Re-animating businesses in a land full of zombies: economic uncertainty and the use of pre-pack administrations in the restructuring of debt-laden and moribund companies

Richard Wolff

The UK economy is currently in a state of flux with conflicting signs of growth and contraction, of optimism, and of gloom, emerging on a daily basis. Q4 2010 registered a fall of 0.6 percent in economic output – since ‘adjusted’ to 0.5 percent – only for this reverse to be reversed with recently reported growth in Q1 2011 of 0.5 percent. So in six months the economy has neither grown nor contracted.

Many confusing indicators abound in the business media which report varying degrees of business confidence in certain sectors, such as manufacturing, which has seen recent rises in output, but also confirm contrasting concerns, for instance regarding recent retail results, with the British Retail Consortium confirming the biggest drop in sales on the UK high street on record.  

No matter what positive spin is generated by government ministers trying to talk up confidence, the facts remain that VAT has risen, public sector spending cuts imposed by the coalition government are starting to bite, unemployment is up and discretionary spending is down with the first recorded drop in household income in real terms since 1981. Furthermore, bank lending is still largely unavailable at sensible rates for SME borrowers, growth predictions for 2011 have been cut by the Chancellor from 2.1 percent to just 1.7 percent, inflation is running at double its 2 percent target and the MPC agonises each month over whether to raise interest rates.

With a certain degree of putrefaction discernable in the economy it’s no surprise that there are a growing number of companies, large and small, that are becoming ‘zombified’: a difficult state to describe in general terms but usually one where a company has not got the finances to carry on in its current state, has inadequate or even no equity in the assets on its balance sheet but which is still being propped up by its bank or venture capital/equity stakeholders. Such companies are trading only to pay back what they’ve borrowed and no longer exist to pay dividends to their shareholders or to provide long term growth, jobs or prosperity. They have become, to a greater or lesser degree, ‘the living dead’.

Pre-packs – can they be real ‘re-animators’ of businesses?

There has been much media commentary, especially in recent months, on the use of pre-packaged administrations as a restructuring technique to breathe life back into struggling and failing businesses that are trapped in companies saddled with debt and which are paralysed by lenders and equity stakeholders seemingly incapable of breaking such companies out of a cycle of terminal decline. I am a self-confessed supporter of the pre-pack which, in the right circumstances, can be a restructuring process of first resort. It has been shown to be invaluable in the scenario where a business is viable in the long term but has been overwhelmed, perhaps by a combination of failing customers, a decline in orders and/or an aggressive pack of creditors.  

A statutory interim moratorium provided by the notice of intention to appoint administrators – where appropriate – which prevents creditor action against companies, can and has provided critical breathing space to allow insolvency practitioners to work with management to broker a deal either with existing directors or a third party to take the business and assets into a new trading vehicle with goodwill preserved, jobs retained and with the prospect of long term viability maintained.  

Secured creditors will recover some or all of what is owed to them and unsecured creditors will perhaps recover a small proportion of what is owed to them but will also retain the relationship with a viable customer at a time when new business is hard to find. Importantly where unsecured creditors do not have an economic interest in the outcome of the administration they will not be able to stand in the way of a successful restructuring of the business which must necessarily be pre-packed to preserve goodwill, where trading on is impossible due to a lack of funding and where the ability to market the business widely is constrained by lack of buyers with adequate funding or the need to preserve contracts and goodwill.

While examples of pre-packs abound in the SME sector, there were until recently fewer examples of successful large-scale pre-packaged transactions. This trend now seems to be shifting with the recent acquisition of the British School of Motoring by the Automobile Association and the largest ever pre-pack in UK history, namely the acquisition by Citibank (the main secured creditor) of the business and assets of the EMI music empire from an overleveraged group structure saddled with £3.4 billion of debt and stricken by apparent inertia within its equity stakeholders who were faced with no realistic prospect of achieving value going forward.

While company voluntary arrangements have been a much-vaunted vehicle for restructuring, with JJB recently successfully completing its second CVA in as many years, and well on the way to achieving its additional fund-raising requirements, and HMV now seriously considering such a process, they are not without their detractors and do not always achieve long-term stability. The pre-pack, in the right circumstances, can be a more clinical and economic way of achieving recovery for a business where there was decay, of restoring vigour where there was inactivity and of reconstituting life where there was decay and death.

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