Benefits of pre-pack administrations

The use of "pre-pack" administrations

Dubbed a "new industry buzzword" following their use in high profile retail administrations such as Whittard, USC and the Officers Club, pre-packs are receiving greater attention in the media than ever before. Pre-pack cases are expected to rise in line with general company insolvencies.

Pre-packs are not new but they have increased in volume following the Enterprise Act of 2002. The process is viewed with some suspicion as creditors are informed of the pre-pack after the process is completed. What is more, it often appears that previous owners can buy back the businesses free of many onerous liabilities.

Yet according to R3 which is the trade body for Insolvency Professionals, and is made up of 97% of the UK's insolvency practitioners, the positive aspects of pre-packs are not reported and there are clear benefits to the process in the current downturn. Pre-packs can be an invaluable tool for an insolvency practitioner (IP), keeping a business trading and saving jobs. According to research being undertaken by R3 - In 92% of pre-pack cases, 100% of jobs are saved. Pre-packs also provide a better return for secured creditors when compared with their prospects should the company be simply liquidated.

What is a pre-pack administration?

A pre-pack is a deal for the sale of an insolvent company's business (and/or assets) which is put in place before the company goes into a formal insolvency process, usually administration. The deal for the sale of the business will usually have been worked out before the insolvency practitioner (IP) is formally appointed, and is then rapidly executed once the appointment is made.

The business is usually sold with little or no open marketing. Unsecured creditors are usually not informed of the pre-pack until after it has been completed. Secured creditors will usually be aware of the transaction as they will generally be required to release their security.

What are the benefits of a pre-pack administration?

More jobs are preserved
Pre-packs preserve more jobs than business sales (i.e. a going concern sale of the business negotiated and arranged after the commencement of the insolvency procedure). In 92% of pre-pack cases, all of the employees were transferred to the new company which compares with 65% for a business sale.

They provide a satisfactory return for secured creditors
The reality of a business going through insolvency is that the creditors very rarely receive all of the money owed to them. It is therefore more accurate (and helpful) to consider what creditors might reasonably expect in a distressed situation rather than the total amount owed. The average return for secured creditors in a pre-pack is an average of 42% as compared with 28% in a business sale. The average returns to unsecured creditors in insolvency cases are very low, pre-packs provide just 1% of return, whilst in business sales the average return is 3%.

The value of the business is retained
Pre-packs are deployed successfully when the business' principal assets are the employees, forward contracts or intellectual property, as in all service businesses. Once word of a company's financial difficulty gets out, it becomes much harder for IPs to retain the staff, suppliers and customers necessary to keep the company viable. Suppliers and customers will attempt to take their business elsewhere, leaving the company with few assets and, effectively, no business. Therefore, pre-packs are a tool to bring about the sale of a business which may have otherwise simply shut down.

What are the negative claims made against pre-packs?

Pre-packs are a "stitch-up"
It is understandable that creditors who are informed of a pre-pack deal after the fact would be suspicious of the procedure. Critics also believe some business people use pre-packs to get out of debts and obligations so creditors lose out as a result. There have been moves to improve the transparency of pre-packs. SIP (Statement of Insolvency Practice) 16 was introduced on January 1 2009 to require IPs to disclose to creditors why the decision to pre-pack was taken, the large amounts of associated information concerning that decision and the connections between the purchasing company and the company in Administration, i.e. the Directors and Shareholders.

It isn't right that a business is sold back to the owner of the company
The sale of a business back to connected parties is not exclusively a feature of pre-packs. In 52% of all standard business sales the business was sold back to connected parties. This figure is 59% in pre-pack administrations. This differs from a "phoenix" where the sale always involves the owner or connected parties. Faced with the decision between selling the business to a connected party or winding the company up, the best decision for the creditors is to sell the business on rather than allowing the business to fail as the returns would be considerably less.

R3, the insolvency trade body, is adamant that pre-packs have their place as independent research shows clear evidence that pre-packs (due to their speed) perform better than business sales taking place after an appointment in preserving employment. R3's President Nick O'Reilly said:

"Pre-pack administrations are not controversial when applied to the type of businesses where the principal assets are the employees or intellectual property, as in all service businesses. Trading on a service business is virtually impossible. If you tell the employees to hang in there for another six months or so, they will immediately get on the phone to find alternative employment leaving the company with no assets. Pre-packs are not immune from employment law and have to take the employees with them.

In the current downturn with fewer buyers around, a pre-pack is a good option for many distressed businesses."

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