Pre-pack administrations 

Following their high profile use in the retail sector, ‘pre-pack' administrations are continuing to receive considerable attention in the media due to the perception that they controversially permit failing companies to walk away from their creditors whilst being able to maintain the best assets and simply carry on in business. Very often the new business will be owned by the same management, trade with the same name and have the same suppliers.

However, the positive aspects of pre-packs are rarely reported, the trade body for Insolvency Professionals. Pre-pack administrations can be invaluable in keeping a business trading, saving jobs and in providing a better return for creditors when compared to liquidation.

What is a pre-pack?

A pre-pack is where a buyer is lined up for an insolvent company's business (or assets) before it goes into a formal insolvency process, usually administration, and sold immediately after the appointment of the insolvency practitioner.

Invariably, whilst potential purchasers are approached in advance and valuation exercises performed, little open marketing of the business is carried out. Management are usually in the best position to move rapidly as little or no due diligence is required. Secured creditors are usually made aware of the transaction as they are generally required to release their security. Unsecured creditors however are usually not told about the pre-pack until after it has been completed.

What businesses are best suited for a pre-pack?

A pre-pack allows an administrator to quickly and confidentially sell a failing business before it is permanently damaged.

The types of business where permanent damage can rapidly occur are ones where the principal assets are employees or intellectual property. Employees at a business which has announced its failure and is being marketed openly for sale are unlikely to wait to be rescued. There is a high risk they will search for alternative employment, leaving the business with no assets. It is virtually impossible to trade-on a service business out of insolvency other than via a pre-pack administration.

For many businesses the value is in its brand. Intangible items such as brand and goodwill can be irreparably harmed by insolvency. Businesses with few realisable tangible assets but a strong brand are also best suited for a pre-pack. Retailers often fall into this category where most stores are leased and stock held under supplier retention of title clauses.

Arguments for the use of a pre-pack

  • Saving jobs

    Research undertaken by R3 shows that pre-packs preserve more jobs when compared to a sale of the business as a going concern arranged after the commencement of insolvency proceedings. R3 found that employees were transferred to the new company in 92% of pre-pack cases compared to 65% for a business sale.

  • A better return for secured creditors

    Secured creditors can expect to receive a higher return in a pre-pack (an average of 42%) when compared to a business sale (an average of 28%). Unsecured creditors however fare less well on average, achieving a return of only 1% in a pre-pack compared to an already poor 3% in a business sale.

  • The value of the business is retained

    As already discussed above, pre-packs are best suited when the business' principal assets are the employees, contracts or intellectual property, as is found in all service businesses. Once a company's financial difficulty become public, it becomes difficult to retain the staff, suppliers and customers necessary to keep the company viable. A pre-pack can be used to bring about the sale of a business which may otherwise have been shut down.

  • Survival of the business

    Rather than wait for the company's banks or creditors to appoint an administrator or wind the company up, a pre-pack administration allows the current shareholders to take proactive steps to ensure the survival of the business, an option not open to them otherwise.

Arguments against the use of pre-packs

The highest levels of criticism are levelled where existing management buy back the business following private negotiations with an insolvency practitioner and then continue to trade clear of the original debts in a new "phoenix" company. Unsecured creditors kept in the dark are understandably suspicious of the pre-pack procedure, fuelling claims of illegitimate, self-serving alliances between directors and insolvency practitioners.

  • Administrator's conflict of interest

    Claims of a conflict of interest can arise if an insolvency practitioner who has been acting as an adviser to the original company, to its directors or managers or to an interested third party, is then subsequently appointed as an administrator to execute the sale of the business, as they may have previously given advice to one or more of the interested parties.

  • The business should have been marketed openly beforehand

    Claims that a pre-pack administration is used when instead the business could and should have been more widely marketed even for a short period of time to see if there were any higher offers available.

  • Creditors have no say in the process

    Creditors often object to the fact that they had no possibility of rejecting the new company's offer to purchase the business. They are presented with a ‘done deal'.

  • Businesses should not be sold back to the original owners/managers

    Creditors who lose out often feel aggrieved that the original owners/managers who they blame for their loss are able to run and profit from the new business. However, the sale of a business back to its original owners/managers is not an exclusive feature of pre-packs.

Improved reporting requirements

In the right hands and in the right circumstances, pre-packs are a valuable tool in rescuing insolvent businesses and their use has grown considerably since the Enterprise Act 2002. Pre-packaged administrations are open to abuse however and the Government recognises that the regulatory and enforcement regimes in operation to spot and prevent abuse should be understood and seen to be effective.

Statement of Insolvency Practice 16 (SIP 16) was introduced on January 1 2009 to alleviate some of the criticisms and arguments against the use of pre-packs and to help improve their transparency. The aim of SIP 16 is that creditors are given sufficient information for them to understand the circumstances surrounding the sale and why the particular course of action was chosen. It requires insolvency practitioners to disclose to creditors why the decision to carry out a pre-pack was taken, the associated information concerning that decision and the connections between the purchasing company and the company in administration.

JMW Solicitors' team of insolvency lawyers can provide legal advice to business owners, directors and managers, insolvency practitioners and other interested parties in any aspect of a pre-pack administration. Should you require any advice or assistance please call us on 0345 872 6666 or complete the online enquiry form.

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