April 24, 2018

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April 23, 2018

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A sobering reminder of the potential pitfalls in doing a “pre-pack” administration

VE Vegas Investors IV LLC (“Vegas”) and others vs Shinners and others [2018] EWHC 186 Ch

Background

Vegas encountered financial difficulties and its directors sought insolvency advice from insolvency practitioners at Smith and Williamson (“S&W”) and appointed them to advise on and effect a pre-pack sale of Vegas’s business and assets.

S&W experienced difficulties in obtaining financial information and clarity over the extent of the sale assets from Vegas. This caused issues in finding an arms’ length purchaser and only one external purchaser was identified.

Insolvency practitioners from S&W were appointed administrators of Vegas by the court but they did not report the problems that they had had in obtaining sufficient information from Vegas’ directors when applying for the order. The day after appointment, the administrators then sold the business and assets to a new company set up by the Vegas directors.

Application to remove the administrators

Certain creditors of Vegas brought proceedings seeking the appointment of fresh administrators to investigate claims against Vegas’ directors and/or S&W relating to the pre-pack sale and whether there were breaches of duty by Vegas’ directors and/or S&W which either prevented other options being pursued or caused the transaction to be at an undervalue. The application required removal of the administrators from office from S&W and appointment of administrators from Deloitte since – it was submitted- the S&W administrators were conflicted.

After initially contesting the proceedings, the S&W administrators provided the court with a letter of intention to resign offering to pay all costs. They asked the court to abridge the five days’ notice of resignation that administrators normally provide to creditors – presumably because if the creditors were deemed to have immediate notice of their intention to resign, the court should not have to decide whether to remove them as administrators.

Removal of administrators

The court did not accept S&W’s suggestion and instead removed them with immediate effect. Administrators from Deloitte were appointed in their place.

The court directed itself that the application required a decision about whether was a “serious issue for investigation”, not whether those claims identified for investigation had merit. The court considered there were at least 2 possible scenarios on the facts; one in which the directors did the best they could under time pressure and achieved the only sale that would have been realistic, or, they took advantage of their position enabling the new company formed by them to purchase at an undervalue.

The court considered that the S&W administrators should have appreciated that there were matters to investigate and consider, including:

  1. whether the directors had put their own interests first and the expense of other options and the best price was not achieved;
  2. whether S&W themselves had breached their duties;
  3. whether the business had been marketed with proper due diligence;
  4. whether there was a genuine playing field due to the lack of information; and
  5. whether they should have considered if there was a need to provide different advice, ensure a better process, or sought to prevent or mitigate the actions of the directors.

In the court’s view, the S&W administrators should have concluded from a very early stage that, given their previous retainer, 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 Vegas. The court noted it did not automatically mean the administrators should have resigned, but they could have at least appointed a further or replacement administrator to deal with those investigations. The administrators should not have opposed the court 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 matters could not be resolved.

The court noted that administrators should work with creditors to achieve the purpose of administration. It was in Vegas’ interests to ascertain if claims existed to replenish it estate (including claims against S&W). The court considered the administrators had lost perspective of their role and confirmed it removed them immediately because they had not approached the matter correctly.

By way of completeness the court recorded the fact that it had taken into account the impact on 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), that this was not a case where removal should encourage unjustified applications or cause office holders to “look over their shoulders” and the court also considered but was not persuaded by the views of creditors.

Comment

There a few common sense checks that arise from this case to consider when acting in a similar situation:

  • if the IP engages with the directors to advise on options and then sells to that same group of directors absent a clear and fair marketing exercise, the administrators will be considered conflicted;
  • an IP should consider whether, if he or she assisted the directors pre-appointment, is it best that the IP is either replaced or joined by another IP on appointment who could specifically review any possible conflict;
  • if any critical information required to allow a third party to make a decision on whether to bid is not provided, the IP must tread extremely carefully and ensure information is provided to allow informed bids from all parties, and if not, consider declining the appointment;
  • if a creditor initiates proceedings in circumstances where a firm has acted pre- and post-insolvency and there is a suggestion of conflict which could have merit, IPs may be best advised to be proactive and co-operative (and therefore may retain a role in the process) from the outset. It is clear that the court took a dim view on the IP’s initial resistance to the case and the amount of money and time lost on their defending the application.

Although these type of situations are quite common, it is worth considering the court’s judgment and re-checking that internal procedures are compliant with SIP 16 and the IP’s own conflict and risk rules – and seeking advice where potential issues are identified.

© Copyright 2018 Squire Patton Boggs (US) LLP

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About this Author

Mark Prior, Squire Patton Boggs, Manchester, Restructuring, Insolvency
Senior Associate

Mark is a senior associate in our Restructuring & Insolvency practice based in our Manchester office. 

His particular expertise covers commercial and legal issues involved in corporate recovery, turnaround and reconstruction, and insolvency law. Mark advises on all formal insolvency processes and has considerable experience in preparing and negotiating legal documentation for the sale or purchase of businesses and assets, and distressed property portfolios. Mark has also advised directors on trading and prepared several cases for court...

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