Pre-pack administration: pros and cons

Louise Lang, associate, explains the pros and cons of this useful and valid insolvency process.

What is a pre-pack?

A pre-pack is an arrangement whereby the sale of all or part of a company’s business and/or assets is negotiated and agreed, before an insolvency practitioner (IP) is appointed with the relevant documentation being signed and implemented, immediately or shortly after the appointment is made.

Pre-packs are not a new insolvency strategy. However, the shift from receivership to administration, and the change in focus from the interests of the appointing charge holder to those of the company’s creditors as a whole – coupled with a heightened awareness among creditors, other stakeholders and the media – means that pre-pack administrations have increasingly come under the spotlight in recent years.

The pros and cons of pre-packs

The benefits of pre-packs include:

  • Business continuity: in most industries, a break in trading will inevitably have a detrimental effect on a business. However, trading during insolvency may not be an option if, for example, no funding is available, or if it is not possible to comply with regulatory requirements. Pre-packs facilitate a quick and relatively smooth transfer of a business, allowing trading to continue uninterrupted.
  • Value protection: news of an insolvency appointment or financial difficulty can result in a reduction in the value of a business, as customers, suppliers and employees lose confidence and look elsewhere. The risk of value diminution can be avoided by completing a pre-pack sale before news of the insolvency reaches the marketplace.
  • Job preservation: cost-cutting and reduced trading operations during insolvency can result in job losses. Job preservation is often one of the main reasons for using a pre-pack administration. Avoiding redundancies and securing continued employment for the employees of the business is not only of benefit to the economy generally, but also to the general body of creditors, as it reduces the number and value of preferential and unsecured claims in the insolvency.
  • Reduced costs: the costs associated with trading a business in insolvency can be significant. As control of the business and the risks and costs associated with it are transferred to the purchaser immediately or shortly after the appointment, the administrators can avoid incurring trading costs. Consequently, the costs of a pre-pack administration should be lower and result in a greater return to creditors.

However, there are some criticisms of pre-packs, including:

  • Lack of transparency: though secured creditors will usually be consulted in advance, unsecured creditors will not usually be informed of a pre-pack until after it has completed. As a result, unsecured creditors can feel disenfranchised and suspicious of the procedure. With a view to providing greater transparency to creditors, Statement of Insolvency Practice (SIP) 16 requires IPs to disclose a large amount of information to creditors following completion of a pre-pack administration sale.
  • Insufficient marketing: creditors can be concerned that the maximum value for the business and assets has not been achieved, as due to the nature and timing of pre-packs, marketing opportunities are limited. The IP may test the market by identifying and contacting potential buyers; however, they will be unable to expose the business/assets for sale on the open market. Instead, the IP will usually need to rely on independent valuations. Details of marketing activities and valuations are included in the information to be disclosed in terms of SIP 16.
  • Conflict of interest: the IP can be perceived as having a conflict of interest. They may be approached by the directors of a company who are already planning a pre-pack deal. While it’s unlikely that the IP will be appointed if they disagree with the proposed approach, before accepting an appointment, the IP requires to be satisfied that they can comply with his statutory duties, and that a pre-pack sale is the most appropriate course of action in the circumstances.

Despite these criticisms and the negative press, it is recognised that pre-packs are a useful and valid insolvency tool that can provide the best outcome for all concerned in appropriate circumstances.

About the author

Louise Laing is an associate in the corporate restructuring and insolvency team at Brodies LLP.