Pre-Packaged Insolvency

A pre-pack sale has long been a staple of newspaper headlines and invariably alludes to creditors being "stitched up" by the insolvency process. But what is a pre-pack?

The term "pre-pack sale" refers to an arrangement under which the sale of all or part of a company's business or assets is negotiated with a purchase prior to the appointment of an administrator, who will sign the sale documentation immediately on, or shortly after, his appointment.

Pre pack administration is quite a common insolvency process as there are many advantages, including:

1. The business of the company continues without interruption – this can lead to minimal disruption to customers, suppliers, landlords, employees and other stakeholders in the business.
2. The employees of the insolvent business transfer to the successor business without any uncertainty or delay.
3. A pre-pack sale avoids the cost of trading the company in administration, which means creditors potentially receive a larger dividend and the administrators do not need to find funding to trade the business.
4. The goodwill of the company does not diminish in value which again potentially results in a higher price being achieved than would be otherwise realised.

On the flip side, a pre-pack insolvency is a controversial tool which has some of the following potential disadvantages:

1. In the case of a sale to a party connected to the directors, it can result in the directors who have caused the failure of a business carrying on the successor business with impunity and no accountability for the failure.
2. It leaves creditors of the company in administration exposed as they only have a claim against the insolvent company. 
3. There is a perceived lack of transparency with regards marketing and evaluation which can give rise to the impression that full value may not have been obtained -particularly in the case of a sale to a party connected with the directors.

The ethics of this type of sale have previously been called into question by members of the public and creditors of the insolvent business, and so in an effort to combat any scepticism, the Insolvency Service introduced the Statement of Insolvency Practice 16 ("SIP 16") in 2015, with the aim to improve fairness and transparency throughout the process, especially where a pre-pack sale occurs to a connected party.

SIP 16 provides guidance to Insolvency Practitioners ("IPs") in the pre-appointment period, as well as in relation to the marketing strategies that must be put in place to maintain the ethics of the process. Guidance has also been provided on the disclosure IPs must make to creditors (“SIP 16 Statement”) on why a pre-pack was undertaken, with an onus on enabling a reasonable and informed third party to conclude that the pre-pack was appropriate and that the IP had acted with due regard to creditors’ interests.

When a business is being sold to a connected party, in order to assist with his reasoning, the IP should attach a “viability statement” to the SIP 16 Statement prepared by the connected party and demonstrating how the company will survive for at least 12 months from the date of the statement and what the new company will do differently.

SIP 16 is no longer regulated by the Insolvency Service, but by the regulatory authorities that make up the Joint Insolvency Committee (namely, the ACCA, the IPA and the Institute of Chartered Accountants).

So it is not usually the case that a pre-pack "leaves creditors behind". Notwithstanding the protections referred to above, the controversy around pre-packs is unlikely to go away any time soon.

This article was written by Catherine Maguire.