The pre-packaged insolvency (“pre-pack”) may become an effective debt recovery tool for financial institutions who are secured creditors, when the debtor is insolvent and the lender seeks to quickly cash out its collateral at the best price. This can also apply when in-court restructuring proceedings for the debtor are commenced but then discontinued.
Starting from 1 January 2016, it has been possible for a debtor’s enterprise, an organised part of its enterprise, or assets representing a significant part of its enterprise to be sold in a pre-packaged insolvency, among other situations at the application of a personal creditor, including a creditor secured by the debtor’s assets.1 The law provides that any entity with standing to file a bankruptcy petition against a debtor, including a personal creditor, is authorised to file an application for approval of the terms of sale of the debtor’s assets.2 According to a report by the Court Watch Polska Foundation, in 2016, the first year in which the pre-pack was available in Poland, almost 17% of applications for approval of pre-packs were filed with bankruptcy courts by a creditor.3
A creditor planning to apply to the court for approval of the sale of specific assets of the debtor in a pre-pack may seek out the potential buyer itself and negotiate the terms of sale. Interestingly, the applying creditor may itself become the acquirer (although it should be pointed out that then it is not possible to set off claims held by the creditor against the purchase price—payment must be made in cash). The consent of the debtor, the owner of the assets, is not formally required.
In practice, if an application for approval of a pre-pack is to be prepared and filed by a creditor without the debtor’s consent or against its will, it may prove most problematic to prepare a description and valuation of the assets subject to the pre-pack (a document necessary to organise such a transaction, to be prepared by a person entered in the list of court-appointed experts) and for the potential buyer to obtain information about the debtor’s assets enabling it to make a business decision on the transaction. The debtor may not cooperate voluntarily with the creditor and deny access to the property, refusing to provide any information about its assets. I will return to this issue later in this article.
The terms of sale agreed with the potential buyer are subject to approval by the bankruptcy court along with the announcement of the debtor’s bankruptcy. In this situation, closing of the transaction and satisfaction of the creditor may occur fairly soon after the declaration of bankruptcy. In these actions the bankruptcy estate is represented by the official receiver. If the debtor is subject to an in-court restructuring proceeding, it will also be necessary for this proceeding first to be discontinued by the court.
As a debt recovery tool, the pre-pack may prove particularly attractive if the debtor is not servicing its obligations to the financial institution and has no prospects of repaying its debt in full within a reasonable period, and the lender holding tangible security does not agree to restructuring of the debt on the terms proposed by the debtor or administrator in the in-court restructuring proceeding. The sale of the insolvent debtor’s assets in a pre-pack may also generate benefits for a much wider circle of stakeholders.
Advantages of pre-pack for financial institutions
It can be said from an analysis of the Bankruptcy Law 2003 and the experience so far, including from the use of pre-packs in other jurisdictions, that the sale of the debtor’s assets in a pre-pack can be much more advantageous for a financial institution holding tangible security than satisfaction under other procedures. The most important advantages include:
- Higher rate of satisfaction than from sale of collateral individually
Experience teaches that the elements of the debtor’s assets encumbered by security may achieve a higher value when they are sold as elements of an enterprise or an organised part of an enterprise, because they form part of a greater whole that is in operation, organised around generating income. Hence the sale of collateral in a pre-pack should achieve a higher price than the sale of individual encumbered assets, whether in a bankruptcy or in-court restructuring proceeding or out of court.
- Higher rate of satisfaction than from sale of collateral as elements of an enterprise or organised part of an enterprise in a bankruptcy proceeding under general rules
One of the aims of pre-pack sale is fuller satisfaction of creditors than in a bankruptcy proceeding conducted under general rules.4 A creditor interested in a pre-pack sale may hire investment advisers to seek out potential buyers and then conduct negotiations with them itself or with the support of its advisers. In Polish bankruptcy proceedings, receivers typically do not use external advisers but personally seek out buyers for the debtor’s assets. Often this is limited to publication of brief announcements in the press and online, enabling prospective buyers to inspect the property and answering any questions they may have. Taking such a passive approach, receivers typically receive less satisfactory results than an active creditor supported by investment professionals. Thus if the debtor is suffering serious difficulties and its bankruptcy appears inescapable, it may be more advantageous for the lender to take the initiative in the process and make its own efforts to sell the debtor’s assets in the form of a pre-pack. This also applies in situations where the debtor is undergoing one of the in-court restructuring procedures.
- Liquidation of collateral and exiting the relationship with the debtor more quickly than in bankruptcy proceedings under general rules
The aim of the pre-packaged sale is quicker satisfaction of creditors and much shorter bankruptcy proceedings.5 Participants in bankruptcy proceedings know that secured creditors can wait even years for sale of the collateral and distribution of the proceeds. There can be various reasons for this. The pre-pack can offer secured creditors a remedy for this problem.
