New Pre-Pack Administration and Breathing Space Regulations: Another new dawn for insolvency law?
New Pre-Pack Administration and Breathing Space Regulations: Another new dawn for insolvency law?
STOP PRESS: Since the introduction of The Corporate Insolvency and Governance Act 2020 (CIGA) in June 2020 and the date this blog was written, there have been multiple amendments and extensions to the temporary provisions intended to take account of the continuing unprecedented financial climate caused by the Coronavirus pandemic. We highlight the key updates as follows:
- ‘Suspension’ of wrongful trading liability retrospectively for the period 1 March 2020 to 30 September 2020 under CIGA 2020. Reintroduced by CIGA (Coronavirus) (Suspension of Liability for Wrongful Trading and Extension of the Relevant Period) Regulations 2020 for the period 26 November to 30 April, and subsequently extended by the CIGA (Coronavirus) (Extension of the Relevant Period) Regulations 2021 and expired on 30 June 2021.
- Restriction on the use of creditors’ winding up petitions and statutory demands retrospectively for the period 1 March 2020 to 30 September 2020 under CIGA 2020. This period has been extended on four subsequent occasions to 31 December 2020, 31 March 2021, 30 June 2021 and 30 September 2021. For the period 1 October 2021 to 31 March 2022, winding up petitions can be granted for COVID-19 related debts (but not for outstanding commercial rents where the reason for non-payment was as a result of COVID-19), provided that the petition debt is £10,000 or more and that creditors have sought proposals from the debtor allowing 21 days for a response before petitioning.
- Restrictions on rent-related forfeiture of business tenancies retrospectively for the period 26 March 2020 to 30 June 2020, extended on four subsequent occasions to 31 December 2020, 31 March 2021, 30 June 2021 and is now due to expire on 25 March 2022, and the period in which commercial rent arrears recovery action (CRAR) is restricted has been extended for a further nine months to 25 March 2022.
In our latest update, we offer a guarded welcome to yet another round of new measures in both corporate and personal insolvency, which will affect both pre-pack administration sales to connected parties and the pursuit of problem debt against individuals. Just 6 weeks on from our last Corporate Restructuring & Insolvency blog (which looked back over an extraordinary 12 months for insolvency law in England & Wales “CIGA and the lockdown rollercoaster“), the speed of legislative change in this area shows no sign of letting up.
Pre-packs (as they are colloquially known) and ‘breathing space’ moratoria have long occupied the headlines for a variety of – sometimes controversial – reasons. With the recent elections in view, and (notwithstanding that economic re-growth this year is now forecast to exceed the Bank of England’s original estimates) the prospect of real insolvency pressure this Summer, it is unsurprising that the government chose this moment to finally bring into force some very long-awaited legislation to tackle these issues. Whether the legislation will achieve its underlying aims of restoring public faith in the value of pre-packs and encouraging creditors and individuals to deal with personal debt problems in an orderly and fair way, is a separate question.
The new pieces of legislation enjoy the snappy titles of The Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 (“Pre-Pack Regulations”) and The Debt Respite Scheme (Breathing Space Moratorium and Mental Health Crisis Moratorium) (England and Wales) Regulations 2020 (“Breathing Space Regulations”) and they came into force on 30 April and 4 May 2021 respectively. Disguised behind their long-winded official titles, these regulations contain interesting changes which we explore below, before offering our own verdict.
In passing, we will also touch upon our recent experiences with the insolvency courts sitting remotely during the pandemic and consider what impact this – and the prospect of multiple unconnected spectators watching such hearings online – might have upon the willingness of office holders and their assignees to litigate, and defendants to settle.
