What is Pre-Pack Administration?September 9, 2019
After well over a century in business, the iconic British department store, House of Fraser, was facing severe financial difficulties and the road to liquidation was closing in on them. The end of an era was dawning.
In May 2018, in desperate need of raising serious capital, House of Fraser directors sought to strike a deal with Chinese firm, C.Banner. For the majority of shares in the company, they would invest £70m, which would provide much needed help in House of Fraser's company voluntary arrangement (CVA) rescue deal to repay their creditors.
Just as things were looking promising, however, C.Banner pulled out of the agreement, leaving House of Fraser in a terrible situation once again, unable to carry out their CVA.
As they were facing a final and almighty crash from grace, Sports Direct owner Mike Ashley stepped in, putting a cool £90m on the table for House of Fraser's business and assets as part of a pre-pack administration sale. The deal was closed and Ashley absorbed all of House of Fraser's stores, the brand, and their stock.
House of Fraser then formally entered into administration to tie up all of the assets remaining in the old company shell, using this cash injection to pay off a chunk of their staggering debt.
Pre-pack administration is an option often considered by insolvent businesses. For some, it is ideal. For others, it is not viable. But what does it mean exactly? In this article, I am going to look at what pre-pack administration is, why a company might opt for it, what the process involves, and what the pros and cons of this route are.
What is pre-pack administration?
When we talk about pre-pack administration, it is important to first make the distinction between the company and the company's business and assets.
When a company becomes insolvent and faces liquidation, they have a few options to organise repayment to their creditors. Selling off their business and assets is one way that they can raise some of the necessary capital to pay off their debts.
Pre-pack administration can therefore be understood as an insolvency procedure where a company sells its business and assets. Pre-pack administration comes before a company enters into administration. When a sale has been agreed upon, the company applies to enter into administration. Their appointed administrator will carry out the sale of the business before organising the original company's affairs for dissolution.
This process differs from an ordinary administration sale, which involves the administrator marketing the business and negotiating the sale terms themselves once they have already been appointed. A pre-pack sale is, drumroll, a pre-packed sale for the administrator to carry out when they are first appointed.
With pre-pack administration, the business can also be sold to the existing company directors who will then take the business and assets to a new company called a "newco". In order for this to happen, the directors of the new business must have sufficient funding to buy the assets of the old company (oldco) at a fair value. The business and assets must be sold at a price that reaps the greatest pay-out for the oldco's creditors. If a third party, even a competitor, puts in a higher bid, then the business should be sold to them.
Why would a company opt for pre-pack administration?
Pre-pack administration is a useful option for companies in such dire financial difficulty that it is simply not viable for the administrators to run the company, market it for sale, and arrange the business sale. Opting for pre-pack administration, rather than entering into general administration, is a less risky option. The option of pre-pack administration is used when the directors and proposed administrators agree that the pre-pack will reap the greatest payout for the creditors.
Opting for pre-pack administration is a good option because:
- It allows the company to generate immediate capital to repay creditors, rather than waiting for marketing/arranging a sale after an administrator is appointed.
- It allows their business to be carried on by new owners straight away (or the company's directors, under a new or the same company name if they buy the rights), resulting in less disruption to employment and service contracts.
- The company can enter administration with a protective moratorium without the strain of handling the everyday business running too.
If your insolvent company is on the brink of having legal action taken against it by creditors, or its financial situation will worsen if it continues to trade, then pre-pack administration can be a sound option. The directors can be held personally liable if appropriate action is not taken when trading whilst insolvent, so it's important to get expert advice and see if a pre-pack sale is an option for you.
What does the pre-pack administration process look like?
The pre-pack process needs to be carried out carefully to ensure that the best outcome is assured for the creditors. There are a number of steps that a business must go through to keep it watertight:
1. Contact an insolvency practitioner.
By getting in touch with an insolvency practitioner as early as possible, you can review your options before your situation deteriorates further. The insolvency practitioner will walk you through all your possible options, including a CVA, creditors voluntary liquidation (CVL), refinancing, administration, and pre-pack.
It is necessary to review all options rather than settle on a pre-pack straight away because the ultimate goal is to repay as much debt to the creditors as possible. If a pre-pack will not guarantee this, it should not be considered.
For a pre-pack to be a viable option, the insolvency practitioner needs to check if there are any stumbling blocks posed by floating charge holders, landlords, suppliers, and creditors, particularly if they intend to carry out a newco pre-pack. Some banks do not support newco pre-packs, and the landlord and suppliers may oppose having a new business assuming their lease or contracts. Permission does not need to be sought by the creditors for the process to go forward.
