009 the UK Insolvency Service (the Government body
responsible for the regulation of the English insolvency regime) reported 30
insolvency practitioners to their regulatory bodies for consideration of disciplinary
proceedings as a result of a perceived failure on their part to comply with the required
reporting regime with regard to pre-pack sales13.
On the issue of testing the value realised out of a pre-pack sale, it is worth noting that
the "bar" is arguably set higher than would be the case on a "normal" administration
sale. The "normal" test is that the administrator must sell for a best price reasonably
obtainable in current market conditions. In a pre-pack the aim of the administrator is
to achieve a sale that represents a better option for creditors than might otherwise be
achieved in a traditional administration sale.
The remedies open to a disgruntled creditor
A creditor or member of a company can seek relief against the administrator if:
13
Report on the operation of Statement of Insolvency Practice 16, July-December 2009, Insolvency Service
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"(a)
the administrator is acting or has acted so as unfairly to harm the
interests of the applicant (whether alone or in common with some or all
other members or creditors), or
(b)
the administrator proposes to act in a way which would unfairly harm
the interests of the applicant (whether alone or in common with some or
all other members or creditors)"14.
If the court finds the claim to be well-founded it can grant relief which may include
orders regulating the exercise of the administrator's functions, requiring the
administrator to do or not do a specified thing, call a creditors' meeting or discharge
the appointment of the administrator15.
Misfeasance proceedings can also be pursued against an administrator by, amongst
others, a creditor of the company16.
The grounds of a misfeasance application are that the administrator:
"(a)
has misapplied or retained money or other property of the company,
(b)
has become accountable for money or other property of the company,
(c)
has breached a fiduciary or other duty in relation to the company, "
On a well-founded application, the court may order the administrator to repay money
or restore property to the company, to pay interest and/or to contribute to the assets
of the company by way of compensation for breach of duty or misfeasance.
14
Paragraph 74, Schedule B1 Insolvency Act 1986
For example of an unsuccessful application for the replacement of administrators see Sisu Capital Fund Limited
v Tucker [2006] BCC 463
16 Paragraph 75, Schedule B1 Insolvency Act 1986
15
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The court also has the general power to remove an administrator from office17. The
jurisdiction to do so is expressed in very general terms. Whilst there would have to
be good grounds for doing so, it need not necessarily involve misconduct or personal
unfitness on the part of the administrators – the wishes of the creditors would be a
factor (but not necessarily a determinative factor) that the court would take into
account.
Given the breadth of that jurisdiction, unfair harm applications and misfeasance
applications against administrators tend to be rare. A premature sale may engender
considerable hostility on the part of creditors after the event and, in particular, it may
lead to the appointment of a hostile creditors' committee. Whilst English creditors'
committees do not enjoy the extensive powers and responsibilities of their US
counterparts, they are the first port of call for the approval of the administrator's fees.
An administrator alienates his creditors' committee at his peril!
As noted above, there are also significant regulatory and reputational risks for an
administrator who is perceived to have undertaken a pre-pack sale inappropriately.
Minimising risk
The optimal strategy is for market testing to be undertaken pre administration. That
may seem counter-intuitive given that one of the primary justifications for a pre-pack
is the value destruction of administration and the perception that if a company's
troubles are known it will become "fair game" for its competitors. However, that is not
always the case. In many cases a company's financial difficulties are well known and
some form of accelerated M&A is possible without increasing substantially the risk of
17
Paragraph 88, Schedule B1 Insolvency Act 1986
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value destruction. Even if a full marketing process is unrealistic, some form of limited
market testing is often viable – such as approaching on a confidential basis one or
two of the company's main competitors to solicit expressions of interest.
One strategy that has been explored in the English market is the concept of post
transaction market testing. The broad concept is that the purchaser gives back to the
seller an option to repurchase limited in time to a few weeks. This creates a window
during which the administrator can test the market after the event to see whether a
previously unidentified purchaser comes forward offering better terms than the
existing transaction. If so, it provides the administrator with an opportunity to unwind
the existing transaction and resell to the new purchaser. In a substantial trading
business the unwinding of a transaction so as to leave both parties in the same
position that they would have been in if the transaction had not completed is likely to
be complex. Whilst the concept has been discussed in a number of transactions, the
writer is unaware of any transaction where the structure has been adopted and
tested.
The other classic route to minimising risk is for the administrator to obtain an
indemnity to cover any financial risk. The value of the indemnity will plainly depend
upon the financial covenant of the indemnifier. If the purchasing company is a mere
holding company set up for the purposes of the transaction, its covenant is likely to
be of limited value.
