Restoring confidence in the pre-pack?

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Speed read: Rachel Clark considers whether draft new regulations requiring scrutiny of pre-pack sales to connected parties will be enough to prevent fraud and restore confidence in the process.

Once likened to sustaining ‘Frankenstein monsters’, the use of ‘pre-packs’ is controversial.

Whilst not defined by statute, the term ‘pre-pack’ is commonly used to mean an arrangement to sell all or a substantial part of a business prior to the company entering administration, with the administrator then completing the sale.

At their best, pre-packs allow for viable businesses to be rescued from the brink with an element of continuity, saving jobs and preserving value. They could be fundamental to salvaging UK businesses in the months ahead.

At their worst, they may be used by those involved to sell businesses to themselves at an undervalue, in order to defraud creditors or to evade liabilities on the parts left behind. This is made easier by the fact that such sales are usually completed at pace, only revealed to creditors once they are a fait accompli, and around half of all pre-pack sales are made to a connected party.[1]

In the months and years to come, the key will be to distinguish the legitimate pre-packs from the fraudulent.

The new requirements

On 8 October 2020, the government published its ‘Pre-pack sales in administration report'[2], together with draft regulations[3] requiring that all pre-packs to connected persons be either approved by creditors or scrutinised by an independent evaluator.

Key features include:

  • Although no date has been set, the deadline for the government to exercise its powers is the end of June 2021[4].
  • Specific pre-packs — The new rules will only apply to disposals, hiring outs or sales to connected person(s), within 8 weeks of a company entering administration, of what is (in the administrator’s opinion) ‘all or a substantial part of a company’s assets’.[5]
  • The scrutiny must be by an evaluator, who meets three requirements:
    • the qualification requirement (they must believe that they ‘have the requisite knowledge and experience to provide the report’);[6]
    • the independence requirement (broadly, they must not be connected with the company – directly or indirectly – have a financial conflict, or have provided insolvency, corporate rescue or restructuring advice to the company or a connected company within 12 months prior to the report);[7] and
    • they must not fall foul of any of the exclusions (for example, they must not have any previous convictions for dishonesty or deception).[8]
  • The administrator will be required to send a copy of the report(s) to creditors and to Companies House.[9]

What does this mean?

Whilst these measures are welcome, it remains to be seen whether they will offer creditors real confidence in the pre-pack process.

The wide definition of an independent evaluator is pragmatic. However, it has the potential to downgrade the quality of evaluations, vis-à-vis those which would have been prepared by evaluators from the ‘Pre-Pack Pool’ – a group of independent, experienced business people, selected after the 2014 independent review into pre-packs. [10] There are also serious concerns that ‘opinion shopping’ will take place.

Nor can such evaluations eradicate fraudulent behaviour. Those engaged in pre-packs should continue to be alert to the following:

  • Criminal liability. The authorities already have powers to pursue those engaged in fraudulent pre-pack arrangements through the criminal courts. For example, the common law offence of conspiracy to defraud creditors, or fraud by abuse of position under s.4 of the Fraud Act 2006, may be engaged. Committing the offence of reusing a company name under s.216 Insolvency Act 1986 can also have serious repercussions, including under the money laundering provisions of the Proceeds of Crime Act 2002: potentially rendering the turnover of the new entity ‘criminal property’.[11]
  • Joint Liability. Where a pre-pack is used to avoid or evade tax, HMRC may also consider issuing ‘joint liability notices’ to individuals involved, rendering them personally jointly and severally liable for the tax liabilities of the company, under Finance Act 2020.
  • Reporting Obligations. Insolvency practitioners form part of the regulated sector under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. They therefore have a duty to make a Suspicious Activity Report to the National Crime Agency if there are reasonable grounds for suspecting money laundering, per s.330 Proceeds of Crime Act 2002. As a fraudulent pre-pack could generate ‘criminal property’ (see above), money laundering concerns arise. Red flags for practitioners to look out for could include: transactions conducted contrary to the independent evaluator’s report, after multiple conflicting reports, where “opinion shopping” has clearly taken place, or where an evaluator seems to have come to a strange conclusion.

 

Final thoughts…

As noted by Lord Callanan, Minister for Climate Change and Corporate Responsibility,

“It is important to have an environment where those who are affected by insolvency have confidence in a process that is fair and transparent and achieves the best outcome for creditors, encouraging inward investment and boosting growth.”

The regulations may seem benign, but the repercussions for those who seek to undermine confidence in the system are likely to be quite the opposite.

 

Rachel Clark is a barrister at Bright Line Law who regularly advises on financial crime matters (including tax evasion, cash forfeiture, civil recovery, confiscation, search warrants, unexplained wealth orders, corruption, bribery and fraud).

 

[1] Foreword, https://www.gov.uk/government/publications/pre-pack-sales-in-administration/pre-pack-sales-in-administration-report

[2] https://www.gov.uk/government/publications/pre-pack-sales-in-administration/pre-pack-sales-in-administration-report

[3]https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/922230/Draftregulationstext_1.pdf

[4] Powers were originally inserted into the Insolvency Act 1986 by the Small Business, Enterprise and Employment Act 2015. Those powers expired at the end of May 2020, but were revived under the Corporate Insolvency and Governance Act 2020, section 8.

[5] See Draft regulation 4. Connected persons are defined in paragraph 60(A)(3) of Schedule B1 to the Insolvency Act 1986 as a ‘relevant person in relation to the company’ or a ‘company connected with the company’. A ‘relevant person’ means (i) a director or other officer, or shadow director, of the company; (ii) a non-employee associate of such a person; (iii) a non-employee associate of the company. A company is connected with another if any relevant person of one is or has been a relevant person of the other.

[6] Draft regulation 9

[7] Draft regulation 10

[8] Draft regulation 11

[9] Draft regulation 12

[10] The Graham Review: Referral to the Pool was (and remains) voluntary. Concerning, referrals have slumped – only 23 were made in 2019; 9% of connected party cases.

[11] see R v Neuberg [2016] EWCA Crim 1927