Pre-Packs Revisited

The public’s general perception of pre-packaged administrations (“pre-packs”) continues to be negative.  This is despite the fact that Insolvency Practitioners (“IPs”) are having to show greater transparency of the process by virtue of the best practice guideline, Statement of Insolvency Practice 16 (“SIP 16”).  SIP 16 was introduced more than a year ago.

The typical view of the public, and certain creditors, is that IPs are persisting in the practice of dodgy pre-packs, allowing owners and directors to buy back their businesses for very little consideration.

It must be remembered that the chief objective of SIP 16 was to provide better information for creditors, greater visibility of the process and ultimately to produce better pre-packs.

It should also be noted that the main advantages of pre-packs are generally as follows:

• There is a seamless transfer of the business to a new company.
• Customers are retained and are often largely unaware of process.
• Most employees are retained.  Importantly, this includes employees who might have left if they knew of insolvency.
• There are higher realisations for creditors if goodwill is maintained.  This is particularly true for secured creditors as they generally rank ahead of others.
• Suppliers may have ongoing trade with the business.

Regardless of these advantages, the attack on pre-packs appears to be relentless. It is likely that requirements for IPs will become more onerous as a result of the ongoing public debate.

Adherence to SIP 16

The Insolvency Service is actively monitoring the compliance with SIP 16 by IPs.

An existing monitoring report from 2009 concludes that only 3% of IPs did not materially comply with SIP 16.  This suggests that there is no widespread abuse of the process to the detriment of creditors.

However, there are shades of grey when it comes to compliance with all of the disclosure requirements of SIP 16.  The report suggests that approximately one third of the reports to creditors were not fully compliant in this respect.

In my view, the key elements of the pre-pack that require greater disclosure are:

• Valuations obtained for the business and/or underlying assets – this includes tangible assets (plant and machinery, property, stock) and intangible assets (goodwill, database, website, patents, etc)
• The marketing process – the steps taken to market the business and assets, and to genuinely achieve the highest possible realisations in what is usually a tight timescale.
• So the effect of SIP 16 has been to generally improve the transparency of pre-packaged administrations to creditors, and to provide much earlier information than was previously the case.  On the downside, some of the most important facts, and justifications for the pre-pack, may still be lacking.
• The additional effect of SIP 16 has been to focus the minds of IPs on producing better quality pre-packs and to discourage inappropriate behaviour.

Secured v Unsecured Creditors

The public’s negativity to pre-packs could be turned around by continuing to demonstrate that returns to both secured and unsecured creditors are improved by a pre-pack (as opposed to a business sale without the pre-commencement negotiations associated with pre-packs).

Some IPs might argue that a pre-pack procedure is justified as long as one category of creditor benefits from the process.  It would generally be secured creditors (typically banks) who fall into this category.

The use of pre-packs would be more palatable to the public and unsecured creditors if it could be shown that there are also advantages for the unsecured creditors.

A leader in the research in this field is Dr Sandra Frisby (University of Nottingham).  She has done extensive research over a number years and has used many examples of administrations (pre-packs and the alternatives) in her studies.

Dr Frisby has recently published further conclusions to these studies and the results are encouraging for the use of pre-packs.

For secured creditors, pre-packs generally offer a better chance of a higher return than do business sales.  A secured return of 75% or more has been recorded in a further 3% more pre-packs.

The percentage of pre-packs that return nothing to unsecured creditors has decreased dramatically.  More significantly, the average return from pre-packs to unsecured creditors is 5%, which is 25% higher than the average achieved in business sales (at 4%).

While these are low percentages, it still demonstrates that all creditors may be better off with a pre-pack strategy.

Conclusion

Dr Frisby’s research defies the common perception that pre-packs maximise value for only secured creditors.  A pre-pack does not necessarily shift value towards secured creditors and away from unsecured creditors.

The continued application of SIP 16, and the ongoing monitoring of its use, should lead to better quality pre-packs and the discouragement of inappropriate or dodgy practices by IPs.

Neil Chesterton

The MacDonald Partnership Plc

Appendix 1

Summary of a Pre-Pack Admin

The concept of a pre-pack admin is not new but its use is growing.  It is a procedure in which the sale of a struggling business is agreed before the company is put into Administration.

The basic procedure is as follows:

• The old company is insolvent
• A new company is formed
• The debts of the old company are left with the old entity
• This gives the business a fresh start financially (the business survives but the old company does not).

But one must still remember the 3 key ingredients of a turnaround:

• restructuring (the Administration process itself)
• refinance (new and/or replacement money), and
• management (both people to take the business forward and a properly structured game plan)

The valuation of the assets is paramount to the process.  The IP will always require assets, both tangible and intangible, to be valued by an independent third party.