A “pre-pack” insolvency is one that involves a business sale negotiated in advance of a formal insolvency, implemented by the liquidator or administrator shortly after his or her formal appointment.
Pre-packs will achieve a quicker and cheaper sale than a full blown process by an insolvency practitioner – however if a related party ends up as the purchaser, questions are often asked about how the sale price was set. A report issued this week in the UK raises doubts as to the effectiveness of a voluntary regime intended to mitigate those problems, and further change now seems likely.
Pre-packs in different jurisdictions
In the US, pre-packs are used for the very largest insolvencies – such as Chrysler in 2009 – to try to avoid the worst of the time delays and runaway legal costs of their cumbersome Chapter 11 process (a recent example reported here).
In the UK, pre-packs are typically used to deal with the very smallest businesses, where the costs of a normal sale process and settlement would swallow most of the sale proceeds. Whilst they are an established part of the UK restructuring scene, pre-packs involving a sale to a related party – which most Australians would describe as a ‘phoenix’ transaction – have been controversial in the UK for precisely the same reasons that phoenix transactions are controversial here.
In Australia, pre-packs are seen by many restructuring and turnaround professionals as problematic, because a practitioner who is involved in pre-appointment negotiations probably falls foul of the ARITA requirements for professional independence.
The Graham Review and its recommendations
In 2013 the UK government asked prominent Chartered Accountant Teresa Graham to review the use of pre-packs, and make recommendations to improve their outcomes. The recommendations in her 2014 Report (discussed here) included a process by which related-party transactions could be referred to a ‘Pre-Pack Pool’ – a panel of experienced business people – for review. Notably, this is a voluntary process, and those involved must choose to refer the transaction to the PPP.
As explained on the PPP website, a randomly selected panel member will provide an independent opinion to be shared with creditors. That opinion, provided within two business days and at a cost of £800, will not include any reason or explanation, but will simply set out one of the following three conclusions:
- “Nothing found to suggest that the grounds for the proposed pre-packaged sale are unreasonable”
- “Evidence provided has been limited in some areas, but otherwise nothing has been found to suggest that the grounds for the proposed pre-packaged sale are unreasonable”
- “There is a lack of evidence to support a statement that the grounds for the proposed pre-packaged sale are reasonable.”
The 2017 Annual Report
This week the PPP issued its report for the 2017 calendar year (available on their website). Key statistics include:
- 28% of the 1,289 administrations in the UK were pre-packs (2016: 22%).
- 57% of those pre-packs involved sales to related parties (2016: 51%).
- Only 11% of the related party pre-packs (28%) were referred to the PPP (2016: 28%).
Of those referrals:
- 49% received a ‘not unreasonable’ opinion (2016: 64%).
- 34% received a ‘not unreasonable but with limitations as to evidence’ opinion (2016: 25%).
- 17% received a ‘case not made’ opinion (2016: 11%).
What next for UK pre-packs?
The UK passed legislation in 2015 which created a framework to allow for later regulation if the process proposed by Teresa Graham did not deliver the hoped-for outcome.
The PPP’s 2016 Annual Report noted a slow take up rate in the first year of operation – but recognised that the program was still new. However, the 2017 report shows that against the hopes of the PPP, the referral rate has fallen, and fallen significantly.
It seems likely that a review announced by the UK Insolvency Service in December 2017 will conclude that the voluntary regime has not worked. The next step is less clear: will the UK endorse the referral regime but make it compulsory, restrict or ban related-party sales altogether, or find another option?
For further reading, Michael Murray has written an excellent article recently on pre-packs: here