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Insolvency Law

Expert guidance on all aspects of corporate and personal insolvency

13 MAR 2013

Pre-packs Independent Review and Hansard Comment

The Insolvency Service have announced an independent review of pre-packs following some discussion of the issue in the House of Lords. See the Insolvency Service statement here. It will be interesting to see who is commissioned to undertake the review. My money is on Dr Frisby following her recent cite in the BIS House of Commons report and her long history of empirical work in the area.

Here is there salient bit from Hansard:

"Lord Mitchell (Labour)

My Lords, I speak to Amendment 84AHNZA, which calls for the Government to commission an independent review into pre-pack administrations. Noble Lords will see that this amendment represents the recommendations of the BIS Select Committee report to the Insolvency Service, released on 29 January this year.

It might be helpful if I attempt to define a pre-pack administration. I find many people do not know what it is, and I am not surprised. It is where the directors of a failing company seek to preserve its continuing existence after administration by lining up replacement owners and finance before the administration takes place-in effect, relaunching the company with many of its creditors and minority shareholders stripped out, while effectively continuing the existing business in another name. It gives the business a second chance, but often at the expense of these creditors and shareholders. My contention is that it is often unprincipled and unfair. Usually, there is no creditors meeting and no consultation with the court before this takes place. The sale may be to individuals who were directors of the firm before the pre-pack administration, and the new firm may have a similar name. As I say, the only difference is that the new company is shorn of its debt and maybe its smaller shareholders. Effectively, it is cooking the books. Such firms have sometimes been known as phoenix companies, having risen from the ashes of the old insolvent company.

My interest in pre-packs arose when a company in which I had a minority shareholding interest wanted to restructure its financing to my detriment. To do this, it needed me to sign off on a revised deal. I refused. It threatened me with a pre-pack, a term that I had not heard of before, but about which I learned pretty quickly. I still refused and, fortunately, it backed down. However, I saw how that could be used as a negotiating tactic. More to the point, I saw how the small people can get hurt. Despite that, I am prepared to concede that pre-packs can have a very important function. They can allow a company to continue and the administrator to move quickly to preserve the business and, most importantly, jobs. That is what all of us want.

A few weeks ago, I went to see the BIS Minister responsible for this issue, Jo Swinson MP. I cannot say that it was a particularly helpful meeting. Her approach was that pre-packs are good because they preserve jobs and the company. My view is that they can be bad when creditors such as SMEs are cast adrift and where employees are similarly left in the lurch in a very much weaker position. We beg to differ.

I believe that the time has come to have a comprehensive and independent review into that practice to see where improvements can be made and safeguards can be added. My purpose in introducing the amendment is to oblige the Secretary of State to look seriously at how those abuses can be addressed. They tell me that this is a hugely complex area and that it will be hard to draw up appropriate legislation. Indeed, the Government have tried and failed in this Parliament. My response is, "Since when did we turn our backs on something just because it is too hard?". That should make us more determined.

I recognise the complexities, and I do not introduce the amendment today claiming to know all the answers. Let me outline some of the areas that need to be addressed. The first is consistent with what I have been arguing with regard to levels of remuneration in a company: the need for transparency. To cite the Association of British Insurers in its evidence to the BIS Select Committee in December 2011:

"We think that the heart of the problem lies in the serious conflict of interest inherent in an insolvency practitioner devising a pre-pack sale in secret in conjunction with the directors and secured lenders of a failing company, and then immediately implementing that transaction as administrator with a duty to act in the best interests of all creditors".

The question that many small businesses find themselves asking after a pre-pack insolvency is: to whose benefit is this insolvency? They find that the answer is: those who drew up the insolvency plan and called in the administrator. It is there that the problem lies. When parties connected to the old company are involved in the new company, that compounds the frustration felt by unsecured creditors. The percentage of pre-packs which are sold to connected parties is higher than for business sale administrations.

There have also been some egregious abuses. My honourable friend Luciana Berger MP tabled a Private Member's Bill in the other place to amend the Health and Safety Acts to prevent companies avoiding fines by being in administration. A construction worker, Mr Mark Thornton, had been killed by a steel column on a building site in my honourable friend's constituency. A judge said that he was unable to award a £300,000 fine because the company was in administration. The company responsible was later bought out by its directors in a pre-pack deal and continues to trade. That shows at the extreme level the potential for abuse of pre-packs by connected parties. I am proud that the Labour Party has committed to fixing the health and safety loophole that allowed that and other such cases to happen.

