Threat of extinction looms over pre-packs

THE GOVERNMENT wants to make controversial pre-pack insolvencies more transparent. But will the proposals neuter them?

Businesses sold through pre-pack administrations are usually in the insolvency process for just a few hours. Proposals by business innovation and skills minister Ed Davey could see the process drawn out to increase transparency, and give creditors a bigger say in the future of a company.

Allowing creditors the ability to oppose a business sale in a pre-pack to a connected party, i.e. the company's directors, will bring greater transparency to the process. But at what cost?

The big concern is that the main advantage of a pre-pack - that a business is restructured and sold on before its insolvency devalues and destroys the business - will be lost if that process is delayed.

"The value of a pre-pack is continuity, that's why pre-packs are good. The buyer takes over contracts and keeps the continuity," said Jamie Wheatley, a partner and head of insolvency at law firm Mills & Reeve.

"If that is stopped, it is going to be so much harder to achieve the same value. It could be less likely that a pre-pack is going to be appropriate.

"Pre-packs made up 27% of all administrations in 2010, and this year alone there have been several large cases, including music business EMI, driving lesson company BSM and men's clothing retailer Officers Club (pictured).

In all three instances the transactions were seamless and the businesses were able to continue trading as usual. Continuity of the process meant all lessons for students at BSM were able to continue without disruption, concerts and sales of music went ahead as planned at EMI, and sales of clothing in both stores and the internet were uninterrupted at Officers Club.

The businesses are all big brands. Slowing down the process and letting the world know a business is about to enter a formal insolvency process could devalue it if suppliers cease trading or staff jump ship. If a business loses value because of lack of continuity from delaying the process creditors will receive less dividend payments anyway.

The rapid turnaround of a pre-pack also keeps administration costs to a minimum. The insolvency practitioner (IP) fees are slight and they don't have to find funding to trade the business.

If a sale of a business in a pre-pack is delayed to seek creditor approval this could cause the company to lose value and the cost of the administration to increase. The IP may have no choice but to enter the business into a regular administration, and eventually liquidation, if they cannot afford to trade the business to provide a return to creditors.

"At the end of the day it is about finding the right balance so not driving business rescues into liquidation," said insolvency trade body R3 president Steven Law.

Currently sales to connected parties through a pre-pack are declining. Last year 72% of companies were sold to connected parties through pre-packs, compared to 79% in 2009 according to Insolvency Service figures.

Most pre-packs sold to connected parties involve small companies - where it is unlikely unconnected parties would be interested.

For example, if a small mechanic business entered a pre-pack where the owners client list was made up of his contacts, it is unlikely an outside buyer would have any interest in the business.

The government is also proposing to make transparency reports on pre-packs more publicly available. The reports, known as SIP 16s, were introduced in January 2009 and include information on why the process was the best route, how the company was valued, how it was marketed and why the buyer was chosen. Currently a copy is sent to all creditors and the Insolvency Service. The proposals recommend that they are filed at Companies House for easier access.

According to an insolvency service spokeswoman the alterations will not defeat the purpose of pre-packs.

"Our view through consultation is it would improve pre-packs. It is better for all creditors and we've taken on board all of the view points. These proposals and our recommendations are based on what is best for everybody," she said.

The Insolvency Service hopes to put the proposals out to the profession for their comments later this year. Following a "thorough consultation process" the body aims to bring the changes into practice in April 2013.