A “pre-packaged” sale of all or part of an insolvent business may well be negotiated between a seller, the proposed administrator and the buyer on the understanding that the transaction will be concluded immediately upon or very shortly after the appointment of an administrator. Such sales appear to have become increasingly prevalent; this in spite of the legislature’s intended effect of the Enterprise Act 2002, namely to rescue a viable company as a going concern.
Not unsurprisingly such sales have become the topic of rigorous debate amongst insolvency professionals, legal practitioners and academic researchers. The advantages of the transactions for failing businesses are clearly apparent. Where the insolvency process has become public knowledge the value of a business is likely to be diminished; a quick sale may well avoid or limit this. Business continuity can be preserved more effectively, valuable employees may well choose to remain with the company, jobs are thus preserved and contracts, both with other businesses and customers are much more likely to last.
In contrast, critics of pre-pack transactions question their suitability as a means of realising an insolvent business’ assets. The arguments made against the sales are numerous. Interests of unsecured creditors may well be prejudiced in contrast with those of secured floating charge holders. The principle incentive of the transaction may well be to discharge any secured indebtedness and no more than this. As the company is unlikely to have been marketed on the open market, any consideration received might well be less than that potentially achievable. Apparent lack of transparency in these arrangements as well as possible collusion with intended purchasers are similarly cited as areas of disquiet.
“A general summary of these concerns would be that the speed and secrecy which give rise to the advantages claim for pre-packs may too easily lead the directors and the insolvency practitioner to arrive at a solution which is convenient for both of them and their interests but which harms the interests of the general creditors…" (i)
Statement of Insolvency Practice 16
Most recently in Re Kayley Vending Limited  EWHC 904 (Ch), HHJ David Cooke gave an extended consideration to the approach of the courts in pre-pack administration applications. His intention, following an invitation from counsel in the case, was to give guidance following the introduction on January 1, 2009 of the Statement of Insolvency Practice number 16 (‘SIP 16’).
A primary objective of SIP 16 is to increase transparency and accountability. It is well known that the numerous duties of administrators are outlined in the Insolvency Rules 1986 (‘the Rules’). Similarly within SIP 16, administrators are reminded of their duty to all of those affected by a pre-pack sale and of the importance of explaining to all creditors why the intended sale will be in their interest. Insolvency practitioners are also once more soberly reminded of the potential liability for fraudulent or wrongful trading by those who cause the company to incur credit in the period prior to administration.
It is well established by the courts that an administrator can dispose of company assets without a prior meeting with its creditors (ii). However this is not an unfettered power and the duty of administrators to act with propriety are similarly highlighted in SIP 16. Attention is drawn to Schedule B1 of the Insolvency Act 1986 (‘IA 1986’) and notably paragraphs 74 and 75. The former allows an application to court by any creditor or member of the company for unfair harm to their interests. The latter allows the courts to examine the conduct of the administrator or misfeasance.
As outlined in SIP16, paragraph 8, “it is in the nature of a pre-packaged sale in an administration that unsecured creditors are not given the opportunity to consider the sale of the business or assets before it takes place”. Accordingly, disclosure is a principle aim of SIP 16 and the administrator should convene a meeting as soon as possible after his appointment. Paragraph 9 lists some seventeen items to be disclosed to the creditors by him in order that this information can be assessed, analysed and discussed. HHJ Cooke stated in Re Kayley Vending Limited that this disclosure should not be an onerous task for the administrator, in the course of his due diligence and enquiries such information should already largely be in his possession.
The Enterprise Act 2002 and the administration procedure
The fundamental role of the administrator prior to the Enterprise Act 2002 (‘EA 2002’) remains the same. His statutory purpose is to assess the business and its options and to present proposals based on that study to the creditors. The administrator was appointed by the court and prepared an independent report on the relevant company for that court’s information. This regime often resulted in the court, provided with such costly and lengthy reports, often accepting the administrator’s view of the situation.
The post EA 2002 landscape is almost quite the reverse. An appointment is made by the directors or by holders of a qualified charge and is notified to the court along with the prescribed documentation (note that where the application is made by the directors they must give notice to the holders of a qualifying charge). The court simply receives these documents. None of them contain information about the company’s affairs. However the administrator provides a statement on Form 2.2B that the primary objective of the administration is to rescue the company as a going concern.
