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FOCUS ON… “PRE-PACK” ADMINISTRATIONS |
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New rules for administrators engaged in pre-packaged sales were introduced on 1 January 2009. With so many retailers and other businesses currently falling into administration, this issue’s Focus on… looks at administrations generally and why pre-packaged sales are so contentious. |
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The economic crisis has seen many businesses fall into financial difficulty, most recently in the retail sector. The poor housing market, increases in the cost of commodities (fuel, energy and food) and the shortage of credit have all taken their toll on consumer spending, which has resulted in several large retail chains falling on hard times. Homewares retailer The Pier, childrenswear chain Adams, furniture giant MFI and entertainment group Zavvi UK (to name only a few) all went into administration towards the end of 2008 and Woolworths’ administrators closed its last store on 6 January 2009. The country is now officially in a recession and already this year many more retailers, including furniture specialist Land of Leather, electrical retailer Empire Direct plc and china and ceramics group Waterford Wedgwood, have gone into administration. Unfortunately, the financial troubles of retailers and other companies are far from over, with some insolvency experts predicting an increase in administrations of 50% by mid-2009. Administration aims to rescue a company from its financial troubles so that (where possible) it can continue in business afterwards, to maximise returns to creditors or to realise the company’s assets to make a distribution to one or more secured and/or preferential creditors. An administrator takes over the management of the company’s affairs, business and property for a relatively short period of time, reforming it and/or selling off certain parts of the company’s business or assets as necessary to achieve the aim of the administration (see CLM ¶8845+). Administration also triggers a moratorium ensuring that any pending winding up proceedings are put on hold and preventing most types of legal action being taken against the company during the administration. This gives the company some breathing space while the administrator attempts to revive its fortunes (see CLM ¶8813+). Administrators must be qualified insolvency practitioners and are appointed by the court, the company (or its board), or a qualifying floating charge holder. They have a wide range of powers to achieve the aim of the administration, but they must also follow several statutory requirements and adhere to specific duties. The court may also give directions on how the administrator should perform his functions (see CLM ¶8995+). When an administrator takes up his appointment he must investigate the company and identify its assets, looking for opportunities to increase them. The administrator must then prepare his proposals for the conduct of the administration and how its purpose will be achieved. Ordinarily these proposals must be approved by the company’s creditors. The creditors, particularly unsecured creditors, will be keen to maximise their chances of recovery and so this gives them an opportunity to have some input on the administrator’s proposals. What is a pre-packaged sale? Sometimes an arrangement for the sale of all or part of a company’s business or assets may be negotiated before an administrator is appointed, with the administrator effecting that sale immediately on, or shortly after, his appointment. This is commonly known as a “pre-packaged” or “pre-pack” sale. The courts have held that administrators have the power to effect such arrangements without prior approval of the creditors or permission of the court, if appropriate in the circumstances. Pre-pack sales can potentially improve returns to creditors because a company is usually worth more as a going concern than if its assets are sold individually. In addition, a quick administration process often means that creditors receive payments sooner and fewer costs eat into the pot of money available to them. Pre-pack sales can also safeguard jobs by preserving the business of the failed company. However, the buyer can purchase the failed company’s assets or business without the company’s liabilities, leaving unsecured creditors unable to recoup their debts. With the present economic downturn and the number of companies going into administration, pre-pack sales are proving to be very popular. Several high profile pre-pack sales have recently taken place. For example, in December 2008, immediately after going into administration, Whittard of Chelsea was bought out by private equity group EPIC. What specific duties do administrators have in these circumstances? A new Statement of Insolvency Practice was introduced on 1 January 2009, SIP 16 “Pre-packaged Sales in Administrations”. This sets out the basic principles and essential procedures, with which administrators engaged in pre-pack sales must comply. The purpose of the new statement is to increase transparency in pre-pack sales and give creditors better access to information about the administration process. Administrators must: » keep a detailed record of the reasoning behind the decision for the pre-pack sale to take place and be able to explain and justify why it was appropriate in the circumstances; » make it clear to the directors of the company that they are advising the company and therefore cannot also advise the directors on their personal positions; » encourage the directors to take independent advice, particularly when the directors may acquire assets or other interests as part of the pre-pack sale; » demonstrate that they have: - performed their functions in the interests of the creditors as a whole; and - avoided unnecessary harm to the interests of the creditors as a whole, where the aim of the administration is to realise the company’s assets to make a distribution to a secured or preferential creditor; and » disclose certain information to the creditors in all cases (unless there are exceptional circumstances) with the first notification to the creditors, including: - the identity of the buyer in the pre-pack sale; - details of the business or assets involved and the nature of the transaction; - any valuations obtained of the business or assets of the company; - the consideration payable and terms of payment; - the alternative courses of action that were considered by the administrator; - any connection between the buyer and the directors, shareholders or secured creditors of the company; and - the names of any directors or former directors who will be involved in the management or ownership of the buyer. Where no initial creditors’ meeting is to take place and it is impracticable to send the required information to the creditors with the first notification, the information should be