Stitch-up or