Evaluating control strategies

and more protracted negotiations. Unlike the pre-pack, they involve the opening of new cans of worms. If this is the case, the pre-pack commits the administrator to a course of action that is agreed outside statutory procedures and it is extremely difficult for less powerful creditors to scrutinise the pre-pack and to renegotiate terms. The administrator’s duty to act in the interest of all creditors has been bypassed and it is no answer to this to say that the IP can take an unbiased view of the pre-pack to assess whether it serves all interests fairly – the IP will have to compare the pre-pack proposals with other realistic options but the latter will have been weakened by the development of the pre-pack. The playing field is already tilted in favour of the pre-packaged agreement.

If such concerns point to a need to control pre-packs, what potential is offered by managerial or professional ethics or regulatory strategies? The problem with managerial strategies is that the cost-effective management of a pre-packaged rescue is not necessarily the same thing as the fair management of the rescue. As noted above, the lowest-cost way to manage turnaround may involve a narrow focusing of consultations on major creditors and the construction of a deal that is offered to other stakeholders on what may be close to a take it or leave it basis. This may differ quite markedly from a procedure in which an administrator holds the ring to see that proposals are developed on the basis of inputs from all relevant creditors. Such dangers of unfairness militate in favour of tempering ‘pure’ managerial approaches with provisions on transparency as suggested by Katz and Mumford – who say that where a sale completes a pre-packed agreement, creditors should be provided with such documentation as would allow them to understand the rationale for the sale.83 Other disclosure proposals have not been slow to emerge. Desmond Flynn has made proposals regarding creditor approval of prepack expenses;84 Stephen Davies QC85 has argued for the filing in court of a pre-pack statement and Martin Ellis has suggested that IPs should, in law, have to make public an explanation of why and how the return to

83Katz and Mumford, Study of Administration Cases. As noted above, a new SIP on prepacks was promulgated in January 2009. The SIP is concerned with transparency, not commerciality, and seeks to set out minimum levels of information to be provided to creditors so that they are properly informed and can form a view as to whether the prepack was in their interests. See also R. Heis, ‘Pre-packs – A New SIP’ (2008) Recovery (Spring) 14.

84Flynn, ‘Pre-pack Administrations’.

85Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’.

creditors was optimised.86 Even when such transparency requirements are in operation, however, it may be protested that explaining why the fait accompli was the best available option for the IP does not remove the inevitable bias towards the pre-pack solution.

Using professional ethics to control pre-packs offers, on its face, considerable potential for encouraging fairness. The notion here is that professional IPs only construct pre-packs in a manner that satisfies reasonable expectations of fairness across all creditors. These expectations would be established within the framework of ethics promulgated by systems of selection, training and guidance within the profession.

The problems with this solution may be, firstly, those of adverse selection and incentives. A danger here is that the major creditors, the banks, would possess considerable incentives to use IPs with low ethical sensitivities and ‘more practical’ approaches to the pursuit of bankfriendly turnaround proposals. The market, accordingly, might punish ethical practitioners and reward those of a more ‘practical’ disposition. From this viewpoint there is little reassurance in the contention that reputational concerns will lead IPs to operate even-handedly and openly – the market may reward IPs with reputations for amenability to bank rather than broad creditor interests. A further difficulty with the ‘professional ethics’ solution is that many stakeholders, and the public more generally, may be disinclined to place trust in the ethical judgements of professionals. This is a general problem with self-regulatory systems87 but it is all the more acute a difficulty in circumstances where the relevant professionals have clear incentives to favour the interests of powerful players – as, for instance, when the IPs who act as administrators are seen to be dependent on the goodwill of the banks in developing their practices.88 An additional problem may be that

86Ellis, ‘Thin Line in the Sand’. Lockerbie and Godfrey, ‘Pre-packaged Administration’ (p. 22) suggest that the factors that an administrator may cite as justifying use of a prepack may include: preservation of business relationships; protection of assets; retention of employees; funding requirements; and regulatory factors such as the retention of essential licences.

87See generally M. Moran, The British Regulatory State (Oxford University Press, Oxford, 2003) ch. 4.

88On bank power Davies has written: ‘the power of the clearing banks in the market is such that there is barely a major firm of accountants or solicitors prepared publicly to criticise their conduct or practice, no matter how professionally objectionable’. On incentives and interests of ‘actors’ in administration see ch. 9 above; V. Finch, ‘Re-invigorating Corporate Rescue’ [2003] JBL 527.

pre-packs may not always be set up by IPs – they may be negotiated inhouse by the major creditors or they may be set up by independent, nonprofessional, unregulated specialists (Moulton’s ‘men in BMWs’). Such a pre-pack organiser may operate free from the constraints of any system of professional ethics whatsoever. The real worry is that if such an ‘ethically free’ person constructs a pre-pack that is self-fulfilling (in the sense that it is de facto not feasible to re-open the agreement within realistic timeframes) no amount of ethical shepherding of the deal on the part of the administrating IP will rectify the situation.

Such arguments point to the possible case for regulating pre-packs. On this front a number of strategies may be considered: professional regulation, external oversight mechanisms and legislative reforms.

A system of professional regulation of pre-packs might be furthered by tightening the monitoring regimes relating to pre-packs.89 The Insolvency Practices Council argued in 2006 that the IS and recognised professional bodies should require IPs acting as administrators to: report promptly to creditors when they have executed a pre-packaged sale; explain any decision not to advertise the business on the open market; bear in mind potential conflicts of interest where they have advised the managers of the relevant company on a pre-pack; and disclose potential conflicts of interest to creditors. To this end, R3 issued an SIP on prepacks to cover such matters.90 It might, however, be required that when IPs process a pre-pack through an administration, they file a report to their professional body for scrutiny. A complaints processing regime could also be established so that dissatisfied creditors’ views might be taken on board. Such a system of control, of course, would not solve the problem of ‘mavericks’ and the difficulties that might arise from prepacks that are arranged by parties other than qualified IPs. This is a matter to be returned to below.

