Pre-packaged administration sales have aroused the interest, opprobrium and ire of many a politician and the press in recent times. It was only a couple of months ago that Jamie Oliver's upmarket Barbecoa steakhouses went into administration and the flagship branch at St Paul's in London was bought back by the celebrity chef by way of a pre-pack arrangement.
So what is a pre-pack? It is a term used, in the context of administration, to describe the process through which a company is put into administration and its business or assets (or both) immediately sold by the administrator under a sale that was arranged before the administrator was appointed. That sale is usually to a new company (“newco”) leaving the “old” company’s creditors behind with claims against an empty shell. Contrast this with a “standard” administration when the company is handed over to the administrator who then will commence marketing of the business after his/her appointment.
Pre-packs are not a new restructuring strategy. But they can be (and often have been) controversial, especially where:
- the newco is formed by the company’s former management and it purchases the business and assets of the “old” company in the pre-pack sale and ends up operating the same business as “oldco”; and/or
- there is (or there is perceived to be) a lack of transparency around the marketing/sales process for the “old” company and whether a “proper” market value for that company has been obtained on sale in order to maximise recoveries for the benefit of all its creditors.
The courts have acknowledged that pre-packs are a legitimate restructuring tool, as well as confirming that administrators have the power to sell a company's business or assets without the prior approval of the court or creditors. That said, the courts are very alive to the potential for conflicts of interest in pre-pack situations (particularly where the two circumstances above may exist) as the recent High Court case, VE Vegas Investors IV LLC and others v Shinners and others  EWHC 186 (Ch) has illustrated.
In this briefing David Steinberg, Co-Head of Restructuring & Insolvency at Stevens & Bolton, summarises the facts of case, analyses the decision and offers some practical advice for companies, their directors and insolvency practitioners who might be in the Vegas situation.
Facts & decision
VE Interactive Limited (VE) – a former tech “unicorn” company – was in financial difficulty. New management, having tried to turn around the business to no avail, appointed Smith and Williamson (S&W) on a retainer to advise them on a pre-pack sale of VE’s business and assets.
S&W experienced difficulties in obtaining financial and other information from VE that they needed to market the company to potential purchasers. When that financial and other information was finally delivered it was “deficient” for an arm’s length purchaser. This left the company with one purchaser: Rowchester Limited (Rowchester), a company owned by the VE management team.
Partners in S&W were then appointed administrators of VE, but they did not disclose to the creditor committee the problems they had experienced pre-appointment in obtaining information from VE’s directors to facilitate a “third party” sale. The administrators then proceeded to sell the business and assets of VE to Rowchester the day after their appointment.
Various creditors of VE lodged a court application seeking to remove the S&W administrators from office on the basis of a conflict of interest which:
- prevented the administrators from investigating whether the pre-pack sale to Rowchester was made at an undervalue (Claim #1); and
- whether VE’s directors and the S&W administrators had breached their duties to creditors in completing the sale to Rowchester (Claim #2)
The court ordered the removal of the administrators from office (appointing partners from Deloitte as the replacement administrators), as the judge concluded that the S&W administrators’ objectivity had been potentially compromised and this was “a serious issue for investigation” which justified their removal.
In so removing them, the judge made it clear that he was not reaching any conclusion on the merits of Claim #1 and/or Claim #2 noted above, but he highlighted the following issues as reasons to justify the administrators’ removal from office:
- the S&W partners should have concluded that when they were appointed administrators they were, as a result of the pre-administration retainer, conflicted and unable to carry out an independent investigation into various matters, including:
- whether the directors of VE had put their own interests first at the expense of other sale/rescue options by intentionally or unintentionally delaying the provision of financial information to S&W which, in turn, intentionally or unintentionally excluded other parties from a competitive sales process
- whether the business had been marketed with proper due diligence
- generally whether or not the pre-pack gave rise to a claim by VE against the former directors and/or against S&W for breach of duty
- the clear existence of a conflict once appointed meant that the S&W administrators should not have opposed the application for their removal. They did not have an “adequate appreciation” of their conflict
- the administrators were more concerned with defending the claim against S&W and not the interests of VE and its creditors. They had “lost perspective of their role”
In reaching these conclusions the judge noted that, among other things, he had taken into account the administrators’ professional standing and reputation, the fact that a court should not remove an administrator simply because conduct has fallen short of the ideal (but in this case it had “gone further than that”) and that this was not a case where removal would encourage activist creditor applications or cause insolvency office holders to “have to look over their shoulders”.
“This a rather worrying precedent, since the court’s decision could be interpreted as implying that if a creditor merely asserts that the pre-pack was the wrong thing to do, it needs an independent administrator – who was not involved in the pre-planning for the administration – to be appointed to investigate the transaction. That will significantly increase the cost of the administration. It also begs the question of who will pay for that investigation, if the incumbent administrator and the other creditors believe the pre-pack was the right thing to do.
The cautious approach for practitioners, in light of this decision, is to advise management that they need to engage two different firms – one to assist the directors with the pre-administration preparation for the pre-pack (including any pre-admin marketing of the business) and another to take the appointment and to transact the pre-pack sale, especially if management pursue the option of buying the company’s business and/or assets. This is a significant step beyond current industry practice and existing pre-pack professional guidelines (i.e. Statement of Insolvency Practice 16 or “SIP 16” for short).
It also throws up practical difficulties. First, the additional cost of getting two firms up to speed on the company’s affairs. Secondly, the firm who are appointed as administrators still need to satisfy themselves that the pre-pack sale which has been lined up pre-appointment is the right transaction to do. That firm cannot simply defer to the judgement of the firm who advised the directors on the pre-appointment preparation work.
This decision will inevitably raise its ugly head every time a distressed company is contemplating entering into a pre-pack sale. It may also deter prospective purchasers, if they conclude that their acquisition is likely to be scrutinised by a different officeholder if even a minority of disaffected creditors (and there tend to be at least some of those in the context of a pre-pack – i.e. those whose liabilities were not assumed by the purchaser) cry foul after the event.”