"Leaving the mice in charge of the cheese..." is how one commentator described the now far from unusual phenomenon of the pre-pack administration sale. But what is meant by a "pre-pack"; are they lawful and what is the legitimate area for concern? While they were fairly uncommon in the past, pre-packs now seem to have become all the rage. Why? What scope is there for challenge or review if abuse is suspected?
What is a "pre-pack"?
Quite simply it is the sale of the whole (or quite frequently part) of the business of a company shortly after the appointment of an administrator to a buyer and on terms which have been lined-up and agreed (pre-packaged) prior to the administrator's appointment. Frequently the acquirer may be a new company formed by or with the involvement of the directors of the company in administration - but not necessarily. More often than not, a pre-pack sale is made to an unconnected trade buyer – usually after an orderly sale process has failed to secure a solvent sale.
Are they lawful?
Yes. Although the Enterprise Act 2002 (and previously the Insolvency Act 1986) contemplates that the administrator will call a meeting of creditors and present his proposals for dealing with the assets of the company (including any sale) to the creditors for approval, it has long been recognised that in some cases this will not be possible. There are sometimes compelling reasons to do with the nature of the business which means that it will not be possible to have a period of orderly trading in administration until the business is offered for sale and the approval of creditors secured. In some cases, because of the nature of the business, there is simply not the time to consult creditors about a sale. It was always the case that certain types of business (particularly contracting, consulting or "people" businesses) might evaporate into insolvency unless sold very quickly. Since the decision in the T&D Industries case it has been clear that an administrator has the power to sell before the creditors' meeting and that it is the administrator, rather than the court, which must exercise commercial judgement in deciding whether to do so.
Since that case, we have also had the Enterprise Act 2002 all but abolish the power of debenture holders to appoint administrative receivers and as a result secured lenders such as banks are less likely to take the risk of funding trading while in insolvency. These two developments have contributed towards the trend to pre-packs now being the rule rather than the exception.
Open to abuse!
Many people are suspicious when they see a business being sold free of its existing liabilities, and often to the existing management. Should this be allowed? Well it is certainly the case that the existing company cannot and should not carry on trading if it is loss-making and insolvent. To do so would risk increasing the loss to some if not all of the creditors, and expose the directors to personal liability for wrongful trading and possibly disqualification. If it is accepted that insolvency processes should seek to preserve economic continuity then it is better that part of the business survives in a new entity - even if some creditors lose out, than to collapse entirely, with the loss of all the jobs and all the economic value.
Public concern about lack of transparency and possible mischief led to the issue of a Statement of Insolvency Practice (SIP 16) by R3, the body which regulates the activities of insolvency practitioners. In order to allay public fears about "pre-packs" it sets out the factors which administrators should take into account in any case involving a pre-pack, and also requires administrators to be open and provide information to creditors (including a detailed explanation and justification of why a pre-packaged sale was undertaken) so that they can be satisfied that the administrator has acted with due regard to the interests of all creditors.
Similarly the "Phoenix company" rules on re-use of company and business names by directors of failed businesses under Section 216 of the Insolvency Act 1986 require transparency and notification to all creditors where the business is sold to the existing management and they intend to carry on business in a new entity under the same or a similar name.
Is it possible to challenge a pre-pack?
If there are grounds to suspect abuse of process then the administrator can be challenged for misfeasance under paragraph 75 of Schedule B1 to the Insolvency Act 1986, or possibly injuncted from concluding a sale, if the facts come to light in time. But it is not the case that just because some creditors will lose out that something must be amiss. In the vast majority of cases, administrators and their advisors act properly and professionally in the best interests of the creditors as whole, with a view to preserving at least part of the failed business, together with as many jobs as possible.
Properly conducted and used in an appropriate case pre-packs have a legitimate role to play in preserving some economic activity and employment even where it is not possible to rescue the failing company itself. Equally they present the opportunity for both management teams and trade buyers to secure the viable parts of a failed business on sustainable terms, which has to be in the interests of customers, suppliers, employees and the wider economy.