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Pre-packs: The good, the bad and the alternative

1st Feb 2012
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Pre-pack administrations have been more widely used in the last few years following the financial crisis, reports Keith Steven managing director of KSA Group.

High profile cases like Blacks Leisure, La Senza, DTZ, Bon Marche, and Alexon have meant there has been a spotlight on such deals where the assets of the business are sold to a third party or newco set up by management

In a pre-pack the deal is worked out before the application to court for the administration order. All this happens in one movement and in the past, unsecured creditors, such as trade suppliers, may not even be aware that the business is in difficulty. 

This sort of deal can make the people who lose out, suspicious that they have been ‘stitched up’. The deals that attract the biggest criticism are those where the new company that has bought up the business, is closely associated with the former owners.    

The good

Contrary to popular belief these sorts of deals are not done in a couple of days. If the company is struggling with cashflow, then a pre-pack may be considered over a number of weeks. All other insolvency options or trading out options should be considered. Discussions may be ongoing between the management, secured lenders, landlords, pension trustees, unions, possible outside investors and financiers of future working capital.

Since 2010, the insolvency profession has had to follow a statement (code) of insolvency practice (SIP 16) that requires disclosure of the impending deal to the main stakeholders. Unsecured creditors such as HMRC and trade may still feel impotent, in that they cannot impact upon the deal.

In a pre-pack the new company or a third party buyer, takes over all the employment contracts under rules known as Transfer of Undertakings Protection of Employment Regulations (TUPE).

Pre-packs can preserve jobs, keep the business trading and quickly remove the crisis that caused the insolvency. But they are far from an easy option for the directors, buyer or employees.

The bad

Management can abuse the process by racking up debts quickly and then appear as the only buyer when the business gets forced into insolvency by the legal actions of a creditor. 

Many IPs like pre-packs as opposed to the alternatives like CVA, as there is some certainty and finality to the procedure and they are guaranteed to get paid. 

IPs also like the fact that their own period of risk is short as they have to pay wages, rents, rates, PAYE and VAT during a traditional administration. In effect the business is flipped and the IP’s risk mitigated.

We hear of unscrupulous IPs who agree to pre-pack a company for well below market value of assets. This really looks like a stitch up, SIP16 requirements seem to be steamrollered. One client told us that another IP said “what do you want to buy it for? £20k? Then that will be my fee”!

What about independent valuations, creditor consultation and marketing of the business (SIP 16 requires this) was our reply? How does this generate a better result for creditors as required under the Enterprise Act?

The alternative

A powerful alternative is a company voluntary arrangement or CVA. This is where the company seeks agreement from its creditors to write off part of the (unsecured) debt and repay an agreed dividend over a three-to-five-year period. 

This requires grit and determination from the directors of the business to turn around the company. 

A CVA still has many of the powers of other insolvency procedures, in that it can quickly cut costs by terminating contracts of employment or lease obligations for instance. JJB Sports has used two CVAs to close non-performing stores.

It should also help generate cashflow by freezing payments to creditors while turning current assets of stock, WIP and debtors into cash. Assets aren’t subject to the massive devaluation that always occurs in administration or liquidation.

In a CVA the return to unsecured creditors is usually between 35-100p in £1, whereas in administrations and pre-pack administrations the return is usually 10p or less.

Another reason that CVAs are not considered is the simple fact that many people don’t actually know about them. Directors and their advisers, including accountants, should consider CVA as a powerful option. A common misperception we hear from accountants is that HMRC will not support CVAs, where there is less than 100p in the pound repayment. This is nonsense. The Voluntary Arrangement Service (HMRC) will consider all well-crafted proposals.

Keith Steven is the managing director of Company Rescue and KSA Group - a specialist firm of insolvency and turnaround practitioners. Over the last 15 years he has worked on assignments ranging from large multi-national projects to small manufacturing companies, to simple advice over the phone.

Replies (7)

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By bryce.weir
03rd Feb 2012 13:00

Pre-Packs

There also too many cases where clever changes of business name creep into this whereby by moving the business name & assets around the business gives the appearance of continuity whilst the debts are still in the old re-named business.

The legislation around all of this needs re-examination.

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By miketombs
03rd Feb 2012 13:22

Thumbs up for CVA

I recently started working with a client who owed a sizeable amount to HMRC from previous years but was currently trading profitably and generating positive cashflow. Despite that HMRC seemed intent on losing everything by forcing a liquidation.

We contacted an IP to dscuss a CVA, and subsequently appointed them to prepare the proposal. The CVA was approved last week, all the pressure from the historical problems is taken off the business except of course to meet or beat the obligations under the CVA, and the creditors will end up with 100% payout instead of probably 5%.

A welcome benefit to me of course is that I still have a client!

 

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By Romanista
03rd Feb 2012 14:11

In Scotland, the main topic of discussion in the media for some months now has been that a high profile football team is planning a pre pack if HMRC's case against it succeeds and it becomes insolvent.  Should that happen then the subject may well get national media exposure and perhaps people outside the accountancy profession will start to consider the process in a lot more detail.  That may make life a bit more difficult for some IPs.

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By johnwarren22
03rd Feb 2012 17:21

Pre-packs

Whilst pre-packs may be legal and very convenient for Directors and IP's there is a significant moral dilemna here.  Pre-packs may protect some of the jobs in the failing organisation but what about the creditors and their employees whose businesses and jobs are consequently put at risk?   I know of one franchised organisation that sanctioned pre-packs for twelve of its franchisees over a period of two years.  Each franchisee entered into administration one day and rose phoenix-like from the ashes the next day with the original Director(s) still in place and with a brand new franchise agreement granted by their franchisor.  It became an easy and very popular  "ditch the debt" option within this particular franchise network.  In every case the biggest creditor by a long way was HMRC and in many cases the franchisees had been deliberately withholding Tax and NII payments in anticipation of the pre-pack taking place.  Also, the IP's must have known that this was happening .   There may not be too many tears shed for HMRC as a creditor but actually this is yours and my money that is being lost....! 

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By gwilso25
04th Feb 2012 15:57

CVA

We used a CVA that was prepared by KSA.  A few months on it is very clear that this was by far the best option available to us.

 

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Man of Kent
By Kent accountant
05th Feb 2012 21:05

Thumbs up for CVA's

I advised a business to enter a CVA. The directors were initially reluctant but I managed to convince them it was the best option.

Eighteen months on the business is performing well and the payment proposal of 47p in the £ is being kept to.

Great news for creditors, as most of them are still working for the client and getting paid on time!

 

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By Kelvins
08th Mar 2013 13:32

Pre pack insolvency
The major advantage of pre pack insolvency is that it is helpful in maintaining the continuity of a business and getting rid of the unwanted business contracts and overcome the financial crisis in an easier manner.

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