Pre-Pack Admin – Pros and Cons

The reality of a company becoming insolvent is that the creditors very rarely receive all the money owed to them. Therefore, it would be more accurate (and helpful) to consider what creditors might reasonably expect. When other alternatives such as refinancing or a formal repayment plan have been considered, and, dismissed, a pre-pack administration can be a viable way forward. However, as with any insolvent process, there are pros and cons.

What is pre-pack administration?

A pre-pack administration is a formal insolvency process for insolvent companies. The procedure sees a pre-arranged sale of all, or some of the assets from the insolvent company into a new company, also known as a ‘newco’. The newco can have the same directors as the original insolvent company, or it could be a completely separate party. Along with assets, staff may also move to the new company under new contracts.

Once the assets are sold, the company is placed into administration, often meaning trade can continue without too much disruption. Any assets owned by the original company not sold would be realised through other means, and the company would then close.

Check out more information on pre-pack administration

Cons of pre-pack administration

News that a company has entered into any form of administration can be damaging for its reputation. In addition, pre-pack administration does have other perceived drawbacks.

Pre-packs are a ‘rip-off’ for creditors

Understandably, creditors informed of a pre-pack deal after the fact would be suspicious of the procedure. Critics also believe some business people use pre-packs to get out of debts and obligations, so creditors lose out as a result.

Issues with selling back to the current owners

In addition to some creditors perceiving they’ve been ripped off, they may have issues with a company being sold back to its current owners. The intended recipients of the assets may have been responsible for that company’s downfall; without evidence, they won’t let the new company make the same mistakes as the old.

While this could cause issue for some creditors, the sale of a business back to connected parties is not exclusively a feature of pre-packs. In 52% of all standard business sales, the business was sold back to connected parties. This figure is 59% in pre-pack administrations.

Pre-packs differ from a ‘phoenix’ where the sale always involves the owner or connected parties. Faced with the decision between selling the business to a connected party or winding-up the company the best decision for creditors would be to sell the business on, rather than allowing it to fail as the returns would be considerably less.

Pros of pre-pack administration

As with a standard administration, pre-pack gives the company breathing space to allow for restructuring and protects it from creditor action.

A better return for secured creditors

The average return for secured creditors in a pre-pack administration is 42%, compared with 28% in a business sale. The average returns to unsecured creditors in insolvency cases, however, are very low, – pre-packs provide just 1% of return, while in business sales, the average return is 3%.

The value of the business is retained

Pre-packs are deployed successfully when the business’ principal assets are the employees, forward contracts or intellectual property, as in all service businesses.

Once word of a company’s financial difficulty gets out, it becomes much harder for insolvency practitioners to retain the staff, suppliers and customers necessary to keep the company viable. Suppliers and customers will attempt to take their business elsewhere, leaving the company with few assets and, effectively, no business. Therefore, pre-packs are a tool to bring about the sale of a business which may have otherwise simply shut down.

More transparency

There have been moves to improve the transparency of pre-packs. SIP (Statement of Insolvency Practice) 16 was introduced in January 2009, which required IPs to disclose to creditors why the decision to pre-pack was taken, provide large amounts of associated information concerning that decision, and detail the connections between the purchasing company and the one in administration, i.e. the Directors and Shareholders.

In summary

Pre-pack administration can be a viable way forward for insolvent companies where other insolvency procedures have failed or been rejected. There can be a negative stigma attached to the process, and some creditors may think of it as a quick way for companies to get out of their obligations while essentially getting to keep their company. In practice, creditors may receive more of a return than if the company was just liquidated, and the value of the business could be retained through the insolvency. With the introduction of Statement of Insolvency Practice 16, in which IPs disclose to creditors why the decision for the procedure was taken, there has been an attempt to make the process more socially acceptable.