Pre-pack sales in administration
The term “pre-pack” is used, in the context of administration, to describe the process through which a company is put into administration and its business and/or assets immediately sold by the administrator in a sale that was arranged before the administrator was appointed. The process can be contentious where a company’s assets are sold to a new vehicle formed by the company’s former management, particularly where there is a lack of transparency around the sale and questions around whether proper market value has been obtained.
In order to address such concerns, professional guidelines have been adopted by the regulators of insolvency practitioners, requiring them to adhere to key standards around the marketing and transparency of such deals (Statement of Insolvency Practice (SIP) 16). The standards also highlight the need for insolvency practitioners appointed in contemplation of a pre-pack to be clear that the former directors’ interests are separate from those of the company and its creditors.
Lead up to the VE pre-pack
VE Interactive was a tech start-up company that developed software, including website pop-up windows and email alerts designed to boost sales. It was a rare British “unicorn” – a start-up valued at more than $1 billion. The company won a string of awards and was named as one of the most promising young British businesses by a government backed organisation called Tech City.
However despite the plaudits and high valuation the business was making heavy losses and in March 2017 the chief executive and founder was forced out and management of the business was taken over by a consortium called Treyew. The new management, having failed to turn around the company’s business, sought insolvency advice and then appointed insolvency practitioners (IPs) to advise on and effect a pre-pack sale of VE Interactive’s business and assets.
A week after the IPs’ retainer, and a week before the self-imposed deadline for a pre-pack sale, only one external purchaser had been identified. The IPs had evidently found it hard to obtain financial information from the directors and it was unclear what assets were owned by the company and therefore there was insufficient information available for any would be third party purchaser. A day before the deadline for the sale, the IPs were appointed administrators of VE Interactive by the court. The administrators did not disclose to the court the problems that they had had in obtaining sufficient information from the company’s directors to enable a sale on an arm’s length basis. The administrators then proceeded to sell VE Interactive’s business and assets to the new company owned by the directors the day after their appointment for the sum of £2 million and in the process leave behind £50 million of debts.
The removal proceedings
Various creditors of VE Interactive subsequently brought proceedings seeking the removal of the administrators from office. The grounds for this were that the administrators had a conflict of interest that prevented them from investigating firstly whether the pre-pack sale had been at below market value and secondly whether VE Interactive’s directors and the administrators had breached their duties to creditors in effecting the sale. The claimant creditors’ barrister told the court that the administrators were “completely blind” to the potential for conflicts of interest when selling a failing business to its own directors. He went on to say that the administrators had mishandled the sales process by leaving it until one day before the bid deadline before contacting potential bidders even though the administrators had been hired some 11 days earlier.
The administrators contested this application for the first five days of a six-day hearing. At the end of the fifth day they provided the court with a letter of intention to resign, drafted to be effective eight days later. On the sixth day of the hearing the administrators also offered the following concessions:
- They should pay the costs of the proceedings on an indemnity basis.
- They would bear their own legal costs and not seek reimbursement from VE Interactive’s assets.
- They would not apply for their own discharge from liability as exiting administrators.
- They would hand over the affairs of the administration to the proposed replacement administrators the next day.
In return the administrators asked the court to effectively end the proceedings immediately (without making a decision as to whether to remove them). They asked the court to shorten (abridge) the five days’ notice of resignation that administrators normally have to provide to creditors.
The court refused the abridgement of time application. Furthermore it refused to terminate the proceedings without deciding whether or not to remove the administrators and went on to order the removal of the administrators from office with immediate effect despite their pending resignation. The court made it clear that the grounds for the administrators’ removal was in the interest of VE Interactive’s creditors and shareholders. It was also in the public interest to be confident in the statutory insolvency regime (as enforced by the court in this instance).
The court did not make a substantive finding on whether the underlying pre-pack sale was made at below market value or whether there were related breaches of duty by the directors and the IPs. However, the potential compromise of the administrators’ objectivity was a serious issue for investigation, which justified removal. This was all the more so as the administrators’ own role should be to objectively investigate whether the pre-pack sale gave rise to potential claims by VE Interactive.
The court made the following substantive findings on the existence of a conflict of interest and the shortcomings in the decisions made by the administrators before and after their appointment:
- The administrators should have concluded from the day of their appointment as administrators that, due to their pre-administration retainer to advise on the pre-pack, they had a conflict of interest that prevented them from effectively investigating whether the circumstances of the pre-pack gave rise to a claim by VE Interactive.
- The administrators’ proper role was to work with VE Interactive’s undisputed creditors and shareholders to identify claims that were realisable assets for VE Interactive. This included assessing whether there were claims against the IPs before they were appointed as administrators. There was no reason for the administrators not to pursue these, other than a conflict of interest. The eventual resignation of the administrators shows they accepted this.
- Given that the existence of a conflict of interest was readily apparent once the administrators were appointed, the administrators should not have opposed the application for their removal other than to suggest solutions such as the appointment of additional independent administrators to investigate the pre-pack. The administrators should have expressly raised the problem of conflict with the creditors’ committee, and sought directions from the court if necessary.
- The administrators had lost perspective of what their proper role was. They had been primarily concerned to defend the creditors’ claim against their firm, not with the interests of the company over which they were appointed. Their letter of resignation suggested that the court hearing had led to a perception that they had a conflict of interest: the administrators did not accept the extent of their conflict that existed from the start of the administration. There was no reason why the creditors should have any confidence in the administrators.
- Even the eventual decision by the administrators to resign was not necessarily in the interests of VE Interactive, as this prevented the court from considering whether one or other of the administrators should remain in office to deal with ongoing contentious matters, working with the new administrators.
- Finally, the administrators should not be able to recover their remuneration, costs and expenses whilst in office and should bear their own costs of their resignation.
Critics of the practice of pre-packs will believe they have many of their views confirmed by this case. Whether this is true is open to question. The case is fact specific and involves a scenario that the court could easily conclude required further investigation. The court made it clear that it was not giving a decision on the merits of the pre-pack or a detailed analysis of the conduct of the administrators in effecting it. However, the court had a clear view that where a firm of IPs is retained by the management of a company before an administration to advise on insolvency options and the management then pursue the option of buying the company’s business and/or assets in circumstances which require further investigation, the administrators who are appointed to effect the sale will be unavoidably conflicted (where they are employees of the same IP firm) from the date of their appointment because they are “inextricably bound up in the process by reason of their [firm’s] contractual retainer” and will therefore need to put other measures in place such as appointing an independent administrator.