The Pre-Pack Regulations
The Pre-Pack Regulations follow the latest in a series of public reviews surrounding the transparency of a procedure often criticised by, or on behalf of, unsecured creditors who historically would not have been consulted about, and/or who have been disappointed by the level of dividends paid following, a pre-pack administration sale. In 2014 the Graham Review, led to the creation of the so-called Pre-Pack Pool, composed of a list of approved, experienced professionals who could be consulted on a purely voluntarily basis to offer an independent opinion on the appropriateness of a particular pre-pack sale.
However, referral numbers to the Pool were (and have continued to be) much lower than seemingly intended, even as a proportion of the objectively low number of pre-pack administration sales which have actually occurred in recent years. This, combined with continued press interest creating a sense of controversy much larger than that felt by the majority of creditors, arguably forced the government’s hand eventually to try to overhaul the process once again.
Before we offer our own comment as to the effectiveness of the new Regulations, we first need to go back to basics and remind ourselves as to what a connected party pre-pack administration sale actually is (as opposed to what the mainstream media often mistakenly assume it is).
What is a pre-pack administration?
Put simply, the term “pre-pack administration” describes a process whereby an insolvency practitioner instructed as a prospective administrator negotiates on behalf of an insolvent company and lines up a sale of the company’s business and/or assets prior to their appointment as administrator being lodged with the court, and completes the sale immediately afterwards. There are almost always strong, objective justifications for IPs lining insolvency sales like this up in advance of appointment, not least of which is that they tend to maximise outcomes for creditors by preserving the value of the underlying business where it is possible for it to survive in some form.
The complexity and alleged controversy of pre-packs actually arises only where the intended sale takes place to a connected party (such as a new company run by the existing management or shareholders). In such cases, even under the law prior to 30 April 2021, the administrator has for many years needed to follow a number of careful precautions to ensure that full and sufficient value is being obtained and that creditors’ rights are protected accordingly. Even so, for many a connected party pre-pack sale is indistinguishable from the concept of ‘phoenixism’ – more commonly associated with liquidations – whereby one or more directors are perceived to be able to dump their debt and carry on in a reincarnation of that business under the same or a similar name, as if nothing had happened.
It is only the precise character of the precautions that the Pre-Pack Regulations seek to change. The government implicitly recognises the value of pre-pack sales themselves, so in reality they are just trying to shake the perception that something underhand is going on when the eventual buyer happens to have a connection with the insolvent company.
What do the new Regulations do?
The new Pre-Pack Regulations impose further due diligence and scrutiny where a sale is proposed to a connected person within the first 8 weeks following a company entering administration. Such a sale will now need either:
- creditor approval; or
- a report from an independent ‘evaluator’ who will confirm whether or not, in their view, the proposed consideration is reasonable.
In reality, given the nature of most pre-pack sales which usually demand swift decisions if business value is to be preserved, and that the Regulations would require the company to be in administration for at least 14 days before creditor approval (even if forthcoming) could be effective, we suggest that it is much more likely that future pre-pack sales to connected parties will adopt the evaluator’s report route.
The obligation to select an independent evaluator falls on the connected person themselves and in order to meet the requirements of being ‘independent’, the evaluator must not be connected in any way with the prospective administrator, the connected person or the insolvent company itself. To qualify as independent, the evaluator must not have provided insolvency or restructuring advice to the company at any time in the 12 months preceding the report.
However, to meet the requirements an evaluator does not have to possess any specific qualifications – nor will there be an independent regulatory body governing these evaluators. They simply need to have the requisite knowledge or experience to make such a report, hold professional indemnity insurance covering them acting in their capacity as an evaluator and the administrator must believe that the evaluator has sufficient knowledge and experience to provide the report.
If the evaluator has produced their report and provides an opinion that does not recommend the particular disposal, the purchaser can keep obtaining evaluator reports until they find one which is favourable (although they are supposed to then disclose the unfavourable one(s) as well). Moreover, an administrator can still choose to proceed with the sale notwithstanding an adverse report, but they must then provide a statement setting out their reasons for doing so and the reports must in any event be filed (redacted for any commercially sensitive information) at Companies House.
