There are various routes which can be taken if your business gets into financial difficulty, some of which are designed to rescue the company and/or business, and others which return value to the company’s creditors and result in the winding-up and dissolution of the company and business.
A pre-packaged administration sale (‘pre-pack’) involves the immediate sale of an insolvent company’s business or assets. In this article, our insolvency solicitors explain the procedure, its advantages and disadvantages and how those involved with the company may be affected.
Jump to:
- What is a pre-pack administration?
- What are the usual steps involved in a pre-pack sale?
- How is the business valued in a pre-pack administration?
- Who can buy a business through the pre-pack administration process?
- Advantages of a pre-pack administration
- Disadvantages of a pre-pack administration
- How much does a pre-pack administration cost?
- How long does the pre-pack administration process take?
- Directors in a pre-pack situation
- Employee rights and redundancy in a pre-pack administration
- Creditors’ rights in a pre-pack administration
- Can a pre-pack administration be stopped?
- Summary
What is a pre-pack administration?
A pre-pack administration is where an insolvent company is placed into administration, either by a court order or by the out-of-court route, and the administrator then immediately sells either the business as a going concern or some or all of the company’s business and assets to a third party. Due to the speed of the sale, terms are arranged before the company goes into administration, so completion takes place immediately without the need to trade the business in administration. The purchaser of the business and/or assets may be the directors of the insolvent company or a third party, such as a competitor.
Any debts or liabilities of the insolvent company remain in the company post-sale and are dealt with by the administrator, while any assets which have not been sold as part of the pre-pack sale may be sold separately for the benefit of those creditors. The money paid for the business or assets sold in the pre-pack goes back to the company in administration and is used to repay the costs of the administration, including to repay creditors of the company. The insolvent company will come out of administration once all the affairs are resolved, often moving into liquidation and eventually being dissolved.
What are the usual steps involved in a pre-pack sale?
The steps to a pre-pack are as follows:
- An insolvent company is at risk of liquidation or administration.
- Directors discuss potential options with an insolvency practitioner.
- The insolvency practitioner (administrator) obtains a valuation of the insolvent company’s assets, considers its liabilities, and prepares a Statement of Affairs.
- If the business and/or assets are to be sold by way of a pre-pack, then the terms of the sale are negotiated in advance with the purchaser. The proposed administrator will usually recommend an independent valuation of the business is undertaken to ensure a fair price is reached and will often allow a short period of discreet marketing to take place to ensure the best price is obtained for the benefit of the company and its creditors.
- Once the sale terms are agreed and the finances are in place to effect the sale, the insolvent company will be placed into administration and the sale will be completed, usually on the same day. Creditors must be notified within seven days of the sale.
- A meeting of creditors will be held at which the insolvency practitioner will explain the reasons for the pre-pack, the purpose of the administration, and what are the next steps for the insolvent company.
- Creditors will be paid from the sale proceeds depending on their priority and what is available.
How is the business valued in a pre-pack administration?
There are many protective measures now in place in order to ensure that pre-pack sales are not merely a way of allowing the existing directors of the company to strip the viable parts out of a business, leaving behind the creditors and the failing business, and starting up again in a new co without any consequences.
Now, under their regulatory protocols, a proposed administrator who intends to be appointed to effect a pre-pack administration sale as soon as the company goes into administration, must ensure that they do everything necessary to ensure a fair price is obtained.
In order to make sure a fair price is obtained an administrator will appoint an independent valuer of the assets and business to decide the parameters of a fair value sale. They will also market the business or assets for a reasonable period of time (usually at least 1-2 weeks) to give the open market an opportunity to bid on the assets.
Who can buy a business through the pre-pack administration process?
Anyone can potentially buy a business through the pre-pack administration process.
Who actually buys the business depends on how attractive it is in the open market, and what is being sold. In smaller more niche owner managed companies however there may be less general market interest. If the existing directors believe there remain some good parts to the business that could be taken forward if the financial situation changes. They may then perhaps buy the goodwill, the name, the customer list as part of a pre-pack purchase to take forward into another corporate vehicle.
Advantages of a pre-pack administration
There are several advantages to a pre-pack:
- It can be an extremely speedy process.
- A pre-pack allows for the easy continuation of the business with no or very little interruption.
