Posted on Wednesday 22 June 2011 by Ulster Business

Phoenix firms

Pre-packaged administrations have become commonplace in recent years, but criticism of them has prompted proposed changes to regulation designed to give creditors more protection. However, some insolvency experts are concerned this could force even more companies out of business.

Pre-packaged administration deals have proved controversial ever since their introduction. A pre-pack allows a business that is about to go to the wall to be sold to new owners as soon as it goes into administration, without the need to consult unsecured creditors. They are seen as a solution of choice in many situations because they eliminate the risk of clients cancelling contracts with firms on grounds of insolvency, suppliers holding an administrator to ransom, and lenders refusing to extend funding to a company in administration. What angers some creditors and customers is that the business owner or directors who have led the business to the point of going under are very often the people who buy it back and run it after effectively having their debts cancelled. Pre-packs have the obvious benefit of maintaining employment at the companies involved in them. Late last year 4800 jobs were saved at the East London Bus Group when KPMG arranged a pre-pack deal that saw transport giant Stagecoach buy the company. However, the regularity with which pre-packs have been used since the Enterprise Act 2002 provided administrators with greater power to sell in advance of creditors' approval, has forced a re-think by lawmakers. The UK's Business, Innovation & Skills Minister Edward Davey has outlined measures to "improve transparency and confidence" in pre-pack sales which most notably propose introducing a three day notice period which would give creditors a chance to express their concerns. Administrators would then have to consider these concerns when deciding whether a higher offer was needed for the assets, and include an explanation of why a pre-pack administration was carried out, which would be filed at Companies House. The idea is that this would let credit check agencies and suppliers judge how solid the "Phoenix firm" is. Mr Davey has said the new rules could become law before the end of the year and that they will apply to sales back to parties connected with an administration where the assets haven't been openly marketed. Ian Leonard, associate director of restructuring at KPMG in Belfast, said this could negate the very reasons why insolvency practitioners opt for a pre-pack solution. "One of the primary reasons for advocating any pre-pack administration is that by ensuring there is no interruption to trade, the company may protect the value of its business. Speed of execution of a deal can be key to this process and the proposals by Edward Davey to introduce a three-day challenge period may hinder this. Careful consideration of such a moratorium is required," he said. "A three day window is sufficient time for key stakeholders to become nervous, potentially jump ship and therefore damage the value of the business. A key example to cite in this regard is the administration of the EMI music group which took place in February 2011. "This deal was dependent on ensuring that key artists remained with the record label whilst the pre-pack administration deal was brokered. The deal did not involve an open marketing process for the business, however, if a three-day window was available to creditors to challenge this deal, there would have been a risk that the artists assigned to the label may have become uncomfortable and left which would potentially have resulted in the failure of the company. In such instances the new legislation clearly makes the process potentially less attractive." Colin Dempster, a Partner with Ernst & Young's Transaction Advisory Services team, similarly believes the changes will make life more difficult for administrators and result in more businesses being closed down which could have been saved. "Undoubtedly it will be more difficult. If there is a delay whilst creditors can challenge then the administrator will still face the two challenges of who will fund the business in that time and will the business be devalued by the actions of customers and employees?" he said. "The alternatives to a pre-pack sale would typically be either a period of trading in administration whilst the business is marketed and a buyer hopefully found or an immediate closure of the business, redundancy of the workforce and an auction of any remaining assets." These options are often less palatable than a pre-pack administration, which can produce a higher possible realisable value for the assets, with likely lower related costs. James Neill, senior restructuring manager at BDO in Belfast, further explains that insolvency practitioners look at all other restructuring options before conducting a pre-pack deal. The pre pack process is often used because other tools such as a Trading Administration or a Company Voluntary Agreement (CVA) are not viable in the circumstances. "The process has its critics, but it is important to note that it will only ever be completed in situations where the ultimate returns to creditors are better than in a liquidation scenario. What many fail to appreciate is that if a pre-pack process is not undertaken, a liquidation of the Company, the redundancy of all employees, a 'fire sale' of assets, and ultimately an inferior return for all creditors is in certain instances inevitable," said Neill. "Whilst any measures designed to increase transparency within a process that has many critics, are to be welcomed, it is noted that often a pre-pack is the chosen course of action due to the short time scales for completion and the lack of any other viable rescue options. Three days is a long period in business and often during that period the value in any business could be seriously diminished, resulting in a reduced return for all stakeholders," he added. "The concern is that the proposed three day notice period may lead to a disruption of the pre-pack process and the subsequent failure of the business. Whilst unsecured creditors ranking pari-passu is the cornerstone of insolvency legislation, the concern for insolvency practitioners is that the new proposals may allow for one creditor who is unaware of the lack of alternatives to ultimately stall the process and by doing so, seriously prejudice the returns to all other creditors. A liquidation scenario would potentially then be the only other scenario available when for all intents and purposes a pre pack was in the best interests of all creditors and other stakeholders" said Neill. Roger Pollen, Head of External Affairs at the FSB in Northern Ireland says small business owners see the attraction in saving a good business that has had some bad fortune, but are concerned about the use of the pre-pack as a cynical exercise to profit at the expense of suppliers and other creditors. "When it is working well, it can provide an excellent vehicle for rapid, agreed, voluntary restructuring, with the new entity even purchasing the name of the old and retaining value by offering the appearance of seamless continuity," he said. "When it is abused, the procedure can be deceitful and allows bad practice to prevail, often under a cloak of obscurity and without proper objectivity, evaluation and fairness. However, as with all legal and accounting processes, this abuse can be avoided if it is approached with genuine integrity, such as obtaining independent asset valuations and informing the creditors throughout the process," he added. "In short, when used properly, a 'Pre-pack' can assist in effective business rescues but it is a sharp tool and, used wrongly, can facilitate sharp practice. It should be viewed and treated with caution and its operation should be kept under regular review." KPMG's Leonard notes that while the regulatory changes would potentially address the issue of unscrupulous pre-pack administrations, there are already checks within the process. Disquiet over secret deals being agreed and the lack of transparency for creditors resulted in the issue of SIP 16 (the Statement of Insolvency Practice) in January 2009, which required administrators to provide information on the deals. "The proposed legislation is intended to provide more transparency and to deal with unscrupulous directors who abuse the pre-pack process to dump debt then buy back their own business. These instances are outweighed by the number of pre-packs that are used as a valid rescue tool. It should be noted that under current legislation, creditors have the opportunity to challenge the conduct of an administrator in any case under Paragraph 75, or alternatively take an action for misfeasance under Paragraph 76, of Schedule B1 to the Insolvency (Northern Ireland) Order 1989. There is similarly recourse against directors through the provisions of the Company Directors Disqualification (Northern Ireland) Order 2002. Perhaps further focus should be placed on these remedies," said Leonard. "If the structured deal is the best available for the creditors, it is unlikely that it will be subject to challenge, particularly as SIP 16 dictates that major creditors should be consulted about the deal in any case. Whilst such instances may be seen as a reason to advocate the proposed changes as they add an extra layer of transparency, it is likewise arguable that the proposed changes do not add anything to the process other than an extra layer of cost that will ultimately reduce rather than increase the level of dividend to unsecured creditors," he added. What seems clear is that when it comes to company failures and rescues, someone always loses out, and so the pre-pack will undoubtedly remain under close scrutiny from all sides whether these proposed changes are played out or not.


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