Commentary on these changes
We have reservations about the effectiveness of the Pre-Pack Regulations. In practice we doubt very much that the creditor approval route will be used much, if at all. If a sale is urgent enough to require a pre-pack, the luxury of the administrators taking appointment, circulating their full proposals on day one and instigating a decision procedure to take effect 14 days later is probably nil.
Whilst the requirement for indemnity insurance should weed out any non-professional applicants, the absence of a qualification requirement for evaluators is arguably a missed opportunity to bolster public confidence in the process by affording some sort of kite mark, such as might perhaps have been achieved by insisting that evaluators be drawn only from the Pre-Pack Pool. The reality is that the vast majority of evaluators will, as a result, be insolvency practitioners and/or qualified chattel agents who are already well established in the insolvency industry. As such, the sort of suspicious mind willing to conclude that the administrator’s own regulators are an insufficient guarantee for their rights will readily conclude that these evaluators are mere puppets of a broken system, doing favours for one another’s firms to satisfy the requirements in a formulaic way, which is not in the best interests of creditors.
Part of our concern also relates to the obligation the Regulations impose on the connected person themselves – rather than the prospective administrator – to select the independent evaluator. Arguably, placing this burden on the connected person (who is in effect the buyer and therefore has a vested interest in the outcome) will reinforce creditor suspicions and create a practical disconnect and risk of miscommunication because it is the administrators, not necessarily the buyer, who will know what they will be looking for to justify their decision. In practice, we suspect the connected person’s selection of the independent valuer will be primarily through a professional recommendation and/or introduction made by the prospective administrator in any event.
We are also aware that there are some inconsistencies between the Pre-Pack Regulations and Statement of Insolvency Practice 16 (SIP 16) which was also amended when the Regulations came into effect. For example, SIP 16 uses the broader term ‘connected party’ rather than ‘connected person’ which arguably imposes a greater regulatory burden than the law, requiring the prospective administrator to make more extensive enquiries into the buyer. This further undermines the clarity of the new regulations – the main purpose of their introduction.
In summary, given the Pre-Pack Regulations were ostensibly introduced to provide clarity and certainty, we suspect they have rather missed their mark. The transparency offered by the requirement for there to be an evaluator report at all, and for this report to be published is undoubtedly a change, an increased burden, but the trade-off in terms of improved public confidence is far from guaranteed given that the Regulations are largely devoid of teeth or substance. Creditors were already well protected, and yet most are completely disengaged from the process of administration, and we doubt very much whether the production of these reports is going to improve this. In the circumstances, therefore, this rather feels to us as if it was regulation for regulation’s sake, enacted because the government felt it needed to be seen to be doing something, in much the same way as they legislated last year for the suspension of wrongful trading liabilities without suspending the corresponding liability for breach of duty. In so far as there was a genuine need for this change at all (which, frankly, we doubt) – to tackle an adverse public perception – we do not think the Regulations themselves will achieve that.
If that is right, then the Regulations may ultimately prove counterproductive. What they will definitely do is delay a potential sale by at least 48 hours whilst the report is obtained, increasing the costs of sale, and of the administration generally (including insurance costs) and potentially threatening a viable post-administration sale – which of course is time sensitive at the point it is negotiated (although arguably is technically not, in the true sense of the phrase, a pre-pack at all!). We may therefore see fewer administration sales to connected parties and/or connected parties being effectively excluded from the bidding process, thus suppressing what arm’s length bidders may be prepared to pay. This in turn may lead to fewer administrations generally and an increase in creditors’ voluntary liquidations, where the underlying value of the business to creditors, and jobs, are more likely to be lost, and where directors have the increased burden of s.216 Insolvency Act 1986 in terms of being able to trade under a similar trading style.
