A pre-packaged business sale (or “pre-pack”) is an arrangement under which the sale of a company’s business or assets is agreed in principle with a buyer prior to the appointment of an insolvency practitioner (most commonly an administrator), who then executes the sale shortly after his or her appointment.
The number of pre-packs in the United Kingdom have increased considerably in the past 12 months and are expected to rise in line with general company insolvencies. Recent high-profile deals such as the management buy-outs of MFI, The Officers Club and Whittard of Chelsea have brought pre-packs to the media’s attention. Concerns have been raised regarding their lack of transparency, susceptibility to abuse and undesirable resemblance to the outlawed “phoenix companies” phenomenon.
These concerns have led to the adoption of a new statement of practice for insolvency practitioners involved in pre-pack administrations and to the publication of a report by the Commons Business and Enterprise Committee on May 6, 2009.
The Legal Framework Within Which Pre-Packs Are Effected
Although the UK Insolvency Act 1986 does not expressly provide for pre-packs, the courts have supported their use, confirming that an administrator has the power to execute a pre-pack despite the objections of the majority creditor (DKLL v. HMRC  EWHC 2067). Earlier cases have confirmed that administrators are permitted to sell the assets of a company in advance of their proposals being approved by unsecured creditors and without the direction of the court (Re T& D Industries  1 WLR 646; Re Transbus International  EWHC 932). This line of cases arguably supports the philosophy of limiting judicial intervention in the economic and business decisions of experienced and licensed insolvency practitioners. This is in keeping with the purposes of the provisions introduced by the Enterprise Act 2002, which streamlined the administration process, focusing on company rescue and reducing the courts’ involvement.
An administrator must perform his or her functions with the primary objective of (a) rescuing the company as a going concern or, failing that, (b) achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up or, failing that, (c) realizing property in order to make a distribution to one or more secured or preferential creditors. In a situation where the administrator considers it is not reasonably practicable to pursue the primary objective (for example, where there is insufficient cash to carry on the company’s business as a going concern), the administrator might well conclude that a pre-pack sale is the optimal means of achieving objective (b) or failing that, objective (c).
Advantages and Disadvantages of Pre-Packs
The main criticism that has been levelled at pre-packs is the lack of transparency in the proceedings because unsecured creditors generally only become aware of the sale after it has been agreed, as opposed to the position in a traditional form of administration, where creditors have the opportunity to consider and vote on the administrator’s proposals in a creditors’ meeting. Secured creditors are not affected because they are involved in the pre-pack strategy in giving their consent to release their security over the company’s assets prior to completing the sale. However, the implementation of a recent Statement of Insolvency Practice goes some way towards meeting this concern.
Another concern that has been raised is that proceeds may not necessarily be maximized in the case of a pre-pack, as they are usually effected with limited marketing compared to a normal administration. In many cases, the sale is to the original owners or management who led the company into insolvency. This has led to the perception of pre-packs as an indirect means of creating phoenix companies (a practice outlawed by the Insolvency Act 1986), resulting in a new company with a very similar name, and the same or similar management, business and employees but without the liabilities to the creditors of the insolvent company. Research by Dr. Sandra Frisby of the University of Nottingham concluded that, on average, unsecured creditors recover only 1 percent of their debts during a pre-pack (compared to 3 percent in a private business sale), whereas secured creditors recover an average of 42 percent of debts in a pre-pack (compared to 28 percent on a business sale). In the pre-pack sale of Cobra Beer agreed on May 29, 2009, it has been reported that unsecured creditors who are owed up to £75 million will receive nothing whereas secured creditors who are owed approximately £20 million will be paid in full. However, the percentage of debts recovered by unsecured creditors is inherently limited by their lowly position in the hierarchy of stakeholders.
There is a potential conflict of interest on the part of the proposed administrator (whose appointment may be dependent on his or her prospective approval to the pre-pack strategy). The Commons Committee has said that the appearance of self-serving alliances between directors and insolvency practitioners could lead to reputational damage to the insolvency system.
Complaints have been received by the Commons Committee that competitors are adversely affected by pre-pack sales, as they continue to carry costs and honor financial obligations that the pseudo “phoenix companies” have shed.
