Pre-Packed Administrations: A Necessary Evil or a Lifeline for Businesses?

In the labyrinth of insolvency, pre-packed administrations emerge as a subject of polarising discourse. This process involves the swift sale of a distressed company's assets, often back to its original management team. While some view it as controversial, others see it as a lifeline. But is it fair? Let's navigate through this complex issue.

Understanding Pre-Packed Administrations

A pre-pack administration in the UK refers to the sale of the business and assets of a company immediately on the appointment of administrators. Where the sale is to Connected Parties (typically the directors of the company), the process is regulated by Parliament.

Essentially, it's a deal arranged before administration, typically following an independent valuation, a marketing process to ensure that the Connected Party's offer will be acceptable to a subsequently appointed administrator.

From a commercial perspective such a deal often makes sense because the directors know the business, customers and suppliers and through a pre-pack can offer a seamless service to customers. Particularly with service companies with few physical assets, the directors may be the only purchasers for the business and as a consequence will be prepared to pay a higher price for the “assets” such as they may be.

The advantage for the directors is that they are able to continue the business without the weight of most of the debt which is left behind to be dealt with by the insolvency process. However creditors and third-party observers can be suspicious of pre-packs, characterising them as sweetheart deals intended to favour the incumbent directors, who have caused the problem, over the interests of creditors and other third parties.

The companies emerging from the process are often referred to as phoenix companies; new companies emerging from the ashes of the failed concern.

Since the end of April 2021 the Administration (Restrictions on Disposal etc to Connected Persons) Regulations 2021 (SI 2021/427) have been in force. These provide for a report to be prepared by an experienced, insured and independent business person to make significant disclosures regarding the company and the deal, report on the marketing exercise and conclude whether the “consideration to be provided for the relevant property and the grounds for the substantial disposal are reasonable in the circumstances”.

The intention of these regulations is to deal with the perception that pre-packs benefit the directors at the expense of creditors.

We have found that although they add a layer of cost into the process they provide a useful structure for organising sales before insolvency and in our experience are useful in pushing up prices paid for such businesses due to the formal marketing exercise and competition.

A little known advantage is that the regulations will go a long way to stopping the practice of “chipping” i.e. reducing the price offered just before completion when the Administrators do not have any other option. If the purchaser does this then it will have to get another Evaluator Report and the fact that they have had a previous Evaluator report will have to be disclosed.

The Advantages of Pre-Packed Administration:

• Speed: The process is quick, minimising disruption and preventing further financial decline.
• Job Preservation: Employees' jobs are often saved, offering stability during challenging times.
• Business Continuity: The business can continue operating, preserving value and maintaining customer relationships.
• Higher Returns for Creditors: Following the introduction of the Regulations, pre-packs will be seen to offer better realisations for the insolvent company than either the alternative offers or the normal fall-back of a break-up sale.
• Reduction in liabilities: Pre-pack sales as a going concern will cause the insolvent company’s liabilities for its staff (redundancy etc) to transfer to the purchasing company and so reduce the burden on the insolvent company. We have seen many cases where the purchaser takes over leases for properties, plant or vehicles which would not otherwise be met. The new company may also need to pay suppliers some of their arrears to get them to supply them.
• Cost-Efficiency: The costs of a pre-pack sale are usually lower than the agent's fees on a break-up deal.

Example: Consider a high-street retailer struggling with debt. Through a pre-pack administration, the business was quickly sold, allowing stores to remain open, staff to keep their jobs, and trade to continue with minimal disruption.

The Downsides of Pre-Packed Administration:

• Lack of Transparency: The process is arranged before creditors are informed, leading to potential conflicts of interest.
• Potential for Abuse: Directors may use pre-packs to escape debts and liabilities while continuing the same business.
• Damage to Reputation: The company's credit rating and reputation can suffer.
• Uncertainty for Unsecured Creditors: Unsecured creditors often recover less from pre-pack administrations compared to other insolvency procedures.
• Difficulty in Future Business Relationships: Banks and other professionals often distance themselves from Phoenix companies. Opening a new bank account or obtaining borrowing facilities in the future could be challenging. This is because banks often maintain separate relationships with the creditors who may have lost out as a result of the administration, and they may not want to be viewed as supporting the failed management team.

Example: An IT firm went into pre-pack administration and was sold back to its directors, leaving unpaid suppliers and creditors in the lurch. This led to criticism and damaged relationships with stakeholders, and difficulty establish banking relationships post-administration.

Making an Informed Decision with Independent Evaluator Reports

Navigating the complexities of pre-packed administrations can be challenging. That's where an Independent Evaluator Report becomes essential. This report, a regulatory requirement, provides an impartial and comprehensive evaluation of pre-pack administration proposals. It serves as a vital tool for the Connected Party planning to buy the company out of administration and plays a crucial role in the Insolvency Practitioner's decision-making process regarding whether to allow the administration to proceed.

At Branta, we specialise in crafting these indispensable reports. Our mission is to ensure transparency and fairness throughout the insolvency process, equipping all parties involved with the necessary insights to understand the implications of a pre-pack administration.

If you're a Connected Party considering a pre-pack administration, an Independent Evaluator Report is not just a regulatory necessity—it's an invaluable resource for your decision-making process. To learn more about how we can assist you, visit our Evaluator Reports page.

In the nuanced landscape of pre-packed administrations, there are lifelines for struggling businesses and potential risks. By commissioning an expertly prepared Independent Evaluator Report and conducting thorough due diligence, stakeholders can confidently navigate this complex area.