The Bankruptcy Law 2003 is now constructed in such a way that it should be possible to move within just a few months from filing of the bankruptcy petition with an application for approval of the terms of the pre-pack sale, to conclusion of the sale contract between the receiver and the buyer, delivery of the assets to the buyer, and distribution of the proceeds among the secured creditors. The assumption that the entire procedure can be completed within one year appears entirely realistic. The actual speed of the process will depend however on such factors as the proper preparation by the creditor or its advisers of the bankruptcy petition and accompanying application for approval of the terms of pre-pack sale, in particular the enclosed description and valuation of the assets to be sold. For this process to run smoothly, the information, data and evaluation presented must be reliable and recognised as such by the temporary judicial court supervisor (if appointed by the court) and the bankruptcy court itself.
Advantages of pre-pack for the acquirer, employees, and unsecured creditors
Sale in the form of a pre-pack may also generate benefits for the acquirer, unsecured creditors and the debtor’s employees, and thus their families, and more broadly for the local community. The courts should also look favourably on the procedure of pre-packaged insolvency because it offers a chance to wind up the bankruptcy proceeding much more quickly.
- Acquisition of assets free and clear of debts and encumbrances
A pre-pack sale has the effects of a sale in execution. In general, the investor acquires “clean” assets, free and clear of the debtor’s obligations and encumbrances connected with operation of the enterprise (including tax claims). The acquirer is not jointly and severally liable with the seller for such debts under the rules set forth in the Civil Code.
- Avoiding stigmatising of the enterprise, and retaining suppliers and customers
In the case of a pre-pack, market participants typically learn of the declaration of the debtor’s bankruptcy along with information on the bankruptcy court’s approval of the terms of sale of the debtor’s enterprise or an organised part of the enterprise to a new owner. The search for a buyer, negotiation of the terms of sale, and preparation of the transaction occur prior to declaration of the bankruptcy of the current owner of the enterprise. This provides a chance to head off nervous responses to the news of the current owner’s bankruptcy, so there is a chance that customers and suppliers will not cease trading with the debtor. At the time of the announcement, the identity of the new owner of the enterprise or organised part of the enterprise, who will join the transaction and as a rule plans to continue its operations, will already be known. In some cases, as of the date of declaration of the debtor’s bankruptcy the new owner will immediately assume management of the debtor’s enterprise. This is an obvious advantage for the buyer, as it can retain the existing network of customers and suppliers, but ultimately it is also advantageous for the customers and suppliers.
- Protection of jobs
The aim of a pre-packaged sale is essentially to maintain the enterprise as a going concern and for the new owner to continue the existing business. Consequently, all or most of the staff working in the enterprise should keep their jobs. A study conducted in 2007 in England and Wales showed that when the enterprise was sold in the form of a pre-pack, in more than 90% of the cases all of the employees kept their jobs and the entire staff were let go in only 2% of the cases. By contrast, in the case of sale within standard bankruptcy proceedings these figures were 65% and 16% respectively.6
- Savings for the bankruptcy estate
Sale of the debtor’s assets in a pre-pack should be much cheaper for the bankruptcy estate than sale at a later stage within a standard bankruptcy proceeding.
If the sale of the debtor’s enterprise or an organised part of the enterprise in a pre-pack does not go through, the receiver will be forced to continue paying the current salary of employees (until a sale is conducted under the general rules) or to lay off workers under the relevant procedure. The resulting costs will be charged to the bankruptcy estate.
The same applies to costs connected with further management and maintaining the debtor’s enterprise in operation during the course of the bankruptcy proceeding, if the receiver plans to sell it in whole or in part, as well as the costs of liquidation of the enterprise under general rules, which would not have to be incurred in the case of a pre-pack sale. The estate may also generate significant savings from delivering the enterprise to the buyer as soon as the debtor’s bankruptcy is announced.
- Chance for a higher degree of satisfaction of unsecured creditors
The speed of a pre-pack sale and the resulting savings for the bankruptcy estate can positively impact the rate of satisfaction of unsecured creditors, particularly trade creditors. In the worst case, such creditors would probably be satisfied to a degree comparable to what they could expect in a bankruptcy proceeding under general rules.
More about the actual pre-pack procedure
Below I present some key information for financial institutions about the possible course of a pre-packaged insolvency.
- Bankruptcy petition with application for approval of terms of pre-pack sale
If along with the bankruptcy petition an application is filed for approval of the terms of a pre-pack sale of specific assets, the application should identify at least the assets that are the subject of the pre-pack, the prospective acquirer, and the proposed sale price agreed with the buyer. The bankruptcy court will prefer to sell the enterprise as a whole, and thus an application covering only an organised part of the enterprise or assets representing a significant portion of the enterprise will have to be justified by a concern for a greater degree of satisfaction of the creditors.
