This article was originally written for and featured in Contract Flooring Journal.
With the economic climate still poor it’s clear that there will be more businesses failures, causing great misery to those downstream. As insolvency specialists do their best to realise value for creditors while trying to keep the business saleable as a going concern, the process can leave unsecured creditors unpaid.
The problem with pre-packs: Creditors have argued in some cases that the pre-pack option has been abused. This idea that pre- packs are a ‘stitch-up’, is often understandable, particularly as the unsecured creditors are only informed of a deal after the sale has been completed. In the past, they have had little ability to challenge the terms of the sale.
Creditors can be particularly vocal on a phoenix sale when the directors or shareholders of a struggling company use the pre-pack option to ‘buy-out’ their company.
In fact, the sale of a business back to connected parties is not exclusively a feature of pre-packs. In half of all UK business sales, the business is sold to a connected party. This figure rises by only approximately 10%, in pre- packs. However, it is pre-packs where creditors can be the only class of people who really suffer any loss.
Regulation under SIP 16: In response to creditor concern, a Statement of Insolvency Practice 16 was introduced at the start of 2009. http://bit.ly/N8eGmX
SIP 16 requires administrators, acting on pre-pack sales, to demonstrate that they have performed their functions in the interests of the company’s creditors as a whole.
There is now an obligation to disclose, among other facts, any valuations obtained; alternative courses of action considered by the administrator; the consideration for the sale and the terms of payment; any connection between the buyer and the directors, former directors, shareholders or secured creditors of the company; and who brought the administrator into the process.
Although such information need not be provided before a sale, it should be provided with the first notification to creditors. In any case where a pre-pack sale has been under taken, the administrator should hold the initial creditors’ meeting as soon as possible after his appointment.
Rights of creditors unhappy with a pre- pack: The hope behind SIP 16 was that prevention is better than cure. By clarifying exactly what an administrator is expected to do, it is hoped that the administrator will not play fast and loose with the pre-pack process and will instead ensure that a proper price is paid.
If a creditor is still unhappy, SIP 16 ensures that creditors are given material information on the sale process such as any valuation obtained, marketing efforts etc.
This information would form the basis of any legal claim. Creditors will also be given contact details of other creditors so they can band together to pool resources and information.
They can then take legal advice about the viability of bringing a claim against the administrator or the purchaser. The creditors should be aware that this is an uphill struggle, particularly if the price paid reflects the valuation obtained.
Other actions available to a dissatisfied creditor could be a complaint to the Insolvency Practitioners Association, trade bodies and the like. www.insolvency-practitioners.org.uk
The Insolvency Service has, however, warned that SIP 16 may have to be passed into law, with penalties for non-compliance, after more than one-third of pre-pack deals post SIP 16 were found to be in breach of the guidelines.
According to an Insolvency Service report, 38% of the 497 pre-pack sales reviewed were not fully compliant with the disclosure rules set out in SIP 16.
Of those identified, 7% were deemed to constitute a serious breach of the SIP 16 guidelines warranting referral to the relevant authorising body.
Too early to tell: The reduction in fees brought about by the out of court route into administration, led to a rise in the number of administrations. It will also be interesting to see whether increased fees and a greater degree of scrutiny on administrators, will lead to a reduction in the number of pre-packs.
It is still too early to tell where we are. The current economic climate will probably ensure that the pre-pack remains centre stage of UK business rescues for many years.