I acknowledge that there are strong arguments for pre-packs. To my mind, the strongest of those is the rate of job preservation. Figures from one study suggest that pre-packs preserve the entire workforce 92% of the time, as opposed to 65% of the time in other administrations. So clearly, they are not a bad thing. However, a few factors need to be considered alongside that. Pre-packs have a higher rate of failure than companies restructured in other ways. Another is that those jobs could continue in other companies. Also, the effect on jobs in small companies needs to be considered, as they could be vulnerable to losing out on large payments owed when a company goes into administration. By way of example, the Federation of Small Businesses has told me about a publishing company in London which had to lose a member of staff after it was not paid £100,000 owed to them by a company that went into pre-pack administration.

What possible solutions could the review consider? I know, for a start, that the Government are currently looking to strengthen and clarify the guidelines under SIP 16, which is the Insolvency Service guideline. I welcome that. However, what other safeguards could a review consider in detail? One that has been considered is that when an administrator has been advising a company about a pre-pack administration, before that pre-pack could be sold, an independent administrator would have to inspect the deal. It is true that that would add to the cost of the administration, but it would reassure creditors and remove what some argue is one of the clearest potential conflict of interest when pre-packs are put together: that of the administrator brought in by the management to organise a pre-pack insolvency.

That potential conflict of interest was recognised in 2010 by the judge in the case of Johnson Machine Tool Company Limited, when the court did not allow the administrator to charge his fees for pre-administration work on the pre-pack as an administration expense. That was because the people gaining from the work were not the management or the creditors-exactly what the critics of pre-packs argue.

Clearly, this is a difficult question, not least because there is no set definition of pre-pack in law. That very fact is a sign that some of its abuses were not envisaged by policymakers in the past and that we need a review to see whether improvements can be made and safeguards added. I beg to move."

Viscount Younger Replied:

"Viscount Younger of Leckie (Conservative)

Noble Lords will be aware that the administration procedure is the primary mechanism for effecting business rescues. It is important to recognise that the objective of administration, if the rescue of the company is not feasible, is to provide the best return for creditors. A pre-pack sale is merely a means of achieving that outcome and should therefore always be in the interests of creditors. I am most grateful to the noble Lord, Lord Mitchell, for his helpful description of pre-packs for the benefit of the House.

As the noble Lord said, pre-packs can be an effective way to the best outcome for creditors, enabling businesses to be rescued and preserving jobs, but we recognise that there can be scope for abuse. That scope is greatest where pre-pack sales are to connected parties, such as the directors or their families. Again, I am grateful for the anecdotal evidence given tonight by the noble Lord, Lord Mitchell. That is when most concerns are expressed, and it is vital that everyone involved has confidence that such sales are at fair value. We have been listening carefully to concerns expressed about the use of pre-packs, and Ministers have met with stakeholders to discuss the issue. I am aware that, as the noble Lord, Lord Mitchell, mentioned this evening, he recently met with the Minister for Employment Relations and Business Affairs, Jo Swinson, to discuss the issue. We have also invited those who have complained about the procedure to provide evidence of abuse, so that that can also be pursued.

I reassure noble Lords that work is already under way to improve the transparency about pre-pack sales. There is a statement of insolvency practice, SIP 16, setting out the information that has to be provided to creditors by insolvency practitioners. That is being strengthened to ensure that more information will be disclosed and that creditors will receive that information at an earlier stage. Insolvency practitioners will also have to confirm that a pre-pack sale is in the best interests of creditors. That should provide greater confidence that the pre-pack sale is justified. The Insolvency Service is proactively monitoring information disclosed under SIP 16 reports to establish whether there has been any abuse. Where there is evidence to suggest abuse, it is reported to be relevant regulatory body for action to be taken. Such action can include fines, sanctions and, ultimately, loss of the insolvency practitioner's licence. The Insolvency Service will report on its findings in this regard.

We therefore already have measures in place to protect against abuse, and continue to monitor the pre-pack process to ensure that it is being used appropriately. However, I share many of the concerns raised by the noble Lord, Lord Mitchell, which I know have been expressed on other occasions in both this House and the other place.

I agree that an independent review into the issue would be beneficial. For that reason, I confirm that we will commission an independent review into pre-pack sales in late spring, once the strengthened SIP 16 is in place and after the Insolvency Service has reported on the findings from its monitoring.

On the review issue surrounding continuation of supply to insolvent businesses, this is now the subject of a Government amendment being debated shortly. We propose to consult on the issue prior to implementing reforms and I am satisfied that this will address the concerns in this area. In view of this assurance to commission an independent review into pre-pack sales, I hope that the noble Lord will agree that it would be unnecessary to introduce a statutory requirement to do so, and will therefore withdraw his amendment. I conclude by thanking the noble Lord, Lord Mitchell, for raising this important issue."

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