What are pre-packs and how can they help struggling businesses in the UK?

2 April 2020 | Applicable law: England and Wales

One of the main developments in domestic insolvency over the last 10-15 years has been the evolution of the 'pre-pack' - in other words, the pre-packaged sale of a company's business and assets by its administrator.

Whilst we feel the effects of the COVID-19 ('coronavirus') pandemic, pre-packs may provide the required flexibility to allow businesses to be rescued, whilst at the same time ensuring that goodwill is almost entirely preserved.

What is a pre-pack?

A pre-pack involves an asset sale agreement being executed by an administrator on behalf of the company, although almost all of the work relating to the proposed sale takes place prior to their appointment. The administrator will also be closely involved in the marketing and negotiation process in the lead up to their appointment, as they must ensure that they obtain a good price for the business and assets for the benefit of all the creditors.

Once the sale of the company's business and assets has been negotiated, the company will then be put into administration, usually by board resolution, and the administrator will execute the asset sale agreement on behalf of the company and, thereafter, account to its creditors for the sale price achieved.

What are the advantages?

The main advantage is that the period of administration is minimised and the company therefore avoids 'lame duck' syndrome whilst the administrator seeks to find a buyer. Typically during this period, the value of its goodwill will collapse and the company runs the risk of losing key employees, as well as suppliers and clients who would understandably be concerned by its financial position.

With a pre-pack, the company's business and assets, together with its employees, will pass relatively seamlessly from the administrator to the buyer, who will have had time to put in place a business plan to ensure that relationships with suppliers and customers are maintained and employees are retained. Apart from the fact that this has the effect of ensuring that the administrator can obtain the best purchase price for the company's business and assets, including goodwill, it also ensures that the cost of the administration will be relatively low by comparison with a traded administration. All this is to the benefit of the unsecured creditors.

What are the disadvantages and how are they addressed?

The main criticisms are that unsecured creditors are generally kept in the dark as to what is happening and therefore do not get any say on the pre-pack proposal. Secured creditors are usually involved because they generally have to consent to the release of their security where secured assets are to be included in the sale. The opaqueness can stick in the throat particularly when the buyer is a company which has been formed by the directors of the company in administration.

Administrators also have to be careful not to get too close to the directors appointing them. In VE Vegas Investors IV LLC and others v Shinners and others [2018] EWHC 186(Ch), the Court removed the administrators of a company, who had facilitated a pre-pack sale to the former directors of the company, due to a conflict of interest it had identified. Administrators, therefore, must act with a heightened sense of correctness in circumstances where there are likely to be disgruntled creditors. They must also be aware of opaque transactions simply being undertaken to allow the existing directors to offload debt in return for a smaller sum of money and, essentially, to start over again.

In order to allay concerns about 'phoenixism' and the real concern that pre-packs were not ensuring proper realisations for the business and assets, the Statement of Insolvency Practice 16 ('SIP16') was introduced in 2009. SIP16 ensures that creditors are given information about the marketing of the business and the alternatives that had been considered to make the process more transparent. SIP16 sets out various rules that the administrators must follow, including information to be disclosed to creditors within seven days of the pre-pack sale.

Appointing an administrator and their role

UK directors are able to appoint an administrator without reference to the Courts. Previously, this proved prohibitively expensive as the application for an administration order would involve obtaining expert evidence to show the benefits of an administration over a liquidation process. This is something that other jurisdictions do not have. Whilst the procedure is open to abuse (and indeed in the early days no doubt was abused), in general the procedure is admired by foreign insolvency practitioners who operate within more rigid restrictions that are not necessarily for the benefit of unsecured creditors.

The key role of the administrator is to make sure that they obtain the best possible price for the business and assets. They will therefore take steps to market the business prior to their appointment, but as confidentially as possible. Whilst SIP16 contains more demanding standards for advertising a business for sale through a pre-pack, it is recognised that the value of the business could be lost overnight and, therefore, administrators can still sell the business and assets with a minimum degree of marketing and advertising. Everything depends on the facts of each case and the experience and know-how of the administrator.

In the event that an administrator makes a wrong call then, as in the case referred to above, the Court may become engaged. Creditors also have a statutory right to bring actions against administrators. This in itself adds a further incentive for administrators to ensure that their call is a good one (and in the best interests of the business) so that they are protected from disaffected creditors.

Whilst there is no provision for pre-packs in the Insolvency Act 1986, the UK Courts have recognised their importance in saving businesses. At a time that companies are facing the economic effects of the COVID-19 pandemic, and tightening cash flow, pre-packs offer a cost effective flexibility that may be key to rescuing businesses, if not the overarching companies themselves. It is therefore vital that businesses and their directors understand the options available when facing insolvency so that they are able to protect the interests of the business, the creditors and themselves.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.


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