In his latest Coffee Break Briefing, insolvency expert, Malcolm Niekirk, looks at pre-pack evaluation experiences, including when an evaluation is required, how the process works and the practical issues that can arise.
In case you missed it, you can read a summary and watch a recording of the webinar here.
Pre-pack evaluations: when is an evaluator’s report required?
Pre-pack administrations can help preserve business value, protect jobs and avoid the cost of trading a distressed business through administration. However, they can also attract scrutiny, particularly where the business or assets are sold to someone connected with the insolvent company.
Since 2021, certain disposals to connected persons have been subject to additional statutory scrutiny.
How did we get here?
The Enterprise Act 2002 introduced a new administration regime which came into effect on 15 September 2003.
Among other changes, it made administration more accessible by creating routes for a qualifying floating charge holder, a company or its directors to appoint an administrator without first making a full court application.
However, trading a distressed business through administration can still be expensive and risky.
That is one reason pre-packs became attractive. The sale is negotiated before the administrator is appointed and completed immediately, or shortly, after appointment.
The speed can preserve value, but it can also create concerns for creditors, particularly where the purchaser is connected with the former owners or management.
Why was the Pre-Pack Pool introduced?
Following the Graham Review, the Pre-Pack Pool was introduced in 2015.
It allowed connected purchasers voluntarily to seek an independent opinion on a proposed pre-pack. However, take-up was low, which ultimately contributed to the introduction of a statutory system of independent scrutiny.
What changed in 2021?
The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 came into force on 30 April 2021.
The Regulations are not limited to pre-pack sales. They apply where an administrator proposes to make a substantial disposal to a connected person during the first eight weeks of an administration.
Where the rules apply, the administrator must not complete the disposal unless:
- creditor approval has been obtained; or
- a qualifying evaluator’s report has been obtained and considered.
So, an evaluator’s report is not always compulsory, but one of those two statutory routes must be followed.
When do the Regulations apply?
There are three main questions to consider:
Is the purchaser connected?
“Connected person” has a wide statutory meaning under paragraph 60A(3) of Schedule B1 to the Insolvency Act 1986.
It can include directors, officers, shadow directors, associates and connected companies.
Common directors can, for example, bring a transaction within the definition.
Is the disposal within the first eight weeks?
The disposal must take place during the eight-week period beginning with the day the company enters administration.
Is it a substantial disposal?
The transaction must involve, in the administrator’s opinion, all or a substantial part of the company’s business or assets. The definition can also include a series of transactions.
It is the insolvency practitioner’s responsibility to establish whether the purchaser is connected and whether the disposal is substantial.
Who obtains the evaluator’s report?
The connected purchaser obtains the report, not the administrator.
The purchaser instructs the evaluator and is responsible for providing the information needed.
The administrator must then receive and consider the qualifying report before making the disposal.
In a pre-pack, the evaluation is often completed before the administrator is formally appointed so that the sale can complete promptly afterwards.
Can creditors approve the sale instead?
Yes.
Creditor approval is an alternative to obtaining an evaluator’s report. However, this can be difficult to reconcile with the timetable of a traditional pre-pack, where the commercial benefit often depends on completing the transaction quickly.
There are also safeguards to prevent connected creditors from forcing through a decision against the wishes of unconnected creditors. For that reason, the evaluator route is much more commonly used.
Who can act as an evaluator?
The Regulations do not create a separately regulated profession of “pre-pack evaluator”.
However, the evaluator must:
- be an individual;
- have sufficient relevant knowledge and experience;
- hold appropriate professional indemnity insurance;
- meet the statutory independence requirements; and
- have no relevant conflict of interest.
An evaluator might be an accountant, surveyor, corporate lawyer or insolvency practitioner if they meet the statutory requirements. The Pre-Pack Pool is one option, but it is not the only one.
What does the evaluator decide?
The evaluator considers two key issues:
- whether the consideration being provided is reasonable; and
- whether the grounds for the disposal are reasonable.
Their report must contain one of two conclusions. A positive opinion means the evaluator is satisfied that the consideration and grounds are reasonable in the circumstances. This is often informally called “case made”.
A “case not made” opinion means the evaluator is not satisfied. The evaluator must also explain their reasons and summarise the evidence relied upon.
The report does not replace the administrator’s own duties and judgement. It is an independent assessment of the reasonableness of the proposed disposal.
What happens if the evaluator gives a “case not made” opinion?
