When companies rise from the ashes

We have all probably faced the situation of discovering that a company with which we have been trading seems mysteriously to have gone off the face of the earth, only to reappear in a slightly different guise after just a few days. The end result is, for instance, that the old company owes us money that does not get paid, but then appears to go on trading much as before whilst ignoring previous liabilities.

Over the years, more than a handful of clients have come to us and asked how this magical process has been achieved. They want to know whether is it legal, rather hoping that it is not. In the corporate world, this phenomenon is known as a ‘pre-pack’. It may arise when a company goes into administration. It is usually legal, but the unsecured creditors are very much at risk of being disadvantaged. So it deserves explanation, for their benefit in particular but for others too.

What is a pre-pack?

Pre-pack is the name given to an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser before the appointment of an administrator. The sale is completed by the administrator shortly after their appointment. This reverses the standard process, where the administrator starts marketing the business after being appointed. The pre-pack purchaser may be a competitor or, as is often the case, the existing management team.

What are the advantages of a pre-pack?

• The main advantages of the process stem from the speed with which it can be concluded. For example:

administration costs can be reduced, which may mean a better return for creditors;

key staff can be retained, as they do not have time to seek alternative employment;

more jobs may be saved than in a normal administration process;

if stock has a limited shelf life, there is more scope to sell it at full value; and

adverse publicity, media speculation or damage to goodwill may be minimised.

• Some unsecured creditors, such as suppliers, may be engaged by the new business.

• Often there is no other option, except liquidation and immediate cessation of business.

What are the disadvantages of a pre-pack?

Lack of transparency

Pre-pack arrangements are generally made quickly and in private, albeit with the co-operation of secured creditors. Unsecured creditors are often unaware that a pre-pack is going to happen, so they do not have the opportunity to protect their interests by considering and voting on the pre-pack proposal.

Lack of accountability

Administrators involved in pre-packs do not have to obtain prior approval for their actions from the Court or creditors in the same way as they do in a normal administration. There are no specific regulations that deal with pre-packs, which can lead to a lack of confidence in the openness of the procedure.

They do not maximise returns for unsecured creditors

A pre-pack sale of a business is often conducted with limited marketing compared with a normal administration. It is therefore impossible for the proposed administrator to test the market fully because of the risk of the company’s financial difficulties being leaked. Consequently, the assets of the company may be sold at an undervalued price or the goodwill of the business may not be valued accurately because of the speed of the sale.

Writing-off liabilities using a pre-pack is a short-term fix

A pre-pack does not subject the company to a restructuring, which is often necessary if the business is to survive in the longer term. It is debatable whether a business that has already failed will do any better if it remains under the control of the same management team.

Pre-packs are similar to the outlawed practice of creating “phoenix” companies

Creditors tend to be suspicious of pre-packs when the business is sold back to the original owners. Under the pre-pack guidelines, administrators have to disclose to creditors the name of the buyer and whether there is any connection between the buyer and the company. There are concerns that there is the potential for abuse of the process by directors seeking to purchase the business at an advantageous price and simply avoiding paying creditors.

Issues for directors of a pre-packed company

• The directors of a company who are involved in a pre-pack need to make sure that they do everything they can to minimise loss to creditors. Directors should take independent legal advice, especially if they acquire an interest in the company’s business and assets through the pre-pack.

• The Insolvency Service has indicated that it will use its enforcement powers to penalise any directors that misuse the administration process to seek to gain a benefit themselves.

Wherever a business or individual becomes drawn into issues surrounding a pre-pack administration, they may need expert legal advice to safeguard their interests. So, the ailing company and its directors, the prospective new owners of its business or assets, the employees, suppliers and creditors may all need advice, either individually or collectively.