Live and Let Die: Pre-packs in Perspective

Prior to the implementation of the Enterprise Act 2002, the majority of company insolvencies were liquidations. The majority now are administrations, and the majority of business and asset sales are through pre-packs.

I. What is “administration”?

Administration is the procedure under the Insolvency Act 1986 where a company may be reorganised or its assets realised under the protection of a statutory moratorium.

Prior to the Enterprise Act 2002, administration could only be commenced under court order. However, this earlier transparency evaporated as the appointment of administrators became, generally, a paper exercise. Thus the time and cost of placing a company into administration was greatly reduced, and is now faster and cheaper than liquidation. Hence a lot of insolvencies which would previously have been liquidations are now administrations.

2. What is a pre-packaged administration (“pre-pack”)?

This is where the sale and purchase of the company’s business and assets, or selected parts of them, are negotiated by the parties shortly before, but in contemplation of, the administrator being appointed. Under a pre-pack sale, businesses are usually sold with limited or no marketing, giving rise to criticism that the best price may not have been achieved.

Unsecured creditors have no notice before the pre-pack happens, and therefore no opportunity to protect or promote their interests by voting on the administrator’s proposals as was previously the case. This is because, post 2003, there is no obligation on the administrator for advance disclosure of his proposals; these are only vaguely disclosed to creditors some weeks later, with no obligation to convene a creditors meeting if there is no prospect of a dividend.

3. What is a “Phoenix” pre-pack?

A Phoenix is where the company closes one day and the business rises from the ashes the next in a new company with the same management, possibly the same or very similar name, but helpfully liberated from its old debts. Management can reacquire the business at a fraction of its value, leaving creditors high and dry and ill equipped to challenge.

It is this process which most concerns unsecured creditors and outrages media pundits and politicians who perceive it as dodgy asset stripping by unscrupulous management, and endorsed by a presumably equally unscrupulous or naive insolvency practitioner (“IP”).

However, there are as many supporters of pre-packs as there are critics. The pre-pack process can preserve goodwill and jobs, is quicker and costs less than the more traditional processes and contributes less to the pocket of the IP. Live and let die is better than die and let rot!

4. The Practical Realities

The notion that pre-packs are a new invention is wrong. They have existed for years but were much less common for the above reasons. However, the legal duties on the administrators (and on the directors) are in principle exactly the same whether pre-pack or otherwise. In fact, the obligation on the IP is more onerous in a pre-pack. Their responsibility is to achieve “the best value reasonably obtainable in the circumstances”. If it can subsequently be demonstrated that he has not got best value then he can be liable to make up the difference. For this reason, the IP will invariably take professional advice.

Nonetheless, IPs might favour pre-packs, particularly during an economic drought, as trading administrations can be very dangerous to them, where costs and debts incurred after appointment are payable before the administrator’s own remuneration.

Unsecured creditors face three major problems with pre-packs. First, lack of information. SIP 16 (effective since January 2009) partly addresses this by providing a reasonable degree of transparency albeit after the event. Second is the risk of throwing good money after bad which in turn relates to the third which is establishing if the price really was materially wrong. The system does nothing to encourage creditors to pool information and resources in scrutinising pre-pack (or non pre-pack) deals; and divided they fall. This may be a legislative lacuna, though in practice unless creditors were to agree on a common agenda rather than pursuing individual ones, it is difficult to see this defect being capable of effective remedy.

In many cases of creditor angst, the reality of the problem can lie in poor communication from directors, the IP, or both, rather than the terms of the pre-pack. A fair question to ask is whether there was a better process which could have been employed in the circumstances, such as more informal arrangements. There is some evidence that such a ‘live and let live’ approach is starting to gain ground in some places, but inevitably slowly and falteringly as the past tries to catch up with the present.

Mike Stubbs
mike.stubbs@mishcon.com