Similarly to the Pre-Pack Regulations, the new Breathing Space Regulations introduce a third-party role to a process, this time in relation to personal insolvency. The Breathing Space Regulations – which we reported on when the new legislation was first scheduled in December 2020 – enshrine the role of a debt advisor to assist individual debtors in managing their debts during a debtor’s ‘breathing space’.
With many individuals struggling with debt problems worsened by the impact of the ongoing pandemic, the stated aim is that the Breathing Space Regulations will assist individual debtors by providing them with a 60-day respite period to secure the professional help they need to rehabilitate their finances.
What is a breathing space?
The Breathing Space Regulations introduce two types of ‘breathing space’:
- The standard breathing space is available to any individual with problem debt and provides the debtor with legal protections from creditor action for up to 60 days. This includes pausing enforcement action, contact from creditors (e.g. letters requesting payment) and a freeze on interest and charges on most of their debts (debts such as secured debts or hire purchase liabilities are excluded).
- A mental health crisis breathing space offers the same legal protections as the standard breathing space but is only available to individuals who are receiving mental health crisis treatment which will need to be certified by an approved medical professional. The respite for these debtors is intended to be longer, lasting for the duration of the debtor’s mental health crisis treatment plus an additional 30 days after their treatment has ended (regardless of how long the debtor’s treatment lasts).
Individuals can access the breathing space scheme through a debt advisor regulated by the Financial Conduct Authority, who will manage the debtor’s breathing space and be the point of contact for the debtor, their creditors (and appointed agents), and the Insolvency Service. For more information on breathing spaces as they apply to creditors, see the government’s Debt Respite Scheme (Breathing Space) guidance for creditors.
Commentary on this initiative
Support for people in times of financial struggle, with an added focus on individuals with mental health issues following the disruption of the past 15 months or more, is undoubtedly welcome.
However, this is a step which was necessary in any event and for which many of us have been agitating over a period of years, so it should not be regarded as a government initiative in response to the pandemic. Nor is the breathing space a solution to debt problems in and of itself. If is, rather, a form of financial triage, which can help to stabilise the position so that all remedies may be considered.
What is important now is that the availability of breathing space moratoria is communicated effectively to the public at large and, crucially, to the finance industry and other creditors, whose duty it clearly is now to signpost the availability of such resources. Typically, it will be in a creditor’s interests in any event to ensure that any debtor is properly advised, since there is a good chance that this will ultimately save the creditor money in terms of enforcement costs, perhaps facilitating an instalment agreement or full and final settlement within a reasonable timescale, or flagging up insolvency and/or mental health issues before the creditor becomes involved in lengthy and unedifying litigation.
Those in debt perhaps for the first time as a result of the pandemic need to learn to steer clear of misleading advertisements online, and instead towards reputable insolvency practitioners and/or debt charities such as Step Change. Whilst a breathing space may be suitable for many, it will only offer a temporary respite in the face of pressing creditors, and it may be that other options such as a debt relief order, formal bankruptcy or an individual voluntary arrangement can be accessed just as readily, and offer a more lasting solution. There is no need to enter into a breathing space first, although it should be noted that on 29 June 2021, to coincide with the expiry of the first 60 days under the breathing space scheme, the debt relief order financial limit will be increased so that these will be available for people with debts up to £30,000 where they satisfy the other qualifying criteria.
Reflecting on all available options and seeking early advice, preferably before creditors are beating a path to the door, before deciding on next steps is crucial in order to avoid unnecessary costs later down the line. There is clearly a role for confidential legal advice here, too, since the viability of bankruptcy or IVAs is often dependent on the status of a debtor’s property interests or contractual arrangements, and upon any transactions which have taken place in the run up to the debt scenario. Insolvency practitioners and debt charities provide a wonderful service and support to help people in debt, but they are not qualitied to give legal advice or to identify all legal obstacles to a given course. If in doubt, a debtor would therefore do well to flag any doubts they have as to the application of the law to their situation, so that they can be referred for appropriate legal advice or input.
