Statement of Insolvency Practice 16 – Pre-Packs

Following on from the article on the government’s announcement on the pre-pack insolvency sales process, this article explains the process further.

In a pre-pack a deal is worked out before the application to court for the administration order. All this happens in one movement and in the past, unsecured creditors, such as trade suppliers, may not even be aware that the business is in difficulty.

This sort of deal can make creditors that lose out, suspicious that they have been ‘stitched up’. The deals that attract the biggest criticism are those where the new company that has bought up the business, is closely associated with the former owners (phoenix).

The good

Contrary to popular belief these sorts of deals are not done in a couple of days. If the company is struggling with cashflow, then a pre-pack may be considered over a number of weeks. All other insolvency options or trading out options should be considered. Discussions may be ongoing between the management, secured lenders, landlords, pension trustees, unions, possible outside investors and financiers of future working capital.

Since 2010, the insolvency profession has had to follow a statement (code) of insolvency practice SIP16 that requires disclosure of the impending deal to the main stakeholders. Unsecured creditors such as HMRC and trade may still feel impotent, in that they cannot impact upon the deal.

In a pre-pack the new company or a third party buyer, takes over all the employment contracts under rules known as Transfer of Undertakings Protection of Employment Regulations (TUPE).

Pre-packs can preserve jobs, keep the business trading and quickly remove the crisis that caused the insolvency. But they are far from an easy option for the directors, buyer or employees.

The bad & down right ugly

Management can abuse the process by racking up debts quickly and then appear as the only buyer when the business gets forced into insolvency by the legal actions of a creditor.

Many IPs like pre-packs as opposed to the alternatives like CVA, as there is some certainty and finality to the procedure and they are guaranteed to get paid.

IPs also like the fact that their own period of risk is short as they have to pay wages, rents, rates, PAYE and VAT during a traditional administration. In effect the business is flipped and the IP’s risk mitigated.

We hear of unscrupulous IPs who agree to pre-pack a company for well below market value of assets. This really looks like a stitch up, SIP16 requirements seem to be steamrollered. One client told us that another IP said “what do you want to buy it for? £20k? Then that will be my fee”!

What about independent valuations, creditor consultation and marketing of the business (SIP 16 requires this).  How does this generate a better result for creditors as required under the Enterprise Act?

The alternatives

A powerful alternative is a company voluntary arrangement or CVA. This is where the company seeks agreement from its creditors to write off part of the (unsecured) debt and repay an agreed dividend over a three-to-five-year period.

This requires grit and determination from the directors of the business to turn around the company.

A CVA still has many of the powers of other insolvency procedures, in that it can quickly cut costs by terminating contracts of employment or lease obligations for instance. JJB Sports has used two CVAs to close non-performing stores.

It should also help generate cashflow by freezing payments to creditors while turning current assets of stock, WIP and debtors into cash. Assets aren’t subject to the massive devaluation that always occurs in administration or liquidation.

In a CVA the return to unsecured creditors is usually between 35-100p in £1, whereas in administrations and pre-pack administrations the return is usually 10p or less.

Source: Statement of Insolvency Practice 16

If you are a creditor facing this, then get in touch with Amril as we can assist you in this matter.