The evolution of pre-packs

Pre-pack administrations are the current hot topic in insolvency. Whittards of Chelsea and USC both used the process. Such high profile cases have resulted in substantial press coverage about the use of the pre-pack, much of which has been uninformed. Some newspaper columnists have even likened pre-packs to the phoenix companies so prevalent during the last recession. So what are pre-packs, why are they such a divisive topic and what opportunities do they present for financiers?

The pre-pack process

A pre-pack occurs most commonly in the context of an administration of a company. It involves the negotiation of a sale of some or all of its business before it goes into administration. The sale is then completed as soon as, or shortly after, the administrator is appointed.

Since the insolvency provisions of the Enterprise Act took effect in 2003 directors have been able to put their company into administration without having to obtain court permission. Certain criteria have to be satisfied, but the main requirement is that the administration will achieve one of three objectives. These are rescuing the company as a going concern, achieving a better result for the company’s creditors than would be likely if the company had gone immediately into liquidation or realising property to pay secured or preferential creditors.

Administration is attractive for a company in financial difficulties because it prevents any legal action being brought against the company without the consent of the court or the administrator. This provides a breathing space during which, in appropriate circumstances, the business can be reorganised with a view to returning it to the control of its directors once the administration is over or selling the business in a form likely to attract a buyer at an acceptable price.

Objections to pre-packs?

Criticism has centred on the fact that a pre-pack can allow a failing business to leave its liabilities behind and emerge immediately after sale as an ongoing business without those liabilities. The fact that the directors whose managerial failings led to the company going into administration are often involved with the purchaser, does not assist public perception either.

Creditors have complained of not being consulted sufficiently. However, the only meaningful economic objection by a creditor to a pre-pack should be that it has failed to realise as much for the business and assets as another available option would have achieved. In practice the objections tend to relate to perceived unfairness which arises from a suspicion of the pre-pack process.

A more balanced view?

The reality of pre-packs is somewhat different from that portrayed by the mainstream media. An administrator is required to obtain the best value for the business and is accountable to creditors, whether secured or unsecured, and the court for all actions taken. It follows that a prepack does not, of itself, indicate that the exit will be a cheap sale to a purchaser backed by the company’s former directors.

In practice a pre-pack often represents the best, or only, chance of obtaining funds for creditors. A purchase involving the former directors may often be desirable, as they tend to be the only parties interested in acquiring the business, because they may be the only persons with the necessary background to trade it.

This approach may be objectionable to the creditors, however the critical question is whether or not more monies could have been obtained using an alternative option.

The regulatory environment

Pre-packs are far from new, dating back to around 2002. However due to the increasing use of prepacks those regulating the insolvency industry felt the need to issue guidance about how insolvency practitioners should deal with them.
Guidelines issued in January 2009 seek to improve the lines of communication by requiring administrators to provide a detailed explanation, and justification, to creditors of a pre-pack sale.

In particular, special mention must be made where the purchasers were connected with the company in administration. The administrator is also encouraged to hold a meeting of creditors as soon as possible following appointment, so as to allow creditors an opportunity to raise any questions they may have.

Financiers

Pre-packs can provide funding opportunities for financiers willing to finance them, or exit routes for those wishing to recover their money and move on. Under the new regulatory regime insolvency practitioners must demonstrate that funding options have been considered and, where relevant, approaches for funding to trade the business made. So to that extent they have a clear incentive to talk to financiers.