- Because of the nature of the process, there is no gap in trading and no publicity regarding the company’s financial state. As a result, there is little time for confidence in the business to be shaken, which can be the case with other, more protracted, insolvency processes. This can have an adverse effect on both trading and the value of the business and attached goodwill if, for example, the administrator tries to sell at a later date.
- Effecting a pre-pack can be a cheaper insolvency option than other options due to the speed of the process.
- A pre-pack can save more jobs than other insolvency procedures.
- If the directors purchased the business from the company in administration, then they may retain control of the business post-sale, rather than it passing to people who have little or no understanding or experience with the business.
- It may be the only option, other than liquidation, for an insolvent company which does not have sufficient funds to continue trading. The proceeds of sale from the pre-pack are available for creditors, whereas there may be little or no value in the business once it has ceased trading in a liquidation situation.
Disadvantages of a pre-pack administration
Notwithstanding the various advantages to a pre-pack, there are also several disadvantages to proceeding in this way and pre-packs have been criticised and been the subject of adverse media attention:
- Traditionally, it is an opaque mechanism. Although any secured creditors of the company will need to be aware of the possibility of a pre-pack in order to release their security, unsecured creditors may not find out about the sale until it has been completed and you may have no say in the process.
- The pre-pack process has little legislative governance. Pre-packs are primarily controlled by the administrator’s professional standards.
- Extensive marketing of the business cannot be undertaken prior to the sale in case publicity about the financial position of the company destroys the value of the business. Arguments have been made that this results in the administrator being unable to fully test the market, possibly resulting in lower returns for unsecured creditors.
- Similarities have been drawn between pre-packs and ‘phoenix’ companies where an indebted company is liquidated and the business is transferred to a new company with the purpose of leaving behind the liabilities. In a similar way, a pre-pack often results in the sale of the business to the directors of the insolvent company, leaving behind creditors.
- There is a potential conflict of interest for the insolvency practitioner, who will be approached by the directors of the insolvent company, prior to its going into administration, to discuss a pre-pack as an option and who may then feel obliged to agree to the pre-pack in order to be appointed as the administrator.
- Pre-packs rarely involve restructuring the business and are likely to lead to the end of the existing company.
- There is a risk that the business will be sold to a competitor, particularly if the directors of the insolvent company do not have the funds to purchase the business or assets.
Protective measures
Various measures have been put in place in an attempt to relieve some of the criticisms and disadvantages of pre-packs.
- From 30 April 2021 a sale cannot be made to a connected person or persons within 8 weeks of an administration appointment without either prior creditor consent, or unless the administrator has received a ‘qualifying report’.
- A connected person is a company or person connected with the company, such as a director(s) or an associate of the company or directors.
- To obtain creditor approval, a decision-making procedure must be used and a period of 14 days’ notice must be given from the date of appointment of administrators. This means if the creditors were to approve, for practical purposes a pre-pack sale to connected persons could not take place on the same day as the administration appointment. The only practical option for pre-pack sale during the 8 weeks from administration to a connected person after 30 April 2021 will be for the purchaser to obtain a qualifying report from an evaluator.
- The details of who can be an evaluator are to be ironed out but they must have ‘relevant knowledge and experience’, be fully independent, and have professional indemnity insurance.
- The report must state that the evaluator is satisfied that the consideration for the sale and the grounds for the substantial disposal are reasonable in the circumstances. If they are not, this doesn’t prevent the pre-pack sale, but it could be compelling evidence of wrongdoing in any future challenge if ignored.
- The report will be provided to creditors within 7 days of the administration appointment along with the usual information that must be provided to creditors and the Registrar of Companies.
- Administrators are required to act in the best interests of the company, rather than the directors, and should not move ahead with a pre-pack unless they can justify their actions to the creditors. Administrators can suffer sanctions if they act improperly.
- Guidelines for administrators have been put in place dealing with such topics as advertising the sale of the business and disclosure requirements if the business is to be sold to any person ‘connected’ with it, for example, the directors. Administrators who fail to comply with this guidance may suffer disciplinary or regulatory action.
How much does a pre-pack administration cost?
There are no set rules as to the cost of a pre-pack and it will often depend on the amount of work involved and complexities of the business. Administrator fees are unlikely to come in much below £15,000 although the speed of a pre-pack may result in lower fees compared to other insolvency procedures. Fees should be discussed in advance with any proposed administrator.
How long does the pre-pack administration process take?
