Controlling the pre-pack

The ‘managerial’ solution: a matter of expertise

One strand of thought sees the pre-pack as giving rise to a set of challenges that can at least partially be seen in managerial terms.61 Thus, it might be said that potential difficulties of holdouts and legal challenges can be dealt with by taking active steps to negotiate pre-packs in a manner that persuades potentially dissatisfied parties to accept that their interests could not be better protected. The key to success lies in expertise: in astute management of the proposed arrangement and the involved parties. This might entail the concluding of deals in which equity stakes are given in return for co-operation. As has been argued:

The risks of nuisance reaction around valuation and value break can be reduced, if necessary, by offering ‘out of the money’ stakeholders a minority participation in the restructured entity. But there are often technical hurdles here, particularly given the limitations on the extent of cram down in the UK … In the end, the ability to approach and effect a pre-pack confidently turns on the quality of the steps and debate that occur during the live side process.62

Ellis has argued that: ‘What we need is [for] responsible IPs to be bold, to have the courage of their convictions and to state publicly and transparently why the business was sold through a pre-pack without advertising or market testing.’63 In order to encourage such transparency, Ellis has advocated not regulation but a simple requirement for IPs to explain publicly how the return to creditors was optimised.

Such explanations will deal with the reasons why particular approaches were taken on such matters as marketing the proposed arrangement. What is clear is that a considerable amount of judgement is involved in, for example, balancing the need to market a sale properly and the need to limit disclosure in order to prevent losses of reputations, business positions and consumer confidence. As one experienced practitioner has stated: ‘Open marketing is about identifying the market and making it aware of the opportunities – it is not about exposing the proposal to the whole world.’64 In the well-managed pre-pack the IP

61See Harris, ‘Decision to Pre-pack’, p. 27; Ellis, ‘Thin Line in the Sand’.

62Harris, ‘Decision to Pre-pack’, p. 27. 63 Ellis, ‘Thin Line in the Sand’.

64Cranston, ‘Pre-packaged Business Disposals’.

task and puts a high premium on arriving at the ‘right’ judgement. As one practitioner has put it: ‘A pre-pack must “feel right” and IPs must be careful. It is not just about getting an agent’s valuation – you need to carefully assess all the options available and balance the interests of secured creditors with other stakeholders. This can often come down to experience and a gut feeling of what is right.’66

A director in corporate restructuring from a ‘Big Four’ firm has similarly emphasised the issue of ethical judgement: ‘For office holders, lenders and other stakeholders there are equally important ethical and reputational matters to assess. Fundamentally, the decision to pre-pack – to adjust the rights of stakeholders against their will or without reference to them – must “feel right” in all circumstances and must be conducted with a sense of fair play.’67

For IPs the relevant code of ethics is the BERR ‘Guidance to Professional Conduct and Ethics for Persons Authorised by the Secretary of State as Insolvency Practitioners’. This has relevance on such matters as the duty to ‘strive for objectivity in all professional judgements’ and relates to such questions as whether an IP who has been involved in negotiating a pre-pack has a ‘material professional relationship’ (with, for example, the company’s directors) that prejudices their objectivity.68 What is clear is that the pre-pack process raises highly acute issues regarding objectivity and conflicts of interest. As Walton argues: ‘Insolvency Practitioners who operate pre-packs have seemingly insuperable conflict of [interest] duty problems.’69

The regulatory answer

Commentators who are concerned about the above modes of controlling pre-packs are liable to assert that regulation of the administrator (and the pre-pack process) is needed if the more vulnerable creditor interests are to be protected. Thus Jon Moulton, the managing partner of Alchemy Partners, has argued: ‘This whole area of pre-packs needs regulation

66J. Godefroy, ‘A Mixed Bag’ (2005) MCR/Upside (Winter) 11.

67Harris, ‘Decision to Pre-pack’, p. 27.

68In this situation, argues Walton: ‘The administrator’s objectivity would appear to be impaired by a potential and actual conflict of duties.’ See Walton, ‘Trick or Treat?’, p. 117 and passim for a discussion of conflicts of interest and duty in pre-packs.

69Ibid., p. 120.

(I generally despise regulation!) or the image of the profession will suffer deservedly from the very dubious actions of a few BMW owners.’70

Moulton has suggested that pre-packs might be controlled from beyond the profession by requiring them to be blessed by a judge before they are implemented. At the least, he argues, practitioners who use them extensively should be scrutinised closely by their professional bodies. The head of regulation at the Insolvency Service has also expressed some concerns.71 Mike Chapman has argued that regulators need to be alert to the advent of pre-packs and should adapt their monitoring procedures so that action can be taken on the abuses that organising administrators may be party to before taking up appointments as office holders.72 Similarly it has been contended by insolvency consultants Wilson Pitts that scrutiny of pre-packs is a matter of professional regulation so that: ‘It is the responsibility of the insolvency profession’s authorising bodies to root out early sales where creditors are dissatisfied as to how those sales have been conducted whilst supporting well orientated pre-pack sales which can be shown to be in the general interest of all creditors.’73 R3 has now issued guidance on pre-packs but some commentators have argued for rigorous complaints mechanisms to control ‘the professional bad apples’.74

A further possibility is to extend statutory controls so that these cover the solicitation of approvals for pre-packs.75 In the USA, it is to be noted, a network of legal rules governs such solicitations in the period

70Moulton, ‘Uncomfortable Edge of Propriety’, p. 3 – whose example of an unethical organiser of pre-packs has him driving a ‘very nice BMW’.