Where a petition for compulsory winding up has been made (often by an unpaid unsecured creditor), the directors are not able to appoint an administrator and must make an application for instruction by the court. This results in adjournment of the petition. The petitioner is made aware of the application and has the opportunity to oppose it. It is in these circumstances that applications for an administrator arrive at court. The court is therefore under a duty in using its discretion to make such an administration order, rather than allowing the winding up petition, to be satisfied that it is the correct course of action.
By Rule 2.4 of the Insolvency Rules 1986 (‘the Rules’), the evidence required to support an application by the company’s directors must provide proof of the applicant’s belief of the company’s inability to pay its debts. By Rule 2.5 the proposed administrator must make a statement that he believes that there is reasonable likelihood of achieving the purposes of administration (on Form 2.2B). As such there is no requirement clearly specified in the Rules to disclose information regarding the purpose of the administration. It is only by virtue of the ‘general’ nature of Rule 2.4(2)(e) requiring that the affidavit in support should contain “any other matters” which will assist the court to come to its decision as to whether or not to make an order that disclosure of a pre-pack sale can be deemed to become relevant. Information concerning the pending intended transaction would clearly be pertinent.
His Honour’s conclusion in Re Kayley Vending Ltd was that the courts in considering applications where pre-pack sales have been negotiated will be assisted by relevant information made available to them by the disclosure required by SIP 16. Furthermore, the generality of Rule 2.4(2)(e) would require any relevant material concerning the pre-pack to be made available to the court. The courts will be vigilant to recognise and accordingly block those applications for administration orders where it is apparent that the process is being used to disadvantage creditors as already discussed in this article. Of course, each case is to be decided upon its merits and upon the information provided and a judge must decide whether or not he has sufficient information at his disposal to consider the application before him.
Commercially sensitive information
The requirements of SIP 16 may cause situations where commercially sensitive information should be disclosed. The court by Rule 7.31(5) can make an order that such information is not made available for inspection. For practical reasons such information should be separated in clearly identified exhibits. The information can be held by the Applicant’s solicitor against an undertaking to lodge it when required by a further order.
Pre-appointment costs of the proposed administrator
His Honour in Re Kayley Vending Limited made an order under Paragraph 13(1)(f) of Schedule B1 of the IA 1986 that the administrator’s pre-appointment costs are to be treated as an expense of the administration. In so doing he followed the approaches of HHJ Norris QC in Re SE Services Ltd (9 August 2006), unreported and HHJ Purle QC in Aldersley Battery Chairs Limited, also unreported.
His Honour made it clear that the order was discretionary under Paragraph 13(1)(f) as opposed to finding all such costs as costs of the Applicant which must be allowed under Rule 2.67(1)(c). He clarified that it is appropriate to make such a discretionary order where the “balance of benefit arising from the incurring of pre-appointment costs is in favour of the creditors rather than... the management as potential purchasers” (iii)
The aim of issued Statements of Insolvency Practice is to provide clarity of approach with regards to varied aspects of insolvency practice. However, SIP 16 has at its core the aim of clarifying those issues peculiar to pre-pack sales. This is a controversial area of insolvency practice where competing interests have not unsurprisingly caused conflict between those involved in a company’s affairs and its future viability. SIP 16 makes it clear that the interests of all creditors, and not only secured or preferential creditors, must be taken into account when such a transaction is contemplated.
The provisions for disclosure under Paragraphs 8-12 of SIP 16 have clearly been drafted to improve the position of general unsecured creditors. Administrators are similarly reminded that they are to consider the interests of all creditors and members of the company. The analysis of HHJ Cooke in the recent case of Re Kayley Vending Limited has made it clear that relevant information placed before the courts as required by the Rules and SIP 16 will be duly scrutinised by judges when using their discretionary powers to make an administration order. It is in this way that obvious abuses of the procedure can be blocked.
(i) Re Kayley Vending Limited  EWHC 904 (Ch) at paragraph 11
(ii) T&D Industries Plc  1 WLR 646; Transbus International Ltd  EWHC 932 (Ch),  All ER 911; DKLL Solicitors  EWHC 2067 (Ch)
(iii) Re Kayley Vending Limited  EWHC 904 (Ch) at paragraph 33
Director and Head of Arrears Management