Legal Matters UK December 2009

Corporate bankruptcies: pre-packs in the UK

Company Administrations in the UK are still on the rise. An administration is the nearest UK equivalent of a US Chapter 11 procedure or an Insolvenzplan in Germany. You may not have heard the term 'pre-packs' but if you become involved with any struggling business in the UK, be it your own or that of a customer, supplier or a tenant, you should know what you are up against. In this edition of Legal Matters UK we have pulled together the facts about pre-packs, the pros and cons, and an outline of the ways in which insolvency practitioners and other professional bodies are aiming to ensure that the procedure is not abused.

What is a pre-pack?

The term 'pre-pack' which is short for 'pre-packaged sale' refers to an agreement to sell all or part of an insolvent company's business and/or assets to a buyer (usually a new company) negotiated just before an administration commences, with the administrators then completing the sale immediately after their appointment.
The use of pre-packs in administrations has been growing in the current recession and some recent high profile retail administrations have meant that they are receiving greater attention in the media than ever before. Much of this attention has focused on the suspicion which unsecured creditors attach to pre-packs and the perception that pre-packs simply allow management teams to strip the valuable assets from a company and leave their debts and liabilities behind.

Pros and Cons of a pre-pack

Pros

Pre-packs are a quick and efficient way of transferring the business and/or assets of an insolvent company. This has an impact on the costs involved in an administration, which can result in a better return for creditors. Businesses are saved which might otherwise just disappear.
Pre-packs can save jobs by ensuring that any disruption to business continuity is kept to a minimum.
Pre-packs, through business continuity, minimise the loss of goodwill from suppliers, customers and other persons who deal with the business and may therefore generate a better return for creditors. 
 

Cons

Unsecured creditors are not consulted and have no opportunity to consider or vote on the proposals until after the sale has taken place.
Because a pre-pack is negotiated in advance of administrators being appointed, there is an argument that the administrators do not have opportunity to properly test the market for the assets and/or business being transferred and so are unable to ensure that the best price has been achieved.
If the business is sold to a new company controlled by some or all of the original owners or managers, creditors may be suspicious that the process is being used to create a 'phoenix' company which has dumped the debts of the old company.

Like every system, pre-pack administrations are not a perfect answer to everyone's problem when a company is experiencing severe difficulties, but it is a tool available to owners or managers of a struggling business to consider using. And it may well be the right thing at the right time. 

Guidelines for administrators

Since 1 January 2009, the UK Government Insolvency Service has introduced a guideline: Statement of Insolvency Practice 16 (SIP 16) which is intended to improve the transparency of pre-packaged administrations.

The guidelines detail the information which should always be given to creditors on a pre-pack including, amongst other things, the identity of the buyer, any connection between the buyer and the insolvent company, any valuations of the business or assets being transferred, and details of the consideration for the sale and the terms of payment.

Although the guidelines are not legally binding as such, insolvency practitioners will face regulatory or disciplinary action if the guidelines are not followed.

Can pre-packs be challenged?

There is a statutory right for creditors to bring an action against an administrator under the Insolvency Act 1986. Such an action may arise where the conduct of the administrators causes unfair harm to a creditor's interest or where the administrators are not performing their functions quickly and efficiently.

The Insolvency Service has also set up a complaints 'hot-line' for pre-packs to enable creditors to complain about a pre-pack administration. This may be used where creditors consider that they have been unduly disadvantaged by an administration (or any other corporate insolvency process). As mentioned above, administrators are likely to face regulatory or disciplinary action if they have failed to comply with SIP 16.

What does pre-pack administration mean to a supplier?

Businesses are heavily reliant on consumer confidence in brands, valuable assets of any business, which can quickly become eroded when it becomes known that a business is in distress. Furthermore, suppliers further up the food chain are often labour intensive and any uncertainty can be a significant worry.

While critics argue that a pre-pack sale doesn't always allow sufficient time for directors to come to an informed decision or creditors to be consulted, conversely the advantage of a pre-pack sale for a retail supplier is the speed with which the situation can be resolved. As shown by recent high profile pre-packs on the High Street such as USC, The Officers Club, Whittards of Chelsea and Robert Tchenguiz's Laurel Pub Company, by moving quickly and ensuring continuity of service, damage to the retailer's name, lack of confidence of suppliers and customers and uncertainty regarding employees can be minimised. Although a pre-pack sale is only one option available to a distressed retailer, it should not be ruled out without careful consideration.

For further information about pre-packs or any other issues involving business restructurings or issues caused by financial stress, please contact a member of our business restructuring services team:     

Sean Mcgrath

0845 165 5396