The draft Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021

Following review and proposal by the UK Government to develop stricter scrutiny of pre-pack administration sales to connected parties, the Government laid the draft Regulations in Parliament on 24 February 2021. These are due to come into force on 30 April 2021. Our previous article summarising the Government’s proposal can be found here.

In summary, the Regulations adopt the Government’s earlier proposal and in a move to increase confidence in the insolvency regime, it has been proposed that administrators will be unable to dispose of all or a substantial part of a company’s business or assets to a person connected with the company within the first 8 weeks of the administration without either:

• the approval of creditors; or
• a qualifying report from an independent, third party Evaluator (whether positive or negative).

Following the original Government proposal in October 2020 and prior to the Regulations being published, R3, the Association of Business Recovery Professionals, wrote to the Insolvency Service to suggest that two fundamental aspects of the proposals be changed, as set out in more detail below.

Pre-pack sales in administration

Despite the initial aim of the proposals being to alleviate concern over the perceived lack of transparency in pre-pack administration sales, the Regulations go further capturing all connected party administration sales within an extended period post-administration. During the proposals stage, R3 had recommended that the regulations be amended to only apply to transactions which have been “negotiated, brokered, arranged and/or discussed with a purchaser prior to an appointment of the administrator” with the substantial disposal being limited to a period of 21 days following appointment rather than the proposed 8 weeks. This request has not been reflected in the Regulations.

The rationale for the 8 week period appears to be that this period of time allows for other prospective buyers to become aware of the insolvency and to put forward alternative offers for the business and assets, generating competitive tension and possibly facilitating the administrators achieving maximum value.

Creditor approval

To obtain creditor approval, a decision making procedure must be used and such process cannot take place before a period of 14 days from the date of appointment of administrators, meaning the only viable option for the vast majority of connected party pre-pack administration sales would be with a qualifying report of an Evaluator. Many sales need to be completed in a very short timeframe to avoid value destruction of certain assets like goodwill, in which case an Evaluator may end up being the only realistic option.

Qualifying criteria of the Evaluator

Concern was also raised by R3 over the prescribed qualification of an Evaluator, being if “… the individual believes that they have the requisite knowledge and experience to provide the report.” The proposals provided no requirement for the Evaluator to be an insolvency practitioner or accountant. R3 suggested that a list of approved opinion providers be maintained by The Insolvency Service to ensure the integrity of the Evaluator and provide some oversight and a framework to the Evaluator role as with the Pre Pack Pool but this was rejected.

The Pre Pack Pool may be an obvious source when looking for Evaluators however it is currently unclear what the status of the Pre Pack Pool will be once the Regulations have been implemented. The Pre Pack Pool (being a private body of independent business professionals) is not referred to in the Regulations. Although a voluntary process, the members of the Pre Pack Pool are experienced and senior business people, recruited as part of a public recruitment exercise, which may have prompted R3 to suggest the inclusion of an approved list of Evaluators maintained by The Insolvency Service.

Although R3’s suggestion of requiring the Evaluator to have professional indemnity insurance was adopted in the Regulations and that the Evaluator must be independent (not connected with the company or an associate of the connected person or connected with the connected person), there is still no real framework for the qualifying criteria for the Evaluator position, potentially diminishing the integrity of the process.

Evaluator’s report

The administrators are required to send a copy of the Evaluator’s report(s) to creditors and to Companies House. The Regulations also require any previous qualifying reports obtained by the proposed purchaser to be disclosed however it is unclear whether this also includes preliminary discussions with an Evaluator prior to a formal opinion being provided leaving the process open to opinion forum shopping.

In its report if the Evaluator makes a statement that they are not satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances, the Regulations do not provide for an appeal, however the administrators may still proceed with the sale however they must explain their rationale for doing so in a statement to the creditors.

Connected persons

A footnote in The Insolvency Service’s report from October 2020 suggests that pre-pack sales to secured lenders, with voting rights in the normal course of business of a third or more, should not be caught by the Regulations. The Regulations do not include such a carve-out in the definition of ‘connected persons’. It has been argued that such parties are not responsible for the failure of the company and should not be treated in the same way as directors or other officers of the company and connected companies.

Conclusion

The Regulations do not appear to deal with certain of the commercial concerns raised by the insolvency industry and it remains to be seen whether the Regulations in its current form will have the desired effect of alleviating creditor concern over the pre-pack process, which is widely recognised as a valuable rescue tool.