What is it?
If a limited company is in trouble owing principally to the cost of furnishing outstanding debts and expensive lease agreements, but there is still a viable market for it's products or services, pre-pack administration, which is only available to limited companies that are
technically insolvent, could be a solution. It provides the company with the opportunity to restructure the business and sell it for the market value, together with any assets. However, the process must begin
as soon as possible to have a chance of success.
The conduct of company directors
Directors of a company in difficulty and heading for insolvency must
act at the earliest opportunity. Failure to do so can result in accusations of wrongful or fraudulent trading which, if substantiated, can result in them:
- having to contribute personally to the assets of an
- being disqualified from taking on any further directorships or
acting in a managerial capacity for a period of between 2 and 15 years; and in the most serious cases;
- facing a prison sentence.
The directors should approach a Licenced Insolvency Practitioner as soon as it is
clear that the company is in trouble. The Insolvency Practitioner acting as Administrator will exercise their commercial and professional judgement in deciding how to best realise the assets of the company and get the maximum return for creditors.
Pre-pack administration introduction
For pre-pack administration (sometimes called phoenixism because, like the mythical bird, the new business rises from the ashes of the old) to take place there must be a buyer. This could be a one or more directors from the old company, or any other party able to produce the necessary investment. It should be understood that a buyer is purchasing the business and assets and not the existing limited company. Directors of the old company who wish to effect a buy-out and set up a new company or ‘newco’ must set up a new company vehicle and have the necessary funding in place
prior to making a bid.
The company should negotiate a pre-pack administration deal for the sale of the business to a buyer prior to the Administrator being formally appointed. Once appointed the Administrator will:
- obtain a market value for the business and its assets;
- consider whether the offer on the table is the best option for realising returns for shareholders and creditors;
- if the business and assets are to be transferred to a new company (‘newco’) obtain details of cash flow, profit and loss and balance sheet forecasts to demonstrate the viability of the new company and its ability to purchase assets.
- prepare a Sale Agreement which, once signed, will complete the sale;
- Inform all creditors of events and why a pre-pack administration was considered to be the most suitable option; and
- distribute the assets of the company according to prescribed legal terms.
In pre-pack administrations, negotiations for the sale of the business should be finalised prior to the appointment of an Administrator who, once in place, can sell the business
immediately. This is different from a standard administration where the Administrator would market the sale of the business and negotiate with potential buyers after they had been appointed.
Advantages of pre-pack administrations
- avoiding the cost of continuing to trade which could result in allegations of wrongful or fraudulent trading;
- the Administrator does not have to carry the risks of continuing to trade. and it prevents further devaluation of the business;
- the cost of the Administrator's fees will be lower than a trading
administration because the risk and amount of work involved is less;
- pre-pack administration gets rid of existing debt and expensive contracts that contributed to the situation in the first place;
- key employees can remain in place, even though there may be a need to let some go;
- under Transfer of Undertaking (Protection of Employment) Regulations 2006 (TUPE) employees transferred to the new company keep their existing employment rights;
- there will be continuity in trading for some customers and suppliers of the old company, although old contracts and agreements will no longer apply.
Disadvantages and criticisms
The pre-pack administration process is viewed by critics to be problematic in that it:
- enables directors to plan the pre-pack administration some months in advance and appoint an Administrator who will quickly arrange for the business and assets to be sold back to them. The main reason for this would be to rid the business of the shackles of existing debt and expensive contracts and leases;
- allows directors of the failed business to remain in control of the new one with no guarantees they will not again make the mistakes that resulted in the administration in the first place;
- ignores the possibility of the business attracting a higher price on the open market.
Furthermore, Wolverhampton University, which recently conducted research on pre-pack administrations concluded that Administrators seem to have a tendency to favour the interests of the management team and secured creditors over other creditors, who are unlikely to even be aware such discussions are taking place and who are likely to get little if anything from the sale of company assets. However, it must be said that a company entering into a pre-pack administration deal was likely to go into liquidation in any case; one of the consequences of which would have been greater jobs losses.
The law relating to pre-pack administration.
The spirit underlying the legislation is that the process leading to a pre-pack administration and the decisions taken must be transparent.
Following the Graham report on pre-pack Administrations a revised statement
of Insolvency Practice 16 was introduced in November 2015. It sets out the
conduct expected of an Administrator and the disclosure required. The list of requirements is extremely thorough and too numerous to include here. However it does increase confidence both in the process and its transparency.