It is often fairly quick. This is needed because once it becomes known that a company is moving towards an administration, the value of that business can quickly start to deplete. Customers may get spooked and move elsewhere, as might key employees. Lenders might start to call in loans. There is a balance to be had in ensuring sufficient marketing so that a fair value is achieved, compared with notifying the market of the impending administration, with the negative knock on effect that can have on the business, which can then reduce the sale price.
As soon as marketing has been completed and a price agreed, the negotiations and sale agreement are carried out very quickly, often within a few days, to ensure the sale can go ahead as soon as possible on the same day as the company goes into administration.
Directors in a pre-pack situation
It is common for the directors of the insolvent company to acquire the business or assets in a pre-pack and essentially ‘start again’. Although there has been criticism of this, with it being likened to a ‘phoenix’ company (see Disadvantages to a pre-pack above), there can be advantages in that the new company is controlled and managed by those who understand and have experience of the business and hopefully, lessons will have been learned, avoiding an insolvency situation in the future.
Directors should however be mindful of their duties and obligations to creditors in this situation and are advised to take independent advice before proceeding.
- When insolvent or on the brink of insolvency, it is important that directors take all steps to minimise any loss to creditors. If not, they could be held liable for wrongful trading and various additional misconduct, which can result in personal liability or even criminal penalties.
- A director can also be disqualified from acting as a director by the Insolvency Service if they disadvantage creditors in order to benefit themselves.
- Where a pre-pack is used to purposely evade liability for a defined benefit pension scheme, anyone associated with the insolvent company, including directors, may be required to contribute to the scheme.
Employee rights and redundancy in a pre-pack administration
Employees are well protected in a pre-pack situation although there is always the risk that they may become unsecured creditors if payment of their salary is in arrears beyond a protected level.
The Transfer of Undertakings (Protection of Employment) Regulations (SI 2006/246) (TUPE) apply in a pre-pack situation. As a result, employees of the insolvent company should transfer across to the purchasing company with their terms and conditions of employment intact and without affecting their length of service. The dismissal of an employee covered by TUPE will be automatically unfair in most situations.
Creditors’ rights in a pre-pack administration
There may well be a number of creditors in a pre-pack situation. Secured creditors will often have notice of the pre-pack as their consent to the release of their security will usually be required. Unsecured creditors, such as employees to the extent that they have not been paid, suppliers who have not been paid, HMRC and so on, are in a different position. On a pre-pack sale, they are unlikely to have prior notice until after the sale has taken place.
Employees
The purchaser of the business will take on the majority of liabilities relating to the employees although some might be dealt with by the Secretary of State, including the payment of up to eight weeks’ unpaid salary.
Suppliers
Suppliers with whom the new company wants to trade will sometimes be notified of a pre-pack sale in advance if they are key to trading post-sale. Although some suppliers may choose to no longer trade with the new company, particularly if they have suffered loss as a result of its insolvency, there is also the chance that they will want to retain the business relationship. They would be advised to do so without allowing credit if possible, and may even be able to negotiate a repayment of some of their losses when negotiating a new contract.
HMRC
If the insolvent company has failed to pay HMRC, the new company may be subject to a VAT security deposit and so have to pay an amount to HMRC in advance.
Can a pre-pack administration be stopped?
Stopping a pre-pack is difficult. The administrator controls the process and if they consider the pre-pack to be in the best interests of the company, it is likely to go ahead. In many cases, unsecured creditors will not be aware of the sale until after its completion and even if they are aware beforehand, the decision to go ahead with the sale or not is still up to the administrator, acting in the best interests of all of the creditors.
There are methods by which creditors can later challenge the administrator’s actions, although it should be noted that by this stage, the sale is likely to have gone ahead. Administrators are required to act in the best interests of the company and achieve the best results for creditors and they can be challenged if they have not fulfilled their duties properly under the relevant guidance or the Insolvency Act 1986. Complaints can also be made through the Insolvency Service’s complaints gateway.
Summary
While pre-packs have traditionally had bad press, regulations surrounding them have been considerably tightened up in the past few years, and they can be a very good way of rescuing the good parts of a business and allowing it to move forward without the existing financial ties holding back progress. Not only can a pre-pack help to save jobs, but the purchase money can be used to pay the creditors of the business moving into administration.
If you think your business is right for a pre-pack administration sale, speak to one of our advisers to discuss your options.