During the course of the negotiations, the applicant may also agree with the prospective buyer on a draft of the asset sale contract. This can be submitted to the bankruptcy court together with the application for approval of the terms of the pre-pack.
In the court order approving the terms of the pre-pack sale, the bankruptcy court may refer to the terms of sale set forth in the draft asset sale contract. The receiver, with whom the acquirer will formally conclude the contract (as the person acting for the debtor’s account), becomes bound in this way by the draft contract. This is a solution entirely advantageous to the buyer and can also expedite the pre-pack procedure, as it eliminates the need for negotiation of the contract with the receiver after the debtor’s bankruptcy is announced.
- Description and valuation of assets
The price at which the debtor’s assets can be sold in a pre-pack cannot be set by the applicant and the prospective buyer arbitrarily. The application for approval of the terms of pre-pack sale must enclose a description and valuation of the assets covered by the application, prepared by a person on the list of court-appointed experts. There is an exception to the rule only when the sale is to be made to a buyer affiliated with the debtor; then the description and valuation are prepared upon order of the bankruptcy court.
The requirement to use a court-appointed expert for valuation of the pre-pack assets and for oversight of this procedure by the bankruptcy court is intended to ensure the transparency of the procedure and to minimise the risk of a negative social perception of the institution of the pre-pack in Poland. In England and Wales, for example, one of the main objections to the use of pre-packs in recent years has been insufficient transparency in the process of valuing the assets being sold.7
It would be desirable for the description and valuation of enterprises and organised parts of enterprises for the purposes of pre-packs to be prepared by court-appointed experts possessing special knowledge about valuation of enterprises, with experience valuing enterprises from the sector in which the debtor operates, if such persons are available.
The description and valuation prepared for the purpose of the pre-pack must contain information about such aspects as, among others:
- The subject of the business, the real estate included in the enterprise (including the area and a designation of the land and mortgage register), other fixed assets and rights, easements and the like
- Mortgages and registered pledges against the enterprise, their value and the value of the encumbered assets, as well as the ratio of the value of the specific encumbered assets to the overall value of the enterprise
- The estimated costs of a bankruptcy proceeding involving liquidation under general rules and under the pre-packaged insolvency, which would have to be incurred on sale of the enterprise as a whole (this element may be optionally included in a separate opinion).
Considering the conditions under which a pre-pack is conducted, in particular that the sale will be made in a bankruptcy proceeding, it should be expected that the valuation will reflect the conditions of a forced sale, as is assumed in a bankruptcy involving liquidation of the debtor’s assets under general rules.
- Access to the debtor’s property and related data and information
When a creditor is considering filing a bankruptcy petition together with an application for approval of the terms of a pre-pack sale, it is essential to gain access to data and information about the debtor’s property, as this is necessary to prepare the description and valuation and for the prospective buyer to take a decision to join the transaction and agree on the terms of sale. Without such access, if the debtor or the administrator in an in-court restructuring proceeding refuses to grant it, it may prove particularly difficult in some cases for the court-appointed expert to prepare the description and valuation and for the creditor to come to terms with the prospective buyer (especially in the case of medium-sized and large manufacturers).
Because the law allows creditors to take the initiative in a pre-packaged insolvency, against the debtor’s will, practitioners are faced with the challenge of how a creditor can effectively exercise this right when the debtor refuses to cooperate.
If the creditor is a financial institution, it should look first to the provisions of its agreements with the debtor, for example the credit agreement and security documentation, for grounds obliging the debtor or administrator in an in-court restructuring proceeding to provide access to the assets to be included in the pre-pack and to provide the creditor with the information it needs. In the case of new financing, at the stage of negotiation of the credit agreement, for example, lenders should seek to draft the agreement so that the requirements for a pre-pack, in terms of the description and valuation of the relevant assets of the debtor, and the information and data vital for a potential buyer, can be obtained, and for the creditor to be able to negotiate freely with potential buyers of the assets. Depending on the situation, these provisions should be subject to performance by the debtor or by an administrator appointed for the debtor in an in-court restructuring proceeding.
- Sale price
The estimated value determined by the court-appointed expert may serve as a point of departure for the creditor in negotiations with potential buyers. For purposes of determining the price which the parties will finally decide to include in the application for approval of the pre-pack filed with the bankruptcy court, this value can be reduced as necessary by the costs of the proceeding which would have to be incurred in connection with a liquidation of the assets in a bankruptcy proceeding under general rules. This has to do with costs that would not occur in the pre-pack sale. If the price proposed in the application is equal or higher than this amount, the bankruptcy court is bound by the application.
