Is pre-pack administration a smart strategy to rescue a struggling business, or is it just prolonging the failure of a company that should have folded? With a significant increase in pre-pack deals, many are questioning their long-term viability and impact on creditors.
What is an administration?
Administration is a legal process that companies can only enter into if they are able to achieve one of the following three statutory purposes:
- rescuing the company as a going concern, or
- achieving a better result for the company’s creditors as a whole than if the company was wound up without being first in administration, or
- realising property to make a distribution to one or more secured or preferential creditors.
The appointment of an Administrator can happen either via a Court application or using an out of Court procedure, so the process can move quickly. The Administrator’s role is crucial when acting in the interests of the creditors, and one of their key powers is to continue trading the business during the administration process.
What is a pre-pack administration (“pre-pack”)
A pre-pack administration (commonly referred to as a “pre-pack”) is when a company in financial difficulty arranges a sale of its business or assets before entering the administration. Where the sale of the business is to the original owners or management, this is known as a ‘connected party sale’. The sale is then affected by the Administrator, not the directors, immediately after the administration begins.
Why does a pre-pack continue to be so popular?
The main benefit of a pre-pack is that, by prioritising the confidentiality of the company’s financial difficulties, the business is able to preserve its brand and goodwill during an accelerated marketing process and be sold as a going concern. As well as maximising the business’ value, jobs are often protected as well as supplier and customer contracts, which consequently minimises the losses suffered by creditors.
According to the Insolvency Service, pre-packs have dramatically increased by 171%, from 201 in 2021 to 545 in 2023. Statistics suggest there has been a further increase in the number of administrations during 2024, and it is likely that a fair proportion of them will be pre-packs.
What is the issue with a pre-pack administration?
From the outset, there has always been a perception that by entering into a pre-pack, the company is able to leave behind its debt and have a fresh start, often with the same owners and/or management. This, together with the speed and confidentiality associated with a pre-pack sale, has often left creditors feeling disenfranchised from the process.
As a result, pre-packs, and in particular connected party sales, have been widely criticised, and research has been carried out which suggests sales back to connected parties has an increased likelihood of failing a second time. However, sometimes a connected party may be the only interested purchaser.
How have the perceptions of pre-packs improved?
In 2009, Statement of Insolvency Practice (“SIP”) 16 was introduced by the Joint Insolvency Committee and this sets out the standards of best practice required of all Insolvency Practitioners involved in a pre-pack sale. As well as setting out the key marketing essentials that the company is required to conform to, the SIP requires that the Administrator provides creditors with a detailed narrative explanation and justification of why the pre-packaged sale was undertaken, as well as the alternatives considered.
In April 2021, new regulations were introduced that requires all, or a substantial part, of the company’s business and assets are to be sold or hired out to a connected person within 8 weeks of the company entering administration. The transaction cannot take place unless the connected person has obtained a qualifying report from an Evaluator. This is an independent professional with Professional Indemnity (PI) Insurance cover.
Additionally, the proposed purchaser is routinely advised to draw up a viability statement, stating what they will do differently and how the new business will survive for at least 12 months from the date of the proposed purchase.
What to look out for?
Ordinarily by the time you hear of an administration, the pre-pack sale would have already happened. You should review the SIP16 report and the Administrator’s proposals as to how the administration will continue. Consider what the likelihood of a return to creditors will be. Administrator’s proposals must be delivered within 8 weeks of the appointment; however, this is much sooner if a pre-pack sale has occurred.
Within 2 weeks of receiving the proposals, there will usually be the opportunity to vote on the Administrator’s proposal and consider any modifications. This could be a useful tool, particularly if you suspect further investigations are required.
Where the sale was to a ‘connected party’, you should decide whether you intend to continue trading with the new entity. Should the answer be yes, then you should carry out a thorough review of the new entity and consider stricter credit terms that were previously provided. Finally, depending on how vital you are to their supply chain, you may also wish to consider negotiating on the debt they left behind.
Summary
Pre-pack administrations are here to stay, offering a vital lifeline for businesses in financial distress while maximising realisations for the benefits of its creditors. However, as a creditor or supplier, you need to safeguard yourself against any potential second losses, especially if the successor entity does not perform as expected.
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