Vol 6 (2009) - Issue 2

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Pre-Packs – Success or Failure? You Choose

In the UK, the long awaited arrival of the Statement of Insolvency Practice 16 (‘SIP 16’) (pre-packaged sales in administrations) will be greeted by many as an overdue brake on the proliferation of abuse of the transfer of an erstwhile insolvent business to parties who have been conveniently lined up to acquire a business at a knockdown price.

However, before we lay blame at the door of wayward insolvency practitioners who are very happy to turn a blind eye to questioning the merits of such transactions, so long as it secures them a decent fee, we should first look at the root causes of the rapid evolution of the pre-pack.

In my opinion, the blame lays squarely at the door of the legislators and their desire to embrace the rescue culture as embodied by the Enterprise Act 2002.

Before the introduction of the ‘high speed’ administration process in September 2003, transparency existed in almost every administration; at the very least due to the obligation for any application to court for an administration to be supported by a directors’ affidavit and more importantly a 2.2 Report (pursuant to Rule 2.2 of the Insolvency Rules 1986) of the proposed administrator, as there was no automatic ability to appoint an administrator until then. The justification for the making of an Administration Order had to be clearly explained to a judge (who typically did not just waive such applications through) and was immediately placed on the record. This was originally a long-winded and expensive process, rarely preferred by secured lenders, who typically opted for the tried and tested administrative receivership, which offered them greater speed and control.

To the extent that pre-packaged business sales were undertaken in pre-Enterprise Act administrations, these therefore carried the obligation of full disclosure to the court in advance of any sale, rather than nowadays when an administrator’s proposals and strategy are often vaguely disclosed to creditors some ten weeks later, without even obliging the office holder to call a creditors meeting, if he perceives there being no prospect of a return to creditors.

No wonder directors of companies of all sizes embraced this innovative new practice in their droves, especially where they saw an opportunity to buy back their businesses (or at least the parts of it they most desired) relatively unchallenged and signed off by a licensed Insolvency Practitioner.

That’s the cynical view. which is clearly not without a ring of truth. But as a former cynic, after some five years of the new regime, I find myself a complete convert to a properly managed pre-pack process, and here’s why.

For sure, there will always be several abusers of any relatively toothless regulatory process, both amongst the population of directors of failed and failing companies and amongst some of the Insolvency Practitioners whose advice they seek. However, they are in the minority and the companies over which they have influence are relatively modest in size.

The vast majority of companies are run by honest directors who, by and large, obtain independent and objective professional advice, although none of us as Insolvency Practitioners are totally immune from giving directors advice as to why buying a business back from its administrator might be an attractive proposition for them.

Obtusely, the key advantages of pre-packs actually run contrary to the ‘best interests’ of any self-serving office holder; namely that trading administrations (or receiverships) are very expensive and generate significant fees and therefore a rapid arms-length sale should typically benefit creditors.

Informal research undertaken on a broad spectrum of retail administrations between 2004 and 2007 shows that for every GBP 1 of retail sales, on average 19 pence was expended on professional fees supervising that trading, and that is before taking into account the cost of wages, rent and other overheads incurred during an administration trading period. Therefore, the costs of a protracted trading process in an administration often serve as a catalyst for a rapid pre-negotiated sale.

The essence of a pre-pack has been largely misconstrued by the popular and financial press to represent a mechanism for directors to buy back from their nominated administrator, business and assets from their failed companies at a fraction of their market value without exposing the business to the market, leaving creditors with a fait accompli that they have little desire and even less financial muscle to challenge.