What of the role of external oversight mechanisms? Some commentators, as noted, have argued that judges should perhaps bless pre-packs before they are implemented.91 Such judicial oversight would correspond to the scrutiny that is involved when the pre-pack proposals are

89See Flynn, ‘Pre-pack Administrations’. On the monitoring and regulation of IPs see ch. 5 above.

90IPC, Annual Report 2006 (IPC, London, 2006), noted in C. Laughton, ‘Editorial’ (2007)

Recovery (Summer) 2. R3, Statement of Insolvency Practice 16 (2009).

91See Moulton, ‘Uncomfortable Edge of Propriety’, p. 3.

implemented by means of an application to court for an administration order. It is to be noted, however, that paragraphs 14 and 22 of Schedule B1 of the Insolvency Act 1986 allow qualifying floating charge holders, the company or directors to commence administrations without the need for a court order. It could, accordingly, be argued that, having gone this far to create out-of-court routes into administration, Parliament might be reluctant to institute a judicial approvals mechanism in relation to pre-packs. Such an approvals process would undermine the speed and flexibility of the process92 and, moreover, would be difficult to set up in a way falling short of abolishing the paragraphs 14 and 22 routes into administration. It might be provided in law that the entry into administration would have to be by court order whenever there is a pre-pack but this would present two real problems. First, it would be necessary to define the precise circumstances, understandings or agreements that constitute a ‘pre-pack’ (which would create much work for lawyers and a good deal of uncertainty). Second, parties wishing to avail themselves of the out-of-court route into administration might find it relatively easy to circumvent any stipulations regarding the judicial approval of pre-packs by keeping their negotiations at a sufficient level of informality to escape the definition of pre-pack – at least until the point at which they have appointed an administrator.

Nor can it be expected that any system of judicial oversight (whether involving pre-packs or not) will involve a significant judicial willingness to interfere with the judgements of administrators. As noted above, the courts have shown themselves to be reluctant to second-guess commercial decisions that are made in difficult corporate circumstances even when the administration process is sought to be instituted by court order.93 In DKLL Solicitors v. HM Revenue & Customs94 a firm was insolvent (to the tune of about £2.4 million) and owed HMRC £1.7 million. Two of the equity partners of DKLL made an administration application to the court with a view to effecting a pre-pack sale for £400,000. HMRC opposed the application, arguing that it would have opposed the sale (because the price was too low) had it been given the opportunity to do so at a creditors’ meeting. Acting judge Andrew

92See Flynn, ‘Pre-pack Administrations’.

93See IA 1986 Sch. B1, paras. 11–13. It is arguable that the judicial oversight role is restricted by Parliament’s allocation of extensive discretion to the administrator.

94DKLL Solicitors v. HM Revenue & Customs [2007] BCC 908; see Frisby, ‘Judicial Sanction of Insolvency Pre-packs?’. See also Re Structures and Computers Ltd [1988] BCC 348.

Simmonds QC, however, granted the administration order, holding that the court had a discretion to grant such an order even where the majority creditor opposed it. (The legality of a pre-pack per se was treated as uncontentious.) He stated that in applications for the granting of an administration order the court would ‘give weight to the expertise and experience of impartial insolvency practitioners’.95 This statement indicates that a ‘business judgement’ approach may be forthcoming from the judges when they are faced with future pre-packaged administrations.96 Ellis has, furthermore, cast doubt on the capacity of the judiciary to deliver rigorous and fair oversight: ‘Judges aren’t in a position to make commercial decisions, and, even if they were, who would represent the interests of the divergent stakeholders? Where would they source their information?’97

Would legislative reform usefully control pre-packs? A first proposal might be to restrict the negotiation of pre-packs to IPs in order to increase the impact of professional and ethical systems of control and deal with the maverick problem. There may be issues of borderline to be dealt with here. How, for instance, might one stop a bank or another stakeholder from using their good offices to construct turnaround agreements? One way to do this would be to ensure that all pre-packs that underpin applications to court for administration orders are scrutinised or audited by IPs and certified as fair to all creditors. Such a procedure would address the ‘borderline’ and ‘maverick’ issues and would involve oversight not by the judiciary but by professionals specialising in the conduct of such negotiations and capable of making judgements about the feasibility, fairness and reasonableness of business proposals. A system of monitoring by the IPs’ professional body might be combined with such a legislative change. Further legislative reforms might, if necessary, be introduced to place the IPs’ pre-pack auditing function on a statutory basis. A statutory provision might, accordingly, impose an obligation on the IP to ensure, before approving a pre-pack, that the

95DKLL Solicitors v. HM Revenue & Customs [2007] BCC 908 at 913, para. 10.

96In the USA the so-called ‘business judgement rule’ is a principle that makes company directors and officers immune from liability to the company for loss incurred in corporate transactions that were within their authority and power to make when sufficient evidence demonstrates the transactions were made in good faith and with reasonable skill and prudence: see further D. Branson, ‘The Rule that isn’t a Rule – The Business Judgment Rule’ (2002) 36 Valparaiso Univ. LR 631; V. Finch, ‘Company Directors: Who Cares About Skill and Care?’ (1992) 55 MLR 179, 202.

97Ellis, ‘Thin Line in the Sand’. See also Flynn, ‘Pre-pack Administrations’ and Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’, p. 18.