The use of "pre-pack" administrations What are pre-pack administrations? What are the benefits of a pre-pack administration? What are the negative claims made against pre-packs?
Pre-packs are not new but they have increased in volume following the Enterprise Act of 2002. The process has been viewed with some suspicion as creditors are informed of the pre-pack after the process is completed. However since new government regulations came into force in 2021, it is not quite as easy for previous owners to buy back the business as a strategy to remove onerous liabilities (see below).
Yet according to R3, the trade body for Insolvency Professionals, which 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.
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.
The government has published guidance on the latest pre-pack administration rules here.
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.
A recent example, in August 2022, was the collapse of Furmanac, a long-established bed manufacturer. It had been suffering badly with the stop-start Covid lockdowns, only to come out into a period of material supply shortages and cost rises. Normally, this company traded profitably and easily navigated the usual market cycles. A review of the company's finances demonstrated to the administrators that there was a path forward utilising a pre-pack administration that could ensure ongoing trading and safeguard 160 jobs.
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.
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.
More recently (effective 30 April 2021), the government introduced new reforms that essentially require connected party buyers to commission an independent written 'evaluator' opinion on whether the terms of the business sale are reasonable. The evaluator cannot be the administrator or an associate of the company or the administrator. Their report must include:
- a statement whether the evaluator is or is not 'satisfied that the consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances';
- the evaluator’s reasons for coming to their opinion;
- the consideration that will be paid; and
- the identity of the connected person and their connection to the company.
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."
Also see:
Selling your struggling business prior to insolvency
White paper: How to find and buy distressed businesses and assets
How to profit from buying distressed businesses
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