Pre-packs are good for creditors

Pre-pack administrations, where the business of an insolvent company is sold as soon as the administrators are appointed, often to the company’s management or shareholders, are under scrutiny.

• The Business and Enterprise Select Committee (Chairman – Peter Luff MP) examined the issue when Stephen Speed, the head of the government’s Insolvency Service, appeared to be questioned on 27 January.
• BBC Radio 4’s File on Four recently illustrated creditors’ concerns about companies in the printing and retail industries where pre-packs had occurred (transcript here).
• BBC 2’s Newsnight is shortly also to explore the sales of assets to failed companies’ directors or their associates through pre-pack administrations.
• Press articles frequently refer to the effect of insolvencies on creditors and report surprise that businesses can be allowed apparently to continue after dumping creditors.

Two separate issues should not be confused.

Firstly, creditors suffer financial loss in an insolvency because the company has failed. The pain may feel worse if the management thought to be responsible for the loss appears somehow to benefit. But the fact remains that it is the company failure that causes the loss.

Secondly, insolvency procedures operate in the interests of creditors. Of course they must work properly to produce the best result, but that is why insolvency practitioners are highly trained, licensed, strictly regulated and, as officers of the courts, obliged to act properly. Insolvency is a complex process where a highly specialised area of law confronts commercial reality. Explanation is therefore crucial and the regulators emphasise transparency, for example in Statement of Insolvency Practice (“SIP”) 16 “Pre-packaged Sales in Administrations”, which came into effect for adminstrators appointed after 1 January 2009.

Until the recession, few people in business felt the need to think about insolvency, but understanding the insolvency process and its safeguards may help creditors appreciate that the procedures and the practitioners really do act in the interests of the creditors.

How can it be right that the directors appoint the administrator to sell the assets back to them?

The administrator acts for and has his remuneration fixed by the creditors. Of course he may have been introduced by the directors, but they have a legal obligation to call in an insolvency practitioner as soon as it becomes necessary.

Why were the assets sold so cheaply?

The administrator’s job is to get the best result for the creditors (if the company can’t be saved). One of his skills is selling distressed businesses and assets. Sometimes there may have been no obvious marketing, in which case the administrator will have commissioned an independent valuation and taken specialist professional advice to get the best deal.

At the time of the pre-pack sale (or shortly afterwards when they find out about it), creditors may not know enough about the precise circumstances to make a fully informed judgement, which is why the administrator is required by SIP 16 to explain the sale to creditors as soon as practicable. Ideally they should learn about it from the administrator immediately, with a full explanation so that even if not pleased about their losses, they are at least satisfied that the insolvency procedure is achieving the best recovery.

What if I’m not convinced it was the best deal?

Remember that it must be the best result for all creditors, including some who may have different interests; but, if you’re not satisfied, engage in the process.

Talk to the administrator – if you know something he doesn’t, he’ll want to hear from you.

Raise your concerns at the creditors’ meeting – other creditors may share your views or could have a different perspective.

To be involved in monitoring the administration and assisting the administrator to get the best result for creditors, get yourself elected onto the creditors’ committee, but be aware that your duties there will be to act in the interests of all creditors rather than just yourself or an interest group.

It may be possible to nominate another insolvency practitioner to be liquidator once the administration ends, for an independent professional review of the administration. If not, and you still have concerns, you should consider seeking specific advice from an insolvency practitioner or insolvency lawyer on other remedies such as applying to court.

If you think the administrator has done something wrong you may want to complain to his regulator (the administrator has to tell you who that is – there are several), but that is more likely to lead to sanctions against the administrator than to things being put right in your particular case.

Why should the directors get away with it?

Buying a business from an administrator isn’t itself a bad thing. But if you know of impropriety that went on before the administration, tell the administrator. He can then take any necessary action for the benefit of the creditors.

Are pre-packs a good thing?

Independent research into pre-packs by Dr Sandra Frisby of Nottingham University has established that in over 90% of pre-packs all the jobs in the business are saved, compared to only about 60% in other insolvency business sales.

There is no evidence that returns to unsecured creditors are better in pre-packs than in those administrations where the administrator secures funding to allow the company to continue to trade for a period while he markets and sells the business. Pre-packs can, however, reduce the risk of value destruction as a result of the insolvency process; they often realise more than simple liquidation; and they almost invariably cost less than a period of trading followed by a business sale.

The crucial point though is that in any particular case, the insolvency practitioner has to get the best result for the creditors as a whole. There is no evidence that this is not happening in the vast majority of cases. If the administrator has chosen to use a pre-pack it is because he believes that it is in the best interests of the creditors as a whole that he should do so.

Once the administrator has been appointed, the creditors’ money has already been lost; and if the alternative is worse, using a pre-pack is undoubtedly a good thing.