Government plans to “improve transparency and confidence in pre-pack administrations’ have been successfully halted. Although this may sound counter-intuitive, it is not the policy which anti-reform proponents are against, it is the damaging methods proposed by Edward Davey (Minister for Employment Relations, Consumer and Postal Affairs) to implement such a policy.
Transparency as a policy is fine, welcomed even, but exposing a suffering business to the crows (rival companies) should not be the attitude of British business – we should seek to rescue them and guide others around the common pitfalls. Davey’s proposals do the former whereas pre-pack administrations (contrary to popular belief) do the latter as this article shall demonstrate.
Frances Coulson, President of R3 Business Recovery Professionals was quoted as saying “the delay is not surprising, the proposals suited no one’. The proposals in question include the introduction of a ‘notice period’, designed to “give creditors a chance to express concerns’ for the administrator’s consideration prior to the business being sold on. In principle this is a commendable idea, however, as the consultation period following the publication of the draft legislation (Draft Insolvency (Amendment) (No.2) Rules 2011) has shown, one which lacks business nous when it comes to its practical implementation.
By enforcing a notice period, the following unintended consequences will inevitably ensue:
1. Loss of confidence in the business
2. Loss of custom
3. Employees leaving
4. Remaining customers become unserviceable due to staff shortage
5. Ultimately leading to a forced liquidation
6. Creditors receive nothing!
Pro-reformers are likely to argue that the above sequence is merely a persuasive tactic, but consider the feasibility of each occurring and make your own decision – it is not as far-fetched as you may at first believe.
Pre-pack administrations on the other hand, appear to have acquired a negative reputation amongst creditors and critics. This perception is often unfounded, as the method can and often does in fact provide a better deal for both when a company goes bust! A pre-pack administration is the sale of a business and its assets by an administrator to another without the sanction of either the court or creditors. It is no secret that the buyers are often the same personnel as the previous owners (72% of pre-packs in 2010 were to related parties – Insolvency Service), but this should not in itself blemish the reputation of pre-pack administrations.
The most common argument against the use of pre-pack administration is that of previous management taking control of the new company; which they obviously purchased at a knock-down price; clearing all debt of the previous company; leaving unsecured creditors penniless. As a corporate insolvency solicitor, it is obvious that this is a misconception and misunderstanding of how pre-pack’s actually function.
It is not always true that previous directors and management take over the new company, it is merely the outcome of procedure. Procedure which allows obvious and interested parties to make offers for the business or specific assets which the administrator must duly consider – however, aside from previous management, these offers are usually for a nominal amount (well below the market value) with the intention of making a ‘quick buck’.
Another misconception is the apparent ‘underhandedness’ of all management and directors of companies gone bust. Those critics often do not pause to ask why the company felt it necessary to enter administration, for many directors it is humiliating and to be avoided at all costs. More often than not there is a valid reason – for example, they themselves were creditors owed substantial debts which were never paid. Without an income a business cannot function, forcing them into administration.
Once in administration, a pre-pack sale benefits creditors a great deal more than a full and extensive search for prospective purchasers – costing the administrator time and money. Firstly, these incurred costs are deducted from the funds available to creditors. Secondly, the longer a company sits in administration the greater damage is caused to its ‘goodwill’ and thus the value of the business (which translates into the monies available to creditors) decreases. Furthermore, should the management of a new company remain the same as those involved in the administration, it is frequently the case that certain debts owed to important creditors (such as suppliers for the continuation of the trading) will be paid by the new company. If, as most naÃ¯ve creditors would prefer, the administrator sold the business to new buyers, those buyers may indeed use different suppliers and pay no debts – surely a worse prospect!
By avoiding the new legislative proposals, the value of pre-pack administrations to businesses, creditors, employees, and most persons involved shall remain intact, reducing the likelihood of skilled (and relied upon) employees departing the indebted company amid uncertainty surrounding any formal insolvency process.
So what can/has been done to prevent “phoenix firms’ from playing the insolvency system? The Statement of Insolvency Practice number 16 (SIP 16) was introduced in 2009 to prevent the perceived underhandedness of pre-pack administrations – requiring administrators to make full disclosures to creditors of any pre-pack agreement or sale. Disclosures must be made immediately after the agreement has been entered into (but not necessarily beforehand).
Therefore by more stringent Insolvency Practitioner regulation, the likelihood of businesses getting away with “phoenix firm’ conduct is significantly less (as the IP’s risk being struck off).
To conclude: due to the “contentious’ feedback on the initial draft legislation, a revised version is due in January 2012, which many are eagerly awaiting to scrutinize. Transparency regarding businesses in administration is as a policy a good idea, but the methods used to achieve it are as of yet unsatisfactory.
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