According to figures from the Insolvency Service, 2,835 companies went into Administration in 2010, of which approximately 27% were “pre-packed’ by the Administrators.

A pre-pack sale is a situation where the sale of an insolvent company and its assets is agreed before the formal insolvency process (usually administration) is entered. Although not a new process, pre-packaged administrations have become more controversial of recent years, with people, particularly creditors who are often left short as a result of the administration, seeing them as a way for business directors to wipe out debts and being allowed to simply continue with business as usual.

Edward Davey, the Government Minister for the Department for Business, Innovation and Skills, announced on the 31st March 2011 his intention to “inject greater transparency’ into pre-packaged sales of businesses in administration so as to “help ensure that’¦as much is fairly returned to creditors as possible.’

Following this announcement, the draft Insolvency (Amendment) (No.2) Rules 2011 were drafted.  They require Administrators to give three days notice to creditors of an impending pre-pack sale where they propose to sell a significant proportion of the assets of a company or its business to a connected party.

The draft rules are currently the subject of much debate and controversy. Some describe them as going too far, and others as not going far enough. James Anderson of The British Property Federation has stated that “[T]he three day period is not sufficient’ and “should be extended to one week’. However, Steven Law, President of R3 (Association of Business Recovery Professionals) warned that “[T]hree Days is a long time in business, and if unable to trade in that period, is at risk of losing key staff and customers. When faced with this option, directors may simply decide that liquidation is a better route, and this would reduce returns to both secured and unsecured creditors and result in considerably fewer jobs being saved than under a pre-pack.’

There is, however, one thing which everyone seems to agree on, and that is that something should be done to increase the public’s confidence in pre-pack sales. The perception out there is that all pre-packs are underhand, used by directors who wish to dump their liabilities, purchase the business for a nominal value and begin trading again leaving unsecured creditors (usually the taxman) empty handed. Critics point to the potential for abuse of the process especially if the business is sold quickly with little or no marketing and no apparent break in trading, often to the same directors or management. The secured creditors are often consulted about the arrangement however the unsecured creditors are usually only informed after the event and usually have no input into the sale.

However, supporters of pre-packs often point to pre-pack administrations as being the only realistic route to preserving the goodwill of a business. If a company is liquidated then no goodwill can be sold and no value realised for creditors. R3 also found that pre-packs offered the best chance to save jobs in 60% of cases. In the analysis of 89 pre-pack deals carried out during 2009, including six in the North West, 4,846 jobs were saved out of a total of 5,478. Where a sale can be agreed quickly, stock which has a limited shelf life can be sold at full value. A pre-pack sale can mean a quicker realisation of cash for creditors and unsecured creditors may be used by the new business going forward with any debts being repaid by the new company.

This week the Technical Committee of the ILA (Insolvency Lawyer’s Association) published their response to the draft Rules. The Committee considers that the draft Rules are likely to cause “considerable damage to the business rescue market, ultimately resulting in reduced returns to creditors, an increase in job losses, and a consequential increased burden on the welfare state. These effects would be contrary to other stated policy objectives such as improving value for unsecured creditors.’ They note that they are not alone in their concerns.

The ILA Committee recognises that once notice of a proposed pre-pack is given, the value of the business is likely to be eroded and “without the certainty of a completed solution to the business’ financial problems, its customers, suppliers and key employees may disappear.’ It might be that the pre-pack buyer reduces its price offered.

Indeed, there has been no clarification of how the notice provision is going to work in practice. How are creditor representations going to be made and dealt with? There are concerns that creditors will simply be given a forum to make mischief and “create unfairness by enfranchising those creditors who are “out of the money’ (a function of the insolvency itself) at the risk or expense of those who have an economic interest in the realisations.’

I have only briefly mentioned some of the reasons why the ILA Technical Committee is not in favour of the new draft rules being introduced. Instead they suggest that the matter should be dealt with by the individual Administrator certifying in his proposals to creditors that the pre-pack represents the best value reasonably obtainable in the circumstances and is in the interests of creditors as a whole. As the Committee says, good Administrators will satisfy themselves of this already.

There are other options available to the Government to reform the law relating to pre-packs however as we have seen, and as the ILA Technical Committee acknowledge, “transparency is a perception, which cannot be measured empirically’.  The debate on the best way to deal with the pre-pack phenomenon is likely to rumble on for some time to come.