A case not made opinion does not automatically stop the sale.
The purchaser may obtain a further evaluation, although previous adverse reports cannot simply be ignored.
The parties might also:
- change the price or terms;
- provide further evidence; or
- restructure the transaction.
If there is a material change to the property, terms or circumstances after the report is produced, a further qualifying report or creditor approval may be required. An administrator can still proceed despite a case not made opinion if they consider it appropriate, but they must explain why.
What information does an evaluator need?
The evaluator will normally need enough information to understand:
- the company’s financial position;
- the assets being sold;
- the proposed consideration;
- the purchaser’s connection with the company;
- valuations;
- marketing;
- alternative offers; and
- what would happen if the proposed sale did not proceed.
Where there is deferred consideration, the purchaser’s financial position and ability to make future payments may also be important.
The evaluator may raise questions or identify gaps in the evidence before issuing the final report. However, their role is to scrutinise the transaction, not to act as the purchaser’s negotiator or replace the administrator.
Why is the commercial sense-check important?
An evaluator also needs to look at the commercial reality of the transaction.
Key questions might include:
- What happens if the deal does not proceed?
- Is there another credible buyer?
- Can the business realistically continue trading?
- What are the likely outcomes for creditors?
- Is the consideration supported by valuations and marketing?
These questions help the evaluator assess whether the transaction is reasonable in the circumstances.
How does SIP 16 fit into the process?
SIP 16 applies to all pre-packaged sales in administrations, regardless of whether the purchaser is connected.
The two regimes are different.
The 2021 Regulations apply to substantial disposals to connected persons during the first eight weeks of administration.
SIP 16 is the professional standard governing pre-packaged sales.
A SIP 16 statement should explain matters including:
- marketing;
- valuations;
- the purchaser’s identity and connections;
- the consideration;
- alternatives considered; and
- why the administrator considers the deal to represent the best available outcome for creditors.
Where a pre-pack is also a substantial disposal to a connected person, an evaluator’s report is an additional requirement unless creditor approval has been obtained.
What if you think the purchaser is not connected?
Careful due diligence and record keeping are important.
It may be sensible to obtain warranties or confirmations from the purchaser about ownership, directors, control and relationships with the insolvent company. However, those protections do not transfer responsibility away from the insolvency practitioner.
Linked transactions also need to be considered as a whole, because a substantial disposal can be made through a series of transactions.
There is no general rule preventing a purchaser from reselling the assets during the first eight weeks, and non-compliance does not automatically make a sale void. The consequences will depend on the circumstances.
Are there still concerns about the evaluator regime?
Yes. There are still questions around independence, conflicts of interest and how evaluators are selected.
One concern is the relationship between insolvency practitioners and evaluators. For example, do insolvency practitioners tend to recommend particular evaluators, and if so, why?
There are also questions around regulation. Evaluators must be satisfied that they have the necessary knowledge and experience, but there is no separate statutory regulator for evaluators as a profession.
Another issue is the potential for conflicts where an insolvency practitioner has been involved before appointment and later becomes the administrator responsible for reviewing the transaction.
These concerns make independence, transparency and a clear audit trail particularly important throughout the evaluation process.
What helps an evaluator reach a properly supported conclusion?
There is no shortcut to a positive evaluation - a clear evidence pack is key.
For a pre-pack, useful information includes:
- a well-structured SIP 16 statement;
- clear valuations;
- details of the marketing process;
- alternative offers;
- an explanation of the options considered; and
- clear reasons why the proposed deal is commercially reasonable.
Where there has been pre-appointment trading, the evaluator may also need to understand how it was funded, what liabilities were incurred and how creditors were affected.
Is an evaluation more than just another box to tick?
Yes. An evaluator’s report should provide genuine independent scrutiny of two central questions:
- Is the consideration reasonable?
- Are the grounds for the disposal reasonable?
The first thing to establish is whether the proposed sale is a substantial disposal to a connected person within the first eight weeks of the administration.
If there is, the administrator must ensure that the statutory requirements are satisfied before the disposal takes place, either through creditor approval or by receiving and considering a qualifying evaluator’s report.
Insolvency Coffee Break Briefings
Thank you for reading the summary for this Coffee Break Briefing. You can watch the full, detailed webinar here. If you have any questions after reading this article, please don’t hesitate to get in touch with our bright and experienced team. Call us on 01202 499255, or fill out the form at the top of this page, for a free initial chat.
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