provided in the administrator’s statement of proposals, which should be sent to the creditors as soon as possible after his appointment. Why are pre-packaged sales a problem? Pre-pack sales tend to be used where there is a commercial need for urgency and so the company’s creditors generally do not have the opportunity to approve the sale before it takes place. In addition to the characteristic lack of creditor approval, the buyer is often connected with the company in some way, whether as a director, former director or shareholder, or another person or company connected to them (see CLM ¶9930 for the meaning of “connected”). For example, prior to the retail company USC entering into administration in December 2008, a pre-pack sale was agreed whereby a director of USC would buy up to 43 of the company’s 58 stores through another company within his group. This may be because when such a quick sale of the company’s business as a going concern is required, usually only those who know the business extremely well will be willing to buy it at such short notice. The press has been keen to focus on pre pack sales, particularly those entered into with directors or former officers of the company (or persons connected to them), suggesting that as they are negotiated in advance of the administration, there must be something underhand in the process, even when it can be the best solution for all concerned. Creditors and the public are often suspicious of pre-pack sales. Creditors feel disenfranchised and believe that they may have missed out on returns by not being involved in the process. The public perceive these arrangements as unfair and unjust by allowing those who were involved in the management of a failing company to be able to benefit from its administration. There is the potential for these arrangements to be misused by directors and/or those connected to them to disadvantage creditors or to seek to gain benefit for themselves. Reports suggest that the Government is launching an investigation into whether pre packs are being abused (as part of its current inquiry into the operations of the Insolvency Service) and whether the rules need to be changed. It also recognises that small businesses often have large numbers of unsecured trade creditors (relying on trade credit to finance their business) and is concerned that pre-pack sales have a particular impact on small businesses, possibly inflicting more damage to the economy in the current downturn. The head of the Insolvency Service, Mr Stephen Speed, has stated that he has had no systematic evidence of the system being exploited. Whilst the current economic circumstances have brought administrations and pre pack sales into the spotlight, Mr Speed says that it is wrong to draw an inference from that, that the law is not fit for purpose. However, the Insolvency Service will be proactively policing compliance with SIP 16 to encourage transparency and ensure that administrators are able to explain why they decided that a pre-pack sale was appropriate in the circumstances. They intend to review each and every statement prepared by an administrator under the requirements of SIP 16 and will use their enforcement powers to take action where administrators have failed to comply and/or in cases of wrongdoing by directors. The Insolvency Service can take disciplinary action against administrators and disqualify directors in appropriate cases and we are likely to see an increase in such measures being taken as a deterrent to those who might be tempted to abuse the system. What can aggrieved creditors do? Administrators’ conduct If a creditor is not satisfied with the administrator’s conduct during the administration they may seek redress by complaining directly to the administrator concerned, complaining to the administrator’s professional body, or if the administrator has committed a particular breach, taking court action against him (see CLM ¶9016+). A creditor may apply to the court: » seeking inspection of information forming part of the records of the administration, if the administrator has refused to allow such inspection (for example, to find out more information about the pre-pack sale); » on the basis that in negotiating and/or effecting the pre-pack sale the administrator proposes to act, or has acted, in a way which is unfairly harmful to the creditor’s interests (either individually or in common with other creditors); » on the basis of misfeasance, for example, on the ground that the administrator has misapplied money or other property of the company; or » to have an administrator removed. However, the creditor will have to persuade the court that there is good cause before it will make any order for removal. Directors’ conduct Directors owe many duties to their company including agency, fiduciary, common law and statutory duties. They owe additional specific duties to the company if it is insolvency. However, because these duties are owed to the company, rather than to third parties (such as creditors), creditors are not generally able to take any specific action against directors in the case of any breach of duty. Instead the directors may incur civil liability to the company and/or commit a criminal offence. Directors can also be disqualified from acting as a director for a period of between 2 and 15 years if their conduct leading up to insolvency proceedings is considered to be unfit (see CLM ¶3000+). Administrators are obliged to report any conduct of the directors which could lead to their disqualification (see CLM ¶8856). Creditors are able to bring actions against directors: » for misfeasance (with the court’s permission) which can cover the misapplication or retention of company money or property, breach of duty and any other misfeasance (see CLM ¶7457+); or » in relation to transactions defrauding creditors (see CLM ¶7826+). However, in the case of misfeasance the court can only order the director(s) to repay, give back or account for misapplied property to the company or compensate the company by contributing to its assets. Similarly, in the case of transactions defrauding creditors any action is deemed to be taken on behalf of every victim of the transaction. Therefore any relief granted by the court in successful actions against directors is unlikely to benefit an individual creditor bringing the action. It may also be difficult for a creditor in a vulnerable financial position itself, perhaps as a result of the pre-pack sale, to fund court proceedings. This is particularly true for small unsecured creditors, who many argue are left without an adequate remedy. The Insolvency Service is encouraging aggrieved creditors to use its hotline if they wish to complain about a pre-pack sale or consider that they have been unfairly disadvantaged by an administration (or other insolvency procedure). Creditors can contact the Insolvency service by telephone: 0845 601 3546, or email: enforcement.hotline@insolvency.gsi.gov.uk. |