2. Asset Valuation.
If a pre-pack sale is seen as the option that will deliver the greatest payout for the creditors, the process will then be set into motion.
If the hope is to sell the business to a newco, then a plan will need drawn up which includes profit and loss, cashflow, and balance sheet forecasts as well as an indication of working capital requirements. This is necessary to show that the newco will be able to function solvently, otherwise the pre-pack should not go ahead.
RICS qualified surveyors will formally value the assets your company has and the insolvency practitioner will draw up a Statement of Affairs which provides an overview of the company's assets and liabilities.
The insolvency practitioner will then market the business and assets to third party potential buyers.
If the newco plan to purchase the business and assets, they need to provide evidence that they are able to finance it and are allowed to trade. They may receive funding from specialist lenders or venture capitalists.
The newco directors may need to provide personal guarantees too, particularly for SMEs. HMRC may request that the newco pay a security bond before trading, particularly if HMRC was one of the oldco's outstanding creditors.
Moreover, if the existing director's wish to buy the business, they must remember that they have a fiduciary duty of care to the company creditors, so they must avoid conflicts of interest. They must ensure that their purchase is in the creditor's best interest.
When all offers have been made and all funding sources have been verified, the highest bidder wins the business and assets. This could be the newco or even a competitor, but the choice of bidder depends on who receives the greatest amount of funding.
4. Administrator appointment.
Once the buyer has been selected, the company will gather necessary documents and forms to apply for an administration order. When this has processed and the administrator has been appointed, they will proceed with the pre-pack sale, overseeing the complete handover of assets to the buyers.
Under the Statement of Insolvency Practice 16 (SIP 16), introduced in 2013, the administrator is legally bound to give the creditors information about why the pre-pack sale route was chosen. They will organise a creditors meeting where they provide information such as:
- The alternative avenues considered and why they were not deemed appropriate.
- The marketing activities conducted by the company and/or administrator.
- The business and asset valuations obtained.
- The identity of the buyer.
- Any connection between the buyer and the company directors.
The administration will pay the creditors pro-rata with the liquidated asset funds and they will begin making their recommendations for liquidating the original company shell.
The remainder of the administration process will see the administrator organising the company books and records to ensure all remaining assets are properly dealt with before dissolving the company. The process automatically ends after a year unless a request for extension is approved.
What are the advantages of pre-pack administration?
We've already discussed why an insolvent business might turn to pre-pack administration as a solution. Here are some more specific advantages to the process:
- Operating Continuity. Business operations can continue as normal until the appointment of an administrator so turnover doesn't plummet further.
- Fund Preservation. It's a quick process that prevents further losses being made which would reduce funds available for creditors.
- Job Preservation. It is more effective at preserving jobs which would be axed under other initial cost-cutting avenues. Under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE), all employee contracts and benefits must be transferred in tact to the new owners.
- Brand Image. The quickness means the company's brand image is less likely to be tarnished by media and industry attention, which protects relationships with suppliers, employees, and shareholders.
What are the disadvantages of pre-pack administration?
The concept of pre-pack administration has received a great deal of flack for several reasons. Let's look at some of the disadvantages of the process:
- Lack of Transparency. Some view the process are very opaque. Secured creditors are usually consulted in advance of the process, but unsecured creditors are not informed until after the fact. The whole process takes place behind the scenes with little involvement from external parties which can foster a negative view of the company.
- Controversial. To some, it appears that a pre-pack allows company directors to ditch their debts and start the same company afresh. Pre-packs are in fact often the only viable alternative to liquidation, so they were chosen as the option that would raise the most capital for creditors. Whilst pre-packs can be justified, the negative perception is still there.
- Future Damage. The newco owners may find they are refused credit in the future because they were leaders of a company in administration. The administrator is required to submit a report that outlines the conduct of the directors. HMRC ask for this information so they can ban directors with questionable leadership from VAT registration.
- Marketing Scope. Some critics are concerned that because of the time sensitive nature of the pre-pack, full and proper marketing of the business cannot be achieved so the highest bidding opportunity might not have been selected.
Considering a pre-pack?
When your company becomes insolvent, you must carefully watch your step to ensure that you are abiding by legal protocols. Getting in touch with a licensed insolvency practitioner as soon as possible is the absolute best option you can take to avoid further deterioration of the situation. Pre-pack administration shouldn't be pursued without professional advice from an IP.
180 Advisory Solutions offer completely confidential free initial advice to help you navigate your next steps. Navigating situations like this is always easier with expert help, so please don't hesitate to reach out to us for support.