Moreover, as an exception, the court can also grant an application in which the price offered is somewhat lower than the amount referred to above, if supported by a legitimate public interest (e.g. maintaining jobs) or the possibility of continuing the debtor’s enterprise as a going concern.
However, a pre-pack sale to a buyer affiliated with the debtor is permissible only at a sale price no lower than the valuation.
- Approval of terms of pre-pack sale by the bankruptcy court
If the application is granted, in the order declaring the debtor’s bankruptcy the court will confirm the terms of the pre-pack sale, specifying the price and the buyer of the assets in question. In this respect the court is bound by the application; it may not increase or decrease the sale price proposed in the application.
Although it may seem obvious, it should be stressed that the court can approve the terms of sale in a pre-pack only if it also declares the debtor’s bankruptcy. This is a necessary condition. If the court finds that the bankruptcy petition should be denied, then the application for approval of the pre-pack becomes moot.
The ruling on the application for approval of the terms of pre-pack sale is subject to interlocutory appeal. If the application is denied, the applicant has a right to appeal; if the application is granted, any creditor can appeal.
- Payment of the price and conclusion of the asset sale contract
The receiver is obliged to conclude the sale contract with the acquirer, on behalf of the debtor, within 30 days after the court order approving the terms of pre-pack sale becomes legally final (unless the terms of the contract approved by the court provide for some other deadline). The sale contract can be concluded only after the acquirer has paid the entire price to the bankruptcy estate, or the price paid earlier into the court deposit is released to the receiver. It is not permissible to postpone payment or pay in instalments (as is possible for example in the case of a pre-pack in England and Wales).
The application for approval of the terms of pre-pack sale may include a request for the enterprise to be delivered to the buyer on the date of declaration of the debtor’s bankruptcy. In that case, proof of payment of the full proposed price to the court’s deposit account is enclosed with the application. In the interim, until the court order approving the terms of pre-pack sale becomes legally final and the sale contract is concluded, the acquirer will administer the assets within the ordinary course of business, at its own risk and responsibility.
Within the time provided for conclusion of the sale contract, the receiver may file an application with the court to vacate or amend the court order approving the terms of pre-pack sale if after issuance of the order new circumstances have occurred or been disclosed materially impacting the value of the assets that are the subject of the sale. This aspect of the pre-pack procedure is designed to protect the interests of the debtor and its creditors. The parties to the bankruptcy proceeding have a right to file an interlocutory appeal against a court order approving the receiver’s application in this respect.
After the court order approving the terms of pre-pack sale becomes legally final, the bankruptcy court will order the price paid into the court deposit to be released to the receiver (either at the court’s own initiative or upon application of the receiver). Then the receiver should establish and carry out the plan for distribution of the proceeds from the sale of the collateral, reflecting which creditors are secured by the assets in question. The proceeds from sale of a secured asset form a separate fund from which the secured creditor has priority in satisfaction over other creditors (also reflecting the priority among creditors secured by the same collateral, if relevant).
- Assets encumbered by registered pledge
If assets covered by the pre-pack are encumbered with a registered pledge in favour of a creditor other than the applicant, the pledgee’s written consent to the transaction is required. It is impermissible to file an application for approval of the terms of pre-pack sale with respect to assets covered by a registered pledge if the agreement establishing the registered pledge permits the pledgee to claim satisfaction by taking over or selling the pledged asset under the procedure set forth in the Act on Registered Pledges and the Pledge Register 1996, and the pledgee has not consented to the pre-pack. The only exception is the situation where the sale of the pledged asset in a pre-pack covering the entire enterprise is more advantageous for the pledgee than a separate sale of the pledged asset. But the applicant must prove to the bankruptcy court that this is the case.
The proceeds from sale of a pledged asset form a separate fund from which the pledgee has priority in satisfaction over other creditors (also reflecting the priority among creditors secured by the same collateral, if relevant).
Karol Czepukojć, Restructuring & Bankruptcy practice, Wardyński & Partners
1 Art. 56a–56h of the Bankruptcy Law 2003.
2 Justification for proposed Restructuring Law 2015, 7th Sejm, print no. 2824, p. 71.
3 “Pre-pack: Pre-packaged insolvency in its first year in force in Poland”, Court Watch Polska Foundation, p. 19, accessed on 15 May 2017. According to the report, in 2016 thirty applications for approval of pre-packs were filed with bankruptcy courts in Poland, five of them by creditors.
4 Justification for proposed Restructuring Law 2015, supra, p. 71.
6 S. Frisby, “A preliminary analysis of pre-packaged administration”, report to the Association of Business Recovery Professionals, pp. 70–71, accessed on 15 May 2017.
7 T. Graham CBE, Graham Review into Pre-pack Administration, p. 8, accessed on 15 May 2017.