Remote Covid Hearings and Our Experiences
Continuing the theme of third party agents becoming involved in insolvency scenarios, we could not finish this blog without mention of a recent High Court misfeasance case involving the administration, and subsequent compulsory liquidation, of One Blackfriars Ltd (March 2021), and relating this to our own experiences of the courts under lockdown.
The administrators in this case were ultimately cleared of wrongdoing in relation to their involvement (or rather, limited involvement) in the process to value the company’s development site before its sale, and it was found that they were entitled to instruct and rely on the advice of the third-party valuer rather than take a more “hands on” approach to the valuation themselves.
Of at least equal interest to the outcome itself is the fact that this 5-week trial took place entirely by remote video link. The court subsequently reported that the trial was procedurally a great success, citing advantages such as the ability to show the trial bundle on screen to everyone in attendance, and the Deputy Judge remarking that he actually had greater visibility of the witnesses when testifying than in a physical courtroom, which compensated more than adequately for the loss of an overall sense of a witness’ physical demeanour and mannerisms during the proceedings. The trial also enabled public access via a livestream which attracted a number of viewers with an average of 60 people per day following the trial’s progress, perhaps suggesting that public opinion and perception in insolvency proceedings is an ever-growing consideration in pursuing litigation rather than simply the merits of the claim.
Our Corporate Restructuring & Insolvency Team has recent contested party experience in representing cases in court via remote video conferencing. This first-hand exposure has highlighted for us the benefits of adopting innovative methods to ensure hearings and trials alike proceed efficiently. We will continue to monitor developments closely, and in particular whether physical court appearances will resume in earnest once lockdown restrictions are lifted, but our view is that the courts should continue with remote hearings by default, even after the large backlog of cases has been cleared. Clearly there will be cases, particularly involving litigants in person, where the solemnity of an in person trial would be beneficial and/or where remote hearings might produce an injustice in some way, but for the vast majority of cases involving insolvency practitioners, directors and officers who in principle understand their legal duties, there would seem to be little justification for turning back the clock.
If this is the way the courts ultimately go, then taking a leaf from the popularity of the Blackfriars case it may be that IPs and other witnesses in insolvency cases will have to prepare for the possibility of a much wider audience than would have been the case had they appeared in person. Most trials do take place in public, but ordinarily a casual observer is put off by the prospect of having to travel to court and wait around and/or not being able to follow matters because they do not have a personal copy of the bundle. The development of online justice could of course present a cost-effective opportunity for would be litigants to hear what evidence is put in open court in another proceeding (such as a disqualification trial), and it will be interesting to see if it results in more cases settling before trial.
As we said at the outset, we offer a cautious welcome to the incoming Regulations and developments with the courts. We hope our cynicism about the scope of the new Pre-Pack Regulations proves to be ill-founded and that – no doubt after some of the regulatory glitches have been ironed out – insolvency practitioners, buyers and their legal and agent teams embrace the new procedures with open arms. There is of course room for optimism when we consider that IPs have adapted incredibly well to all manner of legislative changes over recent years already. Fighting the perception that connected party pre-packs offend our common morality will be a more difficult task, but hopefully creditors and the business media will learn from the pandemic and accept the fact that many businesses fail notwithstanding their management taking every conceivable precaution to prevent losses to creditors, so they really ought to get behind any reasonable scheme which delivers the best possible return.
Likewise, we hope to see debtors and creditors making full use of the breathing space moratoria and that this improves access to personal insolvency procedures more generally, but also that litigants make the best of the opportunities presented by innovation in the courts.
It is only through good sense and collaboration between stakeholders in insolvency that we are able to keep the value flowing around the economy when it is most needed, as will certainly be the case over the coming months.
Should you wish to discuss any insolvency issue (whether or not raised in this blog), please do get in touch with Mike Pavitt, Chris Parsons, or any other member of our Corporate Restructuring & Insolvency team and we will be delighted to help.