Key pre-pack measures are unworkable

by Richard Crump

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25 Jun 2014

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KEY RECOMMENDATIONS aimed at cleaning up the "scuzzy nature" of pre-pack administrations lack detail and are largely unworkable, insolvency practitioners have told Accountancy Age.

Practitioners support the overall findings of Teresa Graham, the senior accountant who led the government-commissioned review into the use of heavily-criticised pre-pack administrations. However, there are concerns about how her principle recommendations will be implemented and that the reforms fail to understand the "driving force" behind pre-pack sales.

Pre-pack administrations, whereby the sale of the business is marketed prior to the company entering administration and subsequently sold - often to the company's former directors - on appointment of administrators, have been much-maligned for their lack of transparency and because creditors are usually left out of the loop until the sale has taken place.

Graham, who says she is a "deregulator at heart", rejected the idea of placing pre-packs under legislative scrutiny in favour of a series of voluntary measures. She concluded pre-packs should have a place in the UK's insolvency landscape, but nevertheless called for "major improvement" in how they are administered.

"Pre-packs offer significant cost advantages to upstream procedures such as a scheme of arrangement," Graham said at the ICAEW Insolvency and Restructuring Conference last week following the publication of her report. "They bring some limited benefit to the UK economy."

IPs are pleased with the overall tone of Graham's findings, which they interpret as supporting the profession and process and instead scrutinising directors who purchase their own companies in connected party pre-packs.

Giles Frampton, president of insolvency trade body R3, says he understands why "the noise takes place around connected party" deals and "why people get excited", but adds that the IPs "essential duty" is to get the best price.

"Typically, the people who know the most about the business will pay the highest price," he tells Accountancy Age. "The IP comes into clean up the mess and restore order."

Frampton's supports Graham's position that pre-packs are a useful tool, as do most practitioners. It is the detail of her central reforms - chiefly the introduction of a pre-pack pool and viability reviews for connected parties - that has caused controversy.

A dead pool
Graham's recommendations include creating a pool of experienced business people to independently scrutinise a connected party pre-pack deal. Members of the pool should spend no longer than half a day reviewing the proposals under the plans.

It is intended that the process will be low cost and that the fee will be paid upfront by the connected party. The fee will also pay for the administrative costs associated with maintaining the pool.

Questions have been raised as to who will form this panel on such short notice, as the pre-packs by their very nature need to be undertaken very quickly. There is also a risk the pool will fail to attract the right calibre of members.

"There is a reputation issue. It will be difficult to find the right standard of people," says Paul Clark, London managing partner at restructuring specialists Duff & Phelps, adding that members could struggle to "get under the skin" of the business in just half a day.

Graham explains that pool members will not undertake an audit of the business and expects the process to be "slick and fast", but dismissed the idea that it "has to happen on a Friday and go live on a Monday".

"[The pool] is there to satisfy the trustees that sufficient work has been done by connected parties to justify the new company's existence," she says.

However, there are concerns that the pool process will not remain slick and fast for very long. Phillip Sykes, head of restructuring and insolvency at Moore Stephens, says his "overriding concern" is the process will become "longer and more convoluted".

"There is a real risk that the amount of information included in the pool becomes unmanageable, as existing business owners try to protect themselves from any potential litigation by disclosing as much as possible," he says.

An unviable review
Any connected party will also be required to participate in a ‘viability review' for the new company, stating how the company will survive for at least 12 months from the date of the statement. A short narrative will also be provided, detailing what new company will do differently from the old in order that the business doesn't fail again.

A criticism of pre-packs has been that companies with fundamentally unviable business models are allowed back into the marketplace post pre-pack, shorn of old company debts, often to fail again. Academic research commissioned by Graham found a new company in a connected party pre-pack is more likely to fail than a new company unconnected with those controlling the old company.

Frampton says he can "see the point" of viability reviews but that it will be "quite a tough thing" to have a review that says the business will be there in 12 months - which is the minimum requirement for a solvent business to state that it will remain a going concern.

At the same time, Graham's suggestion that the "dumping of debt will not be allowed" was shot down by one IP at the ICAEW event, who claimed that "writing off debt burden is driving force of pre-packs" and that the review placed "too much emphasis on transparency" rather than maximising creditor recoveries.

Voluntary with a kick
IPs are not universally opposed to Graham's proposals. Indeed, her recommendations that valuations must be carried out by a valuer who holds professional indemnity insurance and that proper marketing must be undertaken prior to a sale received a warm response.

Graham is particularly scathing about the current state of pre-pack marketing, finding some of the activities included as marketing in SIP16s - a report filed by the IP about how the pre-pack has been undertaken - are "severely lacking and do the insolvency profession no credit".

For instance, Graham says "it is no longer appropriate" that marketing is carried out by connected parties who deem they are the only one who wants to buy the business. Where marketing is carried out, it should conform to broad "good principles of marketing".

"The business should be marketed as widely as possible, proportionate to the nature and size of the company - its purpose is to make the business's availability known to the widest group of potential purchasers in the time available, via whatever media is likely to achieve this outcome," the review states.

Clark at Duff & Phelps "totally agrees" with Graham's comments about taking a broadcast rather than narrowcast approach and adds that any "decent IP would review who the competition are and approach buyers in market".

All of the proposals are to be adopted on a voluntary basis. And while some IPs have questioned who will actually adopt them, Graham argues the recommendations are "voluntary with a kick"; for example, the SIP16 will say what connected party has or has not done.

Should the measures fail to have the desired impact or are not adopted as Graham hopes, then government should consider legislating. To encourage take up of the proposals, government may wish to consider taking a reserve legislative power at the earliest opportunity, in order that it can act should the behaviours outlined in the report continue.

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