71M. Chapman, ‘The Insolvency Service’s View of Regulation’ (2005) Recovery (Winter) 24. In 2008 the Chief Executive of the Insolvency Service, Stephen Speed, emphasised that IPs need to think ‘very carefully in the pre-administration stage about the relationship they have with the company and how transparent what they are doing is to the creditors’: see (2008) Recovery (Autumn) 59.

72See also Flynn, ‘Pre-pack Administrations’, who discusses the Statement of Insolvency Practice (SIP) 13 obligations on IPs not to assist clients in conduct that will ‘undermine public confidence in insolvency procedures or assist directors in any conduct which amounts to misfeasance’ (see SIP 13 paras. 4.1.1–2).

73Wilson Pitts, ‘Pre-packs: Fast Track or Fast Buck’, Insolvency News, www.wilson-pitts.co. uk/news.

74In January 2009 the R3’s Statement of Insolvency Practice 16 – Pre-Packaged Sales in Administrations took effect. This guidance note was approved by the RPBs and covers disclosures and processes relevant to pre-packs. See also Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’; Flynn, ‘Pre-pack Administrations’.

75Walton, ‘Trick or Treat?’, p. 120 argues that some provision for creditors to vote (perhaps by post) on a pre-pack deal prior to appointment of the administrator ‘may be the answer’.

before the commencement of a Chapter 11 case.76 Thus, the Bankruptcy Code, section 1126(b) states that a party is deemed to have accepted or rejected a plan in the pre-Chapter 11 period if the relevant solicitation was in compliance with the applicable non-bankruptcy rule or regulation, or, if there is no such relevant rule or regulation, the solicitation followed disclosure of ‘adequate information’ as defined in section 1125 of the Code. In addition, rules 3017 and 3018 of the Federal Rules of Bankruptcy Procedure require, inter alia, that plans and disclosure statements be distributed to all affected creditors and equity interest holders; that plans be sent to beneficial owners of securities; and that solicitation periods be reasonable. Securities laws in the USA will, moreover, treat pre-pack solicitations as ‘sales’ of securities and liable to regulation unless the nature of the steps being taken comes within an exemption as set out in the terms of the Bankruptcy Code or the securities laws (e.g. on the grounds that the offering is not ‘public’). Where the Bankruptcy Code applies to a pre-pack, dissatisfied parties may file objections within the time limits indicated in the bankruptcy court’s ‘scheduling order’.77 In the UK Stephen Davies QC has argued that it should be mandatory for advisers to file a statement at court (or possibly with the Registrar of Companies) giving details of the pre-pack, including: the date of first instruction; the reasons for the pre-pack; the period of marketing; all valuations received; the terms of sale; and the total fees by the adviser’s firm and the source of those fees.78 Desmond Flynn, Agency chief executive of the Insolvency Service, has furthermore suggested that it might be provided that administrators should only be allowed to take expenses incurred prior to formal appointment once these have been expressly authorised by the creditors within the administration proceedings. This proposal is designed to ensure not only transparency but also more effective creditor scrutiny of the administrator’s actions.79

76See Vilaplana, ‘Pre-pack Bankruptcy Primer’, pp. 35–42. The BAPCPA 2005 amends s. 1125 of the Bankruptcy Code to the effect that, notwithstanding the prohibition on post- (bankruptcy filing) petition solicitation of pre-packaged plan votes in the absence of a court-approved disclosure statement, votes may be solicited if the preand post-petition solicitation complies with applicable non-bankruptcy law (i.e. securities laws): see Kornberg, ‘Bankruptcy Abuse Prevention and Consumer Protection Act’, p. 35.

77Kornberg, ‘Bankruptcy Abuse Prevention and Consumer Protection Act’, p. 35.

78Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’, p. 18.

79Flynn, ‘Pre-pack Administrations’, p. 3. In 2007 the IS carried out a consultation exercise on draft amendments to the Insolvency Rules 1986 which would allow pre-pack administrators to claim the costs of their pre-appointment work as an administration expense subject to the approval of the creditors of the company: see further P. Walton, ‘Pre-

appointment A dminis tr ation Fees – Papering Over the C rack in Pre-packs? ’ ( 2

Insolvency Intelligence 72.