In this article, Dentons gives its inside view on the pre-pack evaluator's report, made compulsory earlier this year to improve the confidence of creditors in pre-pack administration sales to connected persons. We consider the practicalities of selecting the right evaluator for the job, the potential for "opinion shopping" from evaluators and whether these new regulations have achieved what was intended.
A recap on pre-packs
A pre-pack administration sale can be used to rescue a struggling business as a going concern without subjecting it to the adverse publicity associated with a sale on the open market, which can erode confidence in the business and damage its value. Pre-packs have been criticised as offering an opportunity for owners to buy back a business free of bad debts, with a "phoenix company" arising from the process, generally at the expense of creditors. New regulations brought in earlier this year seek to address these concerns and protect creditors by adding extra conditions that an administrator must satisfy before making a pre-pack sale to a connected person.
What are the new regulations?
The new Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (SI 2021/427) (Regulations) (the Regulations) came into effect on 30 April 2021. For all administrations starting on or after that date, an administrator may not effect a pre-pack admin sale or a sale of a substantial part of the business within eight weeks of the administration to a connected person without either (i) prior creditor approval or (ii) having received a qualifying report. The report must be obtained by the connected person and will set out the evaluator's experience, identify the property that will be the subject of the sale and the consideration to be paid for it, and confirm that "the evaluator is satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances".
Who is a "connected person"?
The question of whether a buyer is a "connected person" is defined in the Regulations by reference to paragraph 60A(3) of Schedule B1 IA 1986, and should be analysed carefully. In broad overview, the buyer will be connected if it is (i) a "relevant person", being a director, shadow director, non-employee associate of a director or non-employee associate of the company, or (ii) where the buyer is another company, the buyer and the company in administration share a common "relevant person". "Associate" is in turn defined in Section 435 IA 1986, and includes those who have control of a company. A person will have control if the directors of the company are accustomed to act in accordance with his or her directions, or if the person is entitled to exercise (or control the exercise of) 1/3 or more of the voting power of the company at any general meeting. Importantly, where two or more persons together satisfy these conditions, they will be taken as having control of the company.
Administrators are advised to conduct thorough due diligence of any buyer, as no excuses are afforded to an administrator who unknowingly facilitates a sale to a connected party without satisfying the requirements of the new regulations.
How have the new regulations been received?
The regulations have been criticised for failing to properly regulate the position of the evaluator: assuming they have the requisite insurance and independence, an individual can be an evaluator so long as they are satisfied that their knowledge and experience is "sufficient". The evaluator is reliant on the information provided by the parties in order to assess the transaction, and may have insufficient time or knowledge of the structure to thoroughly assess it.
Commentators have also pointed out that there is scope for a connected buyer to "opinion shop" by seeking a favourable report from a second evaluator if the first does not support the transaction.
Practical tips
- Given the criticisms set out above, the administrator should require the connected person to obtain the administrator's consent to its choice of evaluator, and should also have oversight of the information provided to the evaluator.
- The timescales for pre-packs are invariably tight. Choosing an evaluator should not be left to the last minute, and it is important to ascertain how much time must be built into the timetable for the evaluator to assess the transaction. In our experience, turnaround times for the report range from a day to three days, depending on the evaluator and the complexity of the deal. Importantly, the term sheet needs to be in sufficiently final form before the evaluator can prepare the report.
- Providing as much information upfront and in advance to the evaluator can ensure the report is produced smoothly and in good time. Key pieces of information for the evaluator will likely include: (a) details of any marketing carried out by the company, (b) a valuation report, (c) an explanation of why a pre-pack is necessary, and (d) details of the connection between the company and the buyer.
- The cost of, and time required to produce, the report varies from evaluator to evaluator, so shopping around can result in best value for the client.