Pre-pack administration – friend or foe?
ADMINISTRATION pre-packs seem to have lost their golden lustre in the past few months following criticism over lost liabilities and unpaid bills.
As the economy continues to falter the number of distressed businesses is set to rise. So are pre-packs really as unfair as their critics would have us believe or a viable alternative to consider.
David Wilson, partner at the Leeds office of business rescue, recovery and restructuring specialist Begbies Traynor discusses whether “revolving door” administrations are friend or foe.
“Increasing numbers of UK businesses are being faced with some stark choices as the recession continues to bite. The last quarter of 2008 saw more than 16,500 firms in Yorkshire and the North East showing significant problems, an increase of 41% on the same period in 2007.
“One insolvency tool that has created a furore in recent months is the increasing use of the administration pre-pack with opinion divided as to whether it is the saviour of failing companies and their employees or simply a way of unscrupulous firms evading their responsibilities.
“The pre-pack deal, sometimes known as ‘revolving door’ administration or accelerated M&A involves a deal for the sale of a company’s business or assets before it enters a formal insolvency process sometimes with little or no marketing.
They have attracted lots of criticism in recent months as the assets and goodwill of collapsed businesses are able to be sold on without their liabilities, sometimes leaving unsecured creditors unpaid. Furthermore, as the new owners are often the previous management, creditors feel particularly aggrieved.
“There have been a number of high profile cases in recent months including Adams Childrenswear, The Officers Club, Whittards of Chelsea and fashion chain USC. Most recently, Mosaic Fashions was put into administration and a deal to buy back some of its brands immediately announced, saving around 8,700 jobs. Despite the controversy surrounding these deals, all have resulted in jobs being saved and the businesses continuing to trade in some form.
“It is worth remembering that the alternative – keeping the business going for a period of time while trying to find a more suitable buyer – may simply delay the inevitable and potentially result in more debt to the detriment of creditors, usually the secured creditors. Administrators face often insurmountable problems trying to continue to trade a business in administration, incurring attendant costs including professional fees and property holding costs with no guarantee of a going concern sale at the end of it – hence the attraction of the pre-pack.
“The new company often takes on certain debts and liabilities, such as employees, HP and lease agreements and warranty claims, which would otherwise become a creditor, reducing the return for other creditors. Pre-pack sales often preserve the debtor book and the work in progress of the business.
Greater Transparency
“What’s more, as of January 1 2009, new rules took effect (Statement of Insolvency Practice SIP 16) requiring administrators in a pre-pack situation to provide creditors with a full and timely explanation of the reasons for choosing a pre-pack rather than deciding to continue trading in the hope of securing a trade sale or going concern sale. The greater transparency demanded by the new guidelines has, of course, been welcomed.
“Keeping the enterprise operating at a time when few people are spending and margins are getting squeezed is financially a difficult and, perhaps, an even more damaging decision. If the business isn’t making a profit, the end result will almost certainly be administration, perhaps liquidation often with the loss of jobs and an even higher level of debt. There are also personal financial liability issues for directors who continue trading once a business is insolvent.
“The leisure industry has been particularly badly hit. A very real scenario for many hoteliers and publicans is that they have paid a premium for their venues a few years back, but are now struggling to cover the interest due to falling sales. Secured creditors normally take their monthly payments from the overdraft facility which often leaves the Crown as a large creditor for outstanding PAYE and VAT.
“The reality for a large number of businesses in leisure and other sectors is that their assets have been refinanced to their limits, based on optimistic values given in better times. There are often very few options available and if the choice is between liquidation and closure or a pre-pack deal via an administration, then it is certainly worth considering.
“In the current market, one offer, even if not attractive on the face of it, is better than none at all. Of course, most of us would prefer to sell a struggling hotel or spa to the Hilton Group, but that simply isn’t on the table in most cases and the choice may be simply between a sale to management or closure. Another restriction on marketing is how an administrator actually funds the business after he has been appointed. It is easy to criticise the administrator for not fully testing the market, but with no funds to cover costs or the trading exercise and little time, the options are limited.
“Faced with limited choices in a crisis situation and when undertaken for the correct reasons, pre-packs keep companies in business and employees in work.
There are important lessons to be learnt by the new owners, which are often but not always, one and the same as the former management. While a pre-pack sale has given them a second chance, this may only be a temporary reprieve unless they understand why the business failed in the first place and restructure to avoid similar problems in the future.”
