Are we ready?

My previous column (Journal, January, 50) discussed Delberry Ltd [2008] EWHC 925(Ch), in which Delberry’s liquidator sought an order for the administrative receivers to produce documents following the sale of Delberry’s business and assets less than a week after the receivers had been appointed. Since then there has been widespread comment by politicians and the press about the use of “pre-pack” sales in administration.

What is a pre-pack? SIP16 (a Statement of Insolvency Practice setting out required practice) suggests that a pre-pack refers to an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator, who then effects the sale immediately on or shortly after appointment.

In the real world

In theory, following appointment, an administrator would trade the business for some weeks, assess the business and its saleability, place adverts in trade press and national newspapers inviting enquiries, receive serious enquiries from competitors, private equity funds and entrepreneurs and thereafter invite best offers together with proof of funding. The office holder would negotiate with the highest bidder and ultimately sell the business to a new owner independent of the former management.

Of course, office holders have to live in the real world. In the UK there is no provision for “debtor in possession” or “DIP” funding giving super priority to a lender who assists the insolvent business to continue to trade. The increased sophistication of credit means that an insolvent company will usually have very few free assets with which to trade. The debtor book may be factored or specifically charged as part of a receivables financing arrangement, whilst even the office furniture and equipment may be subject to lease or finance purchase arrangement. Stock (even farm animals) may belong to a third party. The risk attached to trading is high unless there are assets to generate cash to pay wages and overheads. It is also difficult for the office holder to commit to paying costs unless there is certainty about a buyer for the business.

It hardly needs saying that with the credit crunch there is a shortage of buyers prepared to take the risk of a business with the employees retained while also paying sufficient monies to make the transaction attractive to the office holder and the secured creditors.

When a business in difficulty seeks advice from insolvency practitioners, there is discussion on the options available. Unsurprisingly, “plan B” frequently involves the existing management starting work prior to the formal insolvency on what can be done with the business, and a confidential approach may even be made to a third party without undertaking a public marketing campaign. Coupled with the pressure on all concerned to try and maintain continuity at all costs to protect the value of the business, it is clear why there has been a rise (or an apparent rise) in pre-packs.

Uncovering data

With almost equal inevitability, pre-packs have acquired a poor reputation. Businesses writing off huge debts leaving no return to ordinary creditors, and emerging under new ownership with the same management as before, give rise to suspicion which is difficult to allay.

Dr Sandra Frisby of Nottingham Law School has been collecting data for some time on pre-pack sales, particularly focusing on the return to creditors and on job retention. Her most recent findings demonstrate a reasonably similar rate of survival between companies which acquired their business through a business sale out of insolvency, and companies which acquired businesses through pre-pack sales. Of pre-packs, 60% went to connected parties, compared with 47% connected party acquisition in business sales. The data suggest that pre-pack sales to connected parties are a rising trend. An intriguing aspect of Dr Frisby’s research is that sales (by pre-pack or otherwise) to connected parties are more likely to suffer subsequent failure. The reasons have not been analysed, but they may support the view that the business failed because of the inadequacies of management, often attributed as the reason for the failure in the first place.

Most of the criticism comes, as one might expect, from unsecured creditors facing very low or nil returns. The future appears to hold increasing regulation, which it can only be hoped will not make the pre-pack an impossibility. In January the Insolvency Service wrote to all insolvency practitioners requiring that they be sent a copy of the information given to creditors explaining why a pre-pack was considered the best option, in order that the Service could check the statements for compliance with SIP16. Politicians criticising pre-packs are suggesting a need for regulation, although it is not clear what form that regulation might take, given that there is no evidence to date of systematic abuse and Dr Frisby’s research suggests that pre-packs make a contribution to saving jobs.