Administrators’ pre-appointment costs and pre-packs

The Insolvency (Amendment) Rules 2010 effect a number of changes to insolvency procedure from 6 April 2010. One such change, subject to certain safeguards, is to bring administrators’ pre-appointment costs into the expenses of the administration, which are payable by the administrator out of the assets under his control.

But what exactly are “administrators’ pre-appointment costs” – or, in the language of rule 2.33 (2A), “unpaid pre-administration costs”?

John Tribe has kindly brought to my attention the recently handed down decision of HHJ Purle QC in Johnson Machine and Tool Co Ltd & Anor [2010] EWHC 582 (Ch) (18 March 2010), which clarifies the law as it stands prior to 6 April 2010 but also sheds light on the potential interpretation of the new law.

The significant pre-appointment costs that pre-packs can involve and the ill-informed and over emotive concern often voiced about the procedure make this issue all the more pertinent. What commentator could resist the double whammy of pre-packs and insolvency practitioners’ fees?

The Johnson Machine decision

The Johnson Machine judgment covers two cases, both of which involved court appointed administrators who undertook pre-pack sales of the business and assets to parties connected with the company’s directors.

It cites Kayley Vending Ltd [2009] EWHC 904 (Ch) (15 May 2009) and Re SE Services Ltd (9 August 2006) (unreported – although a note of the judgement is reported in the Kayley Vending judgement), emphasising that administrators’ pre-appointment costs are payable only at the discretion of the court under para 13(1)(f), Schedule B1, Insolvency Act 1986.

Judge Purle strengthens that emphasis by also analysing the position in out-of-court administrations and observing that pre-appointment costs cannot be approved by creditors as part of the administration proposals, which para 49(1), Schedule B1 specifies are “for achieving the purpose of the administration”. He says:

“This has nothing to do with pre-appointment costs.”

Referring to rule 2.106 and rule 2.67(1), he goes on to exclude pre-appointment costs from administrators’ remuneration and expenses, concluding:

“It does not seem to me, therefore, that it lies within the power of the creditors to approve any payment to the administrators in respect of pre-appointment costs which would not otherwise count as an administration expense.”

I confess, with the greatest respect to the learned judge, to finding not wholly convincing the reasons given for his exercise of discretion against allowing the pre-appointment costs.

Where the purpose of the administration is a better result for creditors than liquidation, surely the pre-appointment arrangements for a pre-pack are for achieving that purpose?

The test advanced by HHJ Norris QC in Re SE Services Ltd and approved in the Kayley Vending and Johnson Machine cases is particularly vexing.

Why should creditors be deprived of a benefit (through the prospective administrators not undertaking pre-appointment work for which they will not be paid) merely because the directors are perceived to derive a greater benefit? This has nothing to do with pre-appointment costs.

The Insolvency (Amendment) Rules 2010

Be all that as it may, the law changes from 6 April 2010 with Rule 2.33 (2A):

• (a) “pre-administration costs” are—
• (i) fees charged, and
• (ii) expenses incurred,
• by the administrator, or another person qualified to act as an insolvency practitioner, before the company entered administration but with a view to its doing so; and
• (b) “unpaid pre-administration costs” are pre-administration costs which had not been paid when the company entered administration.
• The key point is that to be allowable as an administration expense, the costs must be incurred with a view to the company entering administration.

In the Johnson Machine case, Judge Purle effectively identified three categories of pre-administration costs:

• insolvency or other advice that may or may not lead to administration, liquidation or some other process;
• formalities required to be completed by the proposed administrator, such as considering and completing form 2.2B and preparing a witness statement in support of an application for a court appointment; and
• considering and arranging a pre-pack.

You may have been expecting all these costs to be covered by the new rule 2.67(1)(h), provided that they had been duly approved by the committee, the creditors or the court.

Whilst I believe that categories (2) and (3) are covered, the line of cases referred to above means that category (1), insolvency advice, is not.

Whether any of the judiciary might be inclined to continue to apply the test from the SE Services case and would therefore consider the extent of benefit to the directors, or in some other way exclude pre-pack costs, is not entirely free from doubt.