The legal basis IN THE CURRENT ECONOMIC CLIMATE IT WOULD The - PDF document

INSOLVENCY AND CORPORATE RESTRUCTURING Jones Day The legal basis IN THE CURRENT ECONOMIC CLIMATE IT WOULD The administrator may perform their functions appear that almost every week another company with the objective specifi ed in c) only if they think and future role is placed into administration and its business and that it is not reasonably practical to achieve either assets are immediately sold, sometimes back to objective a) or b) and they do not unnecessarily of ‘pre-pack’ the former management, owners or other persons harm the interests of the creditors of the company connected with the insolvent company. as a whole (paragraph 3(4) of Schedule B1 to administrations the 1986 Act). In all other circumstances, the The process by which an insolvent company is administrator must also perform their functions in placed into administration and then its business the interests of the company’s creditors as a whole. and assets immediately sold is commonly referred to as a ‘pre-pack’. Recent pre-packs widely As soon as is reasonably practical after the reported in the press include tea and cofg ee company enters administration, and in any event chain Whittard of Chelsea, menswear retailer The within ten weeks of their appointment, the Offj cers Club and the restaurants Tom’s Kitchen administrator must, save as otherwise provided and Tom Aitken. in the 1986 Act, call an initial meeting of the company’s creditors. In advance of the initial The use of pre-packs is increasingly common. meeting, the administrator must send to all known However, opinion is divided as to the use and creditors of the company a report setting out the desirability of this process. This article considers administrator’s proposals for the management of the legal basis for pre-packs and reasons why the the company. process is subject to criticism and mistrust. If the administrator’s proposals are approved at the LEGAL BASIS FOR PRE-PACKS initial creditors’ meeting, the administrator must The Insolvency Act 1986, as amended by the manage the business and afg airs of the company Enterprise Act 2002, (the 1986 Act) provides that in accordance with the approved proposals. If the administrator of a company must perform their the administrator’s proposals are rejected, the functions with the objective of: administrator must apply to court for directions. a) rescuing the company as a going concern; A review of the 1986 Act would not appear to provide for or contemplate the pre-pack procedure. b) achieving a better result for the company’s Instead, the legal basis for pre-packs is set out in creditors as a whole than would be likely if the case law. The most recent case involving pre-packs company were wound up (without fi rst being in is DKLL Solicitors v Her Majesty’s Revenue and administration); or Customs [2007]. c) realising property in order to make a distribution DKLL SOLICITORS v HM REVENUE AND CUSTOMS to one or more secured or preferential creditors DKLL Solicitors involved the insolvency of a limited (paragraph 3(1) of Schedule B1 to the 1986 Act). liability partnership, which are subject to the 1986 Act in substantially the same way as a limited The administrator must perform their functions company. The insolvent fi rm had liabilities of with a view to achieving objective a), unless they approximately £2.4m, of which £1.7m was owed to think either that it is not reasonably practical to HM Revenue & Customs (HMRC). achieve that objective, or that objective b) would achieve a better result for the company’s creditors HMRC presented a winding-up petition against as a whole (paragraph 3(2) of Schedule B1 to the the fi rm. However, before the petition was 1986 Act). heard, an application was issued at court for > ‘Creditors may feel particularly aggrieved that the management is permitted to buy the business at a heavily discounted price.’ Kay Morley , associate, Jones Day E-mail: kmorley@jonesday.com March 2009 The In-House Lawyer 79

INSOLVENCY AND CORPORATE RESTRUCTURING Jones Day its administration. Upon their appointment, the It was also noted by the court that in exercising its proposed joint administrators of the fi rm intended discretion it could take into account the interests to sell the business and assets of the fi rm to two of other stakeholders. The judge was particularly of its partners for a total sale consideration of infl uenced by the fact that the proposed sale would £400,000. HMRC seemed to accept that, following safeguard the jobs of 50 employees. If the fi rm was the decision in Re T & D Industries plc [2000], an not placed into administration, it was most likely administrator had the power to complete a sale that these employees would be made redundant. of the business and assets of a company without the sanction of a creditors’ meeting or a direction While the decision in DKLL Solicitors will give of the court. However, HMRC objected to the some comfort to insolvency practitioners, in administration application on the basis that the sale circumstances where the commercial justifi cations consideration to be paid for the business and assets for a pre-pack are less convincing it cannot be of the fi rm was too low. assumed that pre-packs are beyond challenge. HMRC argued that as the majority creditor it would CRITICISMS OF PRE-PACKS be entitled to oppose the administrators’ proposals The main criticisms levelled at pre-packs are the at the initial creditors’ meeting. Accordingly, it was apparent lack of transparency and the fact that argued that the court ought not to make an order creditors are denied the opportunity to vote on for administration in circumstances where it was the administrator’s proposals for the management known that the majority creditor was opposed of the company. Concerns have also been raised to the proposed sale, and would, in efg ect, be with regard to the perceived objectivity of an disenfranchised by a pre-pack sale without any administrator where they have in the fi rst instance creditors’ meeting taking place. been engaged by the company to advise it on its insolvency options. The judge made the administration order in respect of the fi rm and the pre-pack proposed by the On the face of it, how can creditors be confi dent administrators was allowed to proceed. In reaching that the administrator has achieved the best its decision, the court placed considerable weight possible price for the assets of the company when on the fact that the administrators provided to the there has been no prolonged period of marketing for court a detailed and considered analysis as to why the business and assets of the insolvent company? administration would achieve a better result for the fi rm’s creditors as a whole than would be likely Suspicions are particularly raised in circumstances if the fi rm were wound up (without fi rst being in where the business and assets of the insolvent administration). company have been pre-packed to its existing management. In this situation, creditors may feel On the facts of the case, if the administration particularly aggrieved that the management, who order was not made and the fi rm was subsequently they usually consider to be responsible for the placed into liquidation, the Solicitors Regulation debts of the insolvent company, is permitted to Authority would intervene and the break-up value of buy the business and assets of the company at a the fi rm was estimated to be considerably less than heavily discounted price and then continue trading the proposed going-concern value. through the same business without interruption or recrimination, while the company’s creditors are left By comparison, while HMRC argued that the with an unsecured claim against an insolvent shell. proposed sale consideration was in its view too low, it provided no further evidence as to the alternative Although the 1986 Act provides creditors with market value for the business. In circumstances an opportunity to vote on the administrator’s where a creditor is in a position to provide a robust proposals, in circumstances where there has been a alternative going-concern value to the court, the pre-pack, creditors are efg ectively presented with a court may be more inclined to consider any such fait accompli . In this situation, if a creditor is of the objections when exercising its discretion. view that the administrator has acted in a way that has caused it unfair harm, the creditor may bring The court stated in DKLL Solicitors that a an application against the administrator pursuant majority creditor did not have the right of veto on to paragraph 74 of Schedule B1 to the 1986 Act, or implementation of the administrators’ proposal paragraph 75 in the case of misfeasance. and that the court could exercise its discretion to authorise the implementation of such proposals It should be noted at this point that an administrator if there was a real prospect that the statutory is unable to sell fi xed-charge assets free of purposes of administration would be achieved. security without the prior consent to the relevant 80 The In-House Lawyer March 2009