By Daniel Clarke, Associate Partner, Corporate Services, Pannone Corporate
For many small businesses, the last 18 months have presented an enormous fight for survival. An unprecedented global pandemic, constantly changing lockdown regulations, Government policy, tax relief and more, have combined to create a tumultuous and unpredictable landscape, which sadly not all businesses have come through unscathed.
Insolvency has become a real possibility for some, and many businesses will be considering the options available to them, including the newly reformed ‘pre-pack’ administration process. So, what does the process involve and how can it help businesses?
What is a pre-pack administration?
The term ‘pre-pack’ is used to describe the process whereby the business and assets of a company are sold, via administration, in an arrangement that is typically negotiated in advance of the company concerned formally entering into an insolvency process. The buying party is often (but not always) connected to the company (eg, a new company formed by the existing directors of the company in administration).
When is a ‘pre-pack’ suitable?
‘Pre-packs’ can be a really effective tool for all concerned when they’re used in the right way. Typically, they’re used where a company has a good underlying business but is struggling to meet its ongoing liabilities – it’s not uncommon for there to be an imminent threat of, for example, a winding up petition, or a cessation of supplies/services which would damage the business.
In the last 12 months, the Government introduced various measures, including those in the Corporate Insolvency and Governance Act, aimed at protecting businesses during the pandemic which have provided much-needed respite for struggling companies.
Those measures included restrictions on the presentation of winding up petitions, which made it significantly harder for creditors to take potentially damaging action against companies. Insolvency termination clauses have also been prohibited, preventing suppliers from ceasing their supply, or asking for additional payments while a company is going through a rescue process.
However, not all of these measures are permanent. The restrictions on the presentation of winding up petitions, for example, are set to expire on 30 September 2021. This will inevitably expose companies to additional creditor pressure.
Why are ‘pre-packs’ controversial?
Pre-pack administrations haven’t always had the best reputation, because the sale of the business and assets is often completed before the creditors of the insolvent company are even aware of the administration.
Essentially, the process allows a valid business to survive while relieving it of creditor pressure but also ensuring that its assets are realised for proper value. It’s the latter aspect of that equation that has been an area of concern for some and which the recent reforms have been focused on.
The pandemic prompted huge uncertainty for many businesses, and the option to restructure in this way may well be attractive. For creditors though, the prospect may not be as appealing and is often met with frustration that debtors are ‘getting away with it’.
Why have ‘pre-packs’ been reformed?
Pre-packs have come in for criticism over fears that they don’t give creditors enough visibility as to the process or that they are, for want of a better phrase, a ‘stitch up’. But at the end of April 2021 reforms that aim to increase trust in the process came into play and will hopefully address some of the concerns that creditors have expressed historically.
The reforms follow a lengthy Government consultation. The key change is the introduction of a requirement to seek either creditor approval or a report from an independent evaluator where a substantial disposal of a company’s business and assets takes place to a connected party within the first eight weeks of administration.
This will, in all likelihood, make pre-packs less straightforward and potentially more expensive to complete, but it’s hoped that it will also prove to be an effective way of shaking off the negative perception of pre-packs that exists in some quarters, while still providing struggling businesses with a way out.
One of the key reasons why pre-packs have been so unpopular with creditors over the years is that they don’t know anything about the process until it’s a done deal and, by then, it’s too late to do anything about it. Creditors often feel short-changed and that’s why the reforms have introduced creditor approval or an independent third-party evaluator to the equation. It’s hoped that this will give creditors comfort that the process has been properly considered and scrutinised.
What are the benefits for small businesses?
The number of pre-packs has been steadily falling over the last few years, but the prospect of a rise in popularity is definitely on the horizon. For companies which have struggled to make ends meet during the pandemic, a pre-pack administration is potentially a cost-effective and time-efficient way to rescue an otherwise valid business.
Administered properly, pre-pack administrations create a virtually seamless transfer of business and assets from the insolvent company to the purchaser. This can have significant benefits for the majority of stakeholders involved, because it allows for a high level of continuity.
The business can continue trading under the same name, often from the same premises, and with the same staff. This means that the underlying business retains value, which is ultimately good news for all involved (especially when compared to the potential outcome, for example, in a liquidation). For those reasons, where they are viable, pre-packs have always appealed to struggling businesses.
A creditor’s perspective is often different, of course, but the recent reforms are an attempt to address that, at least to some degree.