It should also be borne in mind that whilst an indemnity may cover financial risk, it
does not address regulatory or reputational risk.
As a general proposition it is highly desirable for the prospective administrators to
have legal representation separate to that of the company. Often that proves not to
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be the case. The company's legal advisers are likely to have been deeply ingrained
in the restructuring. They may have introduced the prospective administrators to the
company and there may be pressure on the administrators to "adopt" the company's
legal advisers. English professional conduct rules do not prohibit such practice but it
increases substantially the risk of claims by disgruntled creditors that the
administrators allowed themselves to be "puppets" of the company. Accordingly,
best practice is that prospective administrators should have independent legal
representation even if it is the company's lawyers who are in the driving seat on the
transaction.
As noted above it is not possible, in the ordinary course, to obtain sanction from the
court approving the pre-pack. The court has said that it is not to be used as a "bomb
shelter" and that it is for the administrators to exercise their commercial judgement
with regard to sales18.
However, in some cases the court has been prepared to give some limited approval
to a proposed pre-pack. In Re Hellas Telecommunications (Luxembourg) II SCA19,
the court was prepared to make an express direction giving the prospective
administrators liberty to enter into the pre-pack once appointed. However, the
evidence before the court in that case demonstrated that there had been an
exhaustive bid process, full disclosure of the process had been made to the court and
there was only one viable bid for the business. Nevertheless and notwithstanding
that direction, the court still left open the point that its direction was not intended to
provide blanket approval to the administrators.
18
19
Re T&D Industries Plc (in administration), Re T&D Automotive Limited (in administration) [2000] 1 BCLC 471
[2009] EWHC 3199 (Ch)
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The next best alternative to market testing will be independent valuation advice (and,
indeed, is desirable even if there has been market testing). However, reliance on
valuation advice alone may be risky. Valuation is not an exact science. A valuer can
be wrong without being negligent as a matter of English law. Accordingly there is a
risk that an administrator who relies on valuation advice alone could sell at an
undervalue and be left facing claims without any recourse against his own advisers.
As noted above, the test to be applied by administrators generally is to achieve the
best price reasonably obtainable in current market conditions. However, the position
remains in a state of development.
The growth of the deleveraging pre-pack
There is an increasing trend to use a pre- pack sale either with or without a scheme
of arrangement as a means of deleveraging companies with complex capital
structures.
In IMO Car Wash20 such a plan was proposed. The group operated the biggest car
wash business in the world. Its financing structure comprised of £313 million of
senior debt and £119 million of mezzanine debt. The Intercreditor deed between the
lenders provided for the senior debt to have absolute priority. The group was
effectively balance sheet insolvent. It had valuation evidence showing that the value
of the group was very significantly less than the uncontested value of the senior debt
and that, therefore, the mezzanine debt was completely "out of the money".
Following discussions with both the senior lenders and the mezzanine lenders, a
proposal was developed whereby the business and assets of the group would be
transferred to a new corporate structure with the senior lenders giving up part of their
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debt in exchange for the equity in the new group. The proposal did not envisage
either the existing group or the mezzanine lenders having any rights at all in respect
of the new group. The proposals were to be contained within schemes of
arrangement for each of the group companies, those schemes to be entered into with
the senior creditors alone. The transfer of assets was to be completed by way of an
administrator to be appointed immediately following the approval of the schemes.
The mezzanine lenders sought to challenge the schemes on the basis of unfairness
contending:

the valuation evidence of the group was wrong,

the arrangements were unfair in that they shut out the mezzanine lenders from
benefiting in any upside,

that the directors should have exerted a bargaining power for the benefit of the
mezzanine lenders.
The mezzanine lenders' challenge was unsuccessful. The court held that a company
is free to select those creditors with whom it wishes to enter into an arrangement and
there is no obligation to consult with a class of creditors who are not effected by the
arrangement (either because their rights are untouched or because they have no
economic interest in the company). The court held that in addressing the issue of
valuation it was appropriate to look at valuation on a going concern basis as opposed
to a liquidation or break-up value but, on the facts of the case, the valuation evidence
supported the senior lenders' position. As such, the mezzanine lenders were unable
to satisfy the court that they had an economic interest to be protected.
20
Re Bluebrook Limited [2009] EWHC 2114
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More recently in Re Hellas Telecommunications (Luxembourg) II SCA21 the court
was faced with a similar position where the proposal was to be achieved by pre-pack
sale alone (as opposed to being linked with a scheme of arrangement). Hellas II, a
Luxembourg incorporated company, was the holding company of WIND Hellas, a
substantial Greek telecoms company. The group had a complex capital structure
involving several tiers of debt at operating company level and a subordinated tier of
debt at Hellas II level. The group was insolvent. It developed a restructuring plan
which envisaged that administrators would be appointed to Hellas II with a view to a
sale of the operating companies being effected and the senior debt being left in situ
(albeit with improved terms). The effect of the plan was to leave behind the
subordinated debt at Hellas II level. A scheme of arrangement was not proposed
because (a) it was unnecessary and (b) the group's liquidity difficulties were such that
there would, in any event, have been insufficient time to pursue such a route.
Having first migrated its centre of main interests from Luxembourg to England, an
application was made to the English court for the appointment of administrators on
the basis that the administrators would, immediately after their appointment,
complete the proposed sale back to the original equity. Although ultimately not
proceeded with, the subordinated lenders sought to challenge the appointment. The
court appointed the administrators and gave tacit approval to the administrators
entering into the pre-pack sale. In doing so it was influenced by the fact that there
had been a full bid process, that the senior creditors were only prepared to sanction
the one preferred bidder and that, on the evidence, there was no real alternative to
proceeding with a sale to that bidder.
21
[2009] EWHC 3199(Ch)
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The use of COMI migration coupled with a pre-pack administration to effect a
deleveraging transaction has caused a certain amount of press comment although
there is no conceptual difficulty with that approach.
Such cases will tend to be fact sensitive depending to a large degree on the flexibility
afforded by the inter-creditor arrangements but they are likely to become more
common. Valuation is likely to remind a hotly contested battleground. Whilst most
valuers are likely to employ analyses of discounted cash flow there can be sufficient
variables to provide for a wide range of outcomes. Assume an "out of the money"
subordinated creditor can show that on a realistic valuation there is an upside which
would see value being returned to the subordinated group if the company can
continue to trade for a period. An administrator may face a difficult decision as to
whether he should act now to protect the senior debt or wait to preserve upside for
the subordinated debt. That issue remains "live" in the English environment.
Government intervention to limit the risk of abuse
As noted above, the pre-pack has attracted ferocious criticism in the press –
particularly in those cases where the business is sold back to the original
stakeholders leaving behind its original creditors. There is a risk that potential
assignments may be hawked around from insolvency to insolvency practitioner by the
stakeholders until they find a suitably "sympathetic" practitioner who is prepared to do
the bidding of the company. The insolvency profession has not always helped itself
in that a number of firms have advertised their services inappropriately and reinforced
the prejudice that they are there to serve the parochial interests of the existing
stakeholders.
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In an effort to meet the criticism, the insolvency professions regulatory bodies
brought into force in January 2009 Statement of Insolvency Practice 16 (SIP16).
SIPs do not carry the force of law but non compliance with a SIP may lead to a claim
of professional misconduct. As such, insolvency practitioners will treat them as if
they have legislative effect.
SIP16 seeks to set out a framework within which pre-packs should be conducted with
particular emphasis on ensuring the transparency of the process and record keeping
by the administrator so that his decisions can be justified to the creditors. It sets out
a list of 17 items which the administrator is required to disclose to the creditors at the
initial creditors' meeting. They include:
1
the extent of his involvement prior to appointment,
2
any marketing activities conducted or valuations obtained,
3
the alternative courses of action that he considered with an explanation of
possible financial outcomes,
4
why it was not possible to trade the business and offer it for sale as a going
concern during the administration, and
5
whether efforts were made to consult with major creditors
6
details of requests made to potential funders to fund working capital
requirements.
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SIP 16 has also been considered judicially in the case of Re Kayley Vending
Limited22, the court indicated that with regard to a court application for the
appointment of administrators where a pre-pack is contemplated it will expect the
evidence put before it to include all of those matters which SIP16 requires to be
made before the creditors .
On 19 March 2010 the Government announced that it is intending to issue a
consultation paper on new measures to boost confidence in pre-packs which may
include options such as:
1
putting SIP16 on a statutory footing with penalties for non-compliance,
2
providing for automatic scrutiny of the directors' and administrator's actions by
the Official Receiver,
3
prohibiting an insolvency practitioner who advised on a pre-pack from
becoming the administrator,
4
requiring court or creditor sanction for pre-packs involving connected parties.
The Insolvency Service continues to monitor compliance with SIP16. In March 2010
they published their second report on its operation for the period July-December
2009. They found that 38% of pre-pack administrations are still not fully compliant
with SIP16. Roughly 20% of the non-compliant cases led to referrals to the
insolvency practitioner's regulatory body for consideration of disciplinary proceedings.
Notwithstanding the criticisms pre-pack sales remain firmly embedded in the English
insolvency framework.
22
[2009] EWHC 904 (Ch)
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