Furthermore, it has been suggested that there is a danger that pre-packs represent a mere short term fix, potentially requiring further restructuring measures if the business is to survive in the long term. Unsecured creditors complain that jobs have been saved at their expense. On the other hand, it should be borne in mind that pre-packs can and often do result in a fast and seamless business transfer, reducing the damage that protracted insolvency proceedings would have on the goodwill of the business, saving more jobs, avoiding the flight of key employees and reducing the costs that a normal administration would involve. Pre-pack administrations tend to be used where commercial pressures require urgent action. It should also be acknowledged that in some cases, the only viable alternative to a pre-pack is the liquidation of the company (because the lack of available cash prevents the carrying on of the business through the administration process). Pre-packs are an important restructuring tool particularly in the service industry, where much of the value of the company is in the staff and the client base rather than in tangible assets.
Considerations for Directors
Directors involved in a pre-pack should take independent legal advice, particularly if they will acquire an interest in the company’s business or assets through the pre-packed sale. Where a company is insolvent or on the verge of insolvency, the directors owe a duty to act in the best interests of the creditors of the company. In particular, in the context of a pre-packaged sale to management, directors will be concerned to avoid any risk of allegations of:
- Transactions in fraud of creditors under section 207 of the Insolvency Act 1986
- Acquisition of assets at an undervalue
- Misfeasance or breach of fiduciary duty through misapplication or retention of company property, in respect of which they could incur personal liability under s.212 of the Act or which could lead to their disqualification as directors
- Involvement in the management of a company with a prohibited name (phoenix companies) under section 217 of the Act
Improving Transparency in Pre-Packs
The Association of Business Recovery Professionals has published a Statement of Solvency Practice 16 (“SIP 16”) which took effect on January 1, 2009, and has been adopted by various regulatory bodies including the Law Society. The new guidance aims to provide greater disclosure of information to creditors, to increase clarity about the administration process and to restore confidence in respect of pre-packs.
The new measures directly address some of the main concerns with pre-packs, in particular, the lack of transparency. Administrators should now include in their first notification to creditors, among other things, an explanation of the background to their appointment, the reasons why they consider that a pre-pack would provide the best results to the creditors as a whole, any valuations obtained of the business or the underlying assets, alternative courses of action that were considered by the administrator, the purchase price and payment terms, the identity of the purchaser, details of any connection between the purchaser and the directors and shareholders of the relevant company, and whether efforts were made to consult with major creditors.
In addition, creditors wishing to complain about a pre-pack or who consider that they have been disadvantaged by any corporate insolvency process, have been encouraged by the Insolvency Service (which authorizes and regulates the insolvency profession) to telephone the Insolvency Service hotline.
In the recent case of In the matter of Kayley Vending Limited  EWHC 904, Cooke J. expressed the view that in pre-pack cases where the administrator is appointed by the court, it was likely that the matters identified in SIP 16 should be supplied to the court (insofar as known or ascertainable at the date of the application) for the purposes of assisting it in deciding whether to make an administration order. In respect of information which is commercially sensitive until completion of the transaction, an application could be made for a direction by the court that it be excluded from public inspection.
How the SIP May Affect the Liability of Administrators
The new SIP 16 guidelines are perceived as a significant improvement to the previous regime and have largely been welcomed by insolvency practitioners. It is considered that the additional disclosure to creditors may potentially lessen the likelihood of action by creditors against administrators in pre-pack situations for misfeasance (on the basis of misapplication of property of the company), breach of fiduciary or other duty in relation to the company or failure to perform their functions as quickly and efficiently as is reasonably practicable. Failure to comply with SIP 16 could result in the administrator being subject to disciplinary or regulatory action.
The Commons Committee has expressed the view that the interests of unsecured trade creditors must take a higher priority, especially where the pre-pack is a sale to the existing management. If the introduction and monitoring of SIP 16 does not prove effective, the Commons Committee has suggested giving stronger powers to creditors or to the court.
The increasing use of pre-packs has brought into focus the inherent tension between the desirability for transparency and the need to act with speed so as to preserve goodwill with a view to maximizing value for creditors and other stakeholders (including clients and employees). The combined effect of SIP 16 and the decision in DKLL v. HMRC have created a better framework for pre-packs going forward, the former increasing transparency, with the latter giving due latitude to experienced insolvency practitioners to carry out pre-packs in tight timeframes while preserving the goodwill of the business and promoting the interests of stakeholders.