Pre-packs - pro or con?

During the past 12 months or so, the global downturn has placed many businesses under increased stress.  The lack of credit availability, financial sector turmoil and the contraction of trade markets in the UK and overseas has contributed to the unprecedented rise in insolvencies, expected to reach 55% by the end of 2009.

Among all this unrest and uncertainty, few aspects of the global downturn have polarised opinion as much as pre-packed administrations.  On the one hand there are the clear benefits of maintaining jobs and re-structuring the ailing company’s finances in a condensed timescale and on the other is the fact that in many instances creditors are left ‘in the dark’ and presented with a ‘done-deal’.  As a result, it’s not surprising that creditors regard pre-packs as a ‘con-trick’.

So, what is a pre-pack? Pre-packaged administrations or ‘pre-packs’ as they are more commonly known are not a new phenomenon, but insolvency practitioners have used them more frequently since the introduction of the 2002 Enterprise Act, which sought to encourage the rescue of more businesses rather than go through receivership and liquidation.  In this respect, it has been hugely successful, as in the early 1990s around 80% of insolvencies ended in receivership, whereas today, most lead to administration.

A pre-pack is a specific process or ‘deal’ that enables an insolvent business to sell of its assets before entering a formal insolvency process. Often used conjunction with the administration procedure, they enable companies enter into administration while allowing them to stay open and safeguard jobs. Industry figures show that they are very effective in saving jobs, with all jobs being secured in more than 90% of deals. They also tend to be of most use to owner managed enterprises or where the value of the business is in assets or key workers that would lose value or be lost once the administration process is declared. As a result, there is often no visible marketing of the business and only secured creditors will be aware of the process in advance as they are required to release their security.

Even HM Revenue & Customs have been on the wrong side of the pre-pack.  In a 2007 court case, regarded as a landmark ruling, HMRC attempted to halt a pre-pack sale arguing that where a major creditor is opposed to a pre-pack, it should be allowed to block the sale.

In this instance, HMRC was owed £1.7million and was keen to wind up a firm of solicitors to receive payment through liquidation.  The courts’ decision supported the pre-pack as being the best way to safeguard the 50 jobs and protect its clients' interests.  The ruling showed that administrations could be granted even when opposed by a major creditor.

In reality, this process means the troubled company can have a deal to sell all sewn up in advance, so it can change ownership, literally, overnight, without a break in trading and maintaining business as usual. However, as most creditors tend to be unsecured, these suppliers are given no prior warning prior to this situation developing and under the current legislation, the new purchaser is not liable for any outstanding debt. This leaves creditors, such as landlords, suppliers and service providers in the lurch, unpaid, and having to make tough decisions about whether to write off the outstanding debt and continue trade under the new ownership. In some cases, their order book is too important to ignore and they have no choice.

In some widely profiled recent case, businesses have declared themselves insolvent one day only to be purchased in a ‘pre-pack’ deal by the same person, under a different guise the next. Although this process is completely legal, there are some fundamental flaws in the process and accountability, which have understandably attracted criticism and accusations of ‘suspicion’ from a number of sectors, not least the ‘duped’ creditors.

However, at the end of January 2009, in a move to help lift the veil of secrecy surrounding pre-packs, the Insolvency Service stated that insolvency practitioners are now required to send them a copy of information given to creditors, explaining why a pre-pack was considered to be the best option. The guidelines, known as SIP 16 require that creditors be given a detailed explanation and justification of why a pre-pack sale was undertaken.  The insolvency practitioner must also show that they acted with due regard for creditors’ interests.

Admittedly, this is a step forward, but the nature of pre-packs mean that there will still be countless suppliers that won’t get paid and will feel they have been ‘conned’.  Like them or loathe them, it appears that pre-packs are now a fundamental part of the current business environment, which means that the incredibly strong opposition to them will also continue until a more transparent process is developed or they are outlawed completely. Currently, Atradius is currently lobbying against ‘pre-packs’ along with the ABI, which has our full support.