Pre-pack Administrations: An Overview

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What is a “pre-pack”?

The term “pre-pack” is used, in the context of administration, to describe the process through which a company is put into administration and its business or assets (or both) immediately sold by the administrator under a sale that was arranged before the administrator was appointed.

Often a pre-pack involves the sale of a company’s business on a going concern basis. However, sometimes a pre-pack will just involve the sale of some or all of the assets of the company. The rest of the company’s assets or the business may be sold off in a separate transaction, or the company may be put into liquidation.

The benefits of a pre-pack strategy

The benefits of a pre-pack strategy depend on the exact circumstances, but can include the following:

  • A pre-pack sale can result in the quick and relatively smooth transfer of a business to a new owner, compared to a sale negotiated at length after the insolvent owner goes into administration. This can minimise the erosion of price caused by the fact of a seller’s insolvency, and also reduce the costs of the administration process, which ultimately results in a better return for creditors.
  • Pre-packs can minimise the erosion of the confidence of a business’ suppliers, customers and employees that is inevitably caused by insolvency proceedings over the owner of the business.
  • Pre-packs can save more jobs than an administration that attempts to continue to trade the business pending a later sale or other type of restructuring.
  • Often there is little choice. If there is no funding available, it may not be possible for the administrator to continue to trade the business until it is sold at a later date or otherwise restructured. The alternative here would be liquidation and the immediate cessation of the company’s business.
Criticisms of pre-packs

The main criticisms of pre-packs are:

  • A lack of transparency. Unsecured creditors often do not realise that a pre-pack sale is going to happen and so have no opportunity to protect their interests by considering and voting on the pre-pack proposal. (By contrast, secured creditors are usually involved, because they usually need to consent to the release of their security where secured assets are to be included in the sale.)
  • A lack of accountability. The Insolvency Act 1986 (IA 1986) does not expressly provide for pre-packs (though it provides the administrator with general powers of sale) and the decision to execute a pre-pack sale is a matter for the commercial judgment of the administrator. Accordingly, the administrator can sell assets of the company before his proposals have been agreed by creditors and without court sanction.
  • Pre-packs do not necessarily maximise returns for unsecured creditors. The value of a business could be destroyed if its financial difficulties are leaked. As a result, an administrator selling the business and/or assets of a company in a pre-pack will not necessarily test the market value of the business by wide advertising for interested buyers. This means that businesses or assets sold by way of a pre-pack are usually sold with limited marketing compared with a normal administration. That said, Statement of Insolvency Practice 16 now contains more demanding standards for advertising a business for sale in the context of a pre-pack in an attempt to address this criticism.
  • Pre-packs are similar to the outlawed practice of creating “phoenix” companies. This outlawed practice involves a company being put into liquidation by its management, before the same business is transferred to a new “phoenix” company, but without the debts of the old company. Creditors tend to be most suspicious about pre-packs when the business is sold back to the original shareholders or directors of the now-insolvent company. This is seen as allowing management to “asset strip” a company or “ditch” its debts. As a result of this criticism, there are now significant disclosures that need to be made to creditors where a sale is to a connected party.
  • The proposed administrator has an inherent conflict of interest. The proposed administrator may be introduced to the company by its directors in the context of a pre-pack proposal that the directors have begun to formulate. If the relevant insolvency practitioner wants to be appointed as the company’s administrator, he has an incentive to agree to implement this pre-pack proposal.
  • Writing off liabilities using a pre-pack is a short-term fix. A pre-pack sale of a business and assets doesn’t subject the business being sold to a restructuring, which is often necessary if the business is to survive in the long term.
 What are the pre-pack guidelines for administrators?

Administrators are subject to professional guidelines that relate specifically to pre-packs. Statement of Insolvency Practice 16 (“SIP 16”) was introduced in response to creditor concerns about pre-packs and aims to address these concerns by making the process more transparent, including by providing creditors with information about the marketing of the business and the alternatives considered. It sets out the standards that the administrator must adhere to, and includes the information that the administrator should disclose to creditors within seven days of completing the pre-pack sale. Although SIP 16 is not legally binding, failure to comply with it could result in an administrator facing regulatory or disciplinary action.  

If the sale contemplated by the pre-pack is to a person or persons connected to the seller (by reference to sections 249 and 435 of the IA 1986), then Statement of Insolvency Practice 13 will also be relevant. This imposes compliance standards and disclosure duties on the administrator in disposals of assets to connected parties that overlap, in the context of pre-packs, to some extent with those under SIP 16. 

Considerations for directors in the context of a pre-pack

Section 214 and section 246ZB of the IA 1986 impose personal liability on directors for wrongful trading. To avoid potential liability for wrongful trading, the directors of an insolvent company need to make sure that they do everything they can to minimise loss to creditors. Directors should take independent legal advice, especially if they will acquire an interest in the company’s business or its assets through the pre-pack. Since 1 October 2015 administrators have had the power to bring an action for wrongful trading, so a pre-pack strategy will not, by itself, necessarily delay or divert a potential wrongful trading action.    

How do pre-packs affect employees?

Pre-packs may be used to rescue a business where its value is concentrated in its skilled employees. If the owner of the business is subject to a protracted administration process then key employees may lose confidence that the company can be saved and seek alternative employment.

Where a pre-pack takes place, the employees engaged in the business will usually transfer to the purchaser through the application of the Transfer of Undertakings (Protection of Employment) Regulations (SI 2006/246) (TUPE), with their existing terms and conditions and length of service preserved. A dismissal as a result of the transfer (whether taking place before or after the transfer) will usually be automatically unfair, although there are exceptions to this, primarily in the event of redundancy. The purchaser will take on most of the employer’s liabilities in respect of its employees, except for certain pre-existing debts which may be met by the Secretary of State, including up to eight weeks’ unpaid wages.  

Do unsecured creditors have any way to challenge a pre-pack?

Creditors have a statutory right to bring an action against an administrator under paragraphs 74 (Challenge to administrator’s conduct of company) and 75 (Misfeasance) of Schedule B1 to the IA 1986.

In the context of a pre-pack, creditors should be aware of the requirements on an administrator in SIP 16 and should check to see whether these have been followed. A less formal way of challenging a pre-pack is to use the IS’ complaints gateway. Administrators could face regulatory or disciplinary action if they have failed to comply with SIP 16 and directors of a company that is pre-packed can be disqualified if their conduct in the period leading up to the pre-pack shows them unfit to be a director. For more information see our guidance note: Directors Duties and Insolvency

For further advice please contact our Restructuring and Insolvency team on 0345 20 73 72 8 or email info@thursfields.co.uk

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