What is a "Pre-Pack"?

A prepack is a deal for the sale of an insolvent company's assets which is put in place before the company goes into a formal insolvency process. Prepacks are commonly used in conjunction with administration. The deal is usually agreed before an insolvency practitioner, such as an accountant, is formally appointed but is carried out by the insolvency practitioner shortly after the company enters formal insolvency.

Prepacks are not new and have been used for many years to sell businesses in insolvency where commercial pressure requires urgent action. There has however recently been a significant increase in the number of prepacks, which has caused the whole procedure to be scrutinised much more closely.

The objective of a pre-pack arrangement is commendable enough – basically their goal is to allow an administrator to sell a business before it is irretrievably damaged by negative publicity and so maximise the value they can achieve in the sale for the benefit of the company's creditors. This is particularly useful with otherwise viable businesses that have simply run into cashflow difficulties and which, like many service sector businesses, rely on the confidence of their customers.

Recent Examples

There have been several high-profile deals over the last six months, including Whittards of Chelsea and The Officers Club, whilst the retailer USC was put into pre-pack by its former owner, West Coast Capital. Subsequently Dundonald, a subsidiary of West Coast, bought a number of USC's stores - leaving the rest with the administrator. Meanwhile, MFI was sold to its management team last year, for £1, only to slip into insolvency again three months later.

Criticism

Insolvency situations rarely result in fully satisfied stake-holders and like any attempt to make the best of a bad situation there may be someone crying foul once a resolution is found. However, there are concerns that these deals suffer from a lack of transparency, a bias towards secured creditors and questions over whether the best value for a business can be achieved by closed-door negotiations rather than an open sale which properly "tests the market" – all of which contributes towards a perceived potential for abuse.

One particular concern of creditors is to ensure that the owners of businesses are not using pre-packs to shake off creditors by simply putting the whole thing into administration and then, through a pre-arranged deal with the administrator, buying back the profitable bits with substantially the same owner/manager continuing in basically the same business. In some cases, instead of re-financing themselves out of trouble, a minority of businesses have been 're-pre-packed'.

Pre-packs were not designed to do this and there is legislation specifically designed to prevent this type of so-called "phoenix" company. Indeed, the rules issued to insolvency practitioners by the Association of Business Recovery Professionals were recently updated (Statement of Insolvency Practice (No. 16)) to clarify how pre-packs should be dealt with.

Nevertheless, the number of directors banned by the Insolvency Service for improperly creating "phoenix" companies rose by 67% in the last twelve months.

Some creditors are fighting back. HM Revenue & Customs, a big victim of pre-packs that was on the losing side in that crucial 2007 case, is said to be refusing to give VAT numbers to companies it suspects of going into pre-pack to dump and, indeed, dump on, their creditors.

Conclusion

Pre-packs are not always successful. R3, the trade body for insolvency practitioners, says the likelihood of a second insolvency rises from 38 per cent to 45 per cent if the business put into pre-pack is sold to a connected party.

The ultimate goal of these arrangements is important and with fewer buyers around pre-packs are a good option for distressed businesses, particularly where the principal assets are the people or intellectual property. However, amid growing concern about "phoenix" situations, future pre-packs are likely to come under increasing scrutiny and, as the recession bites, face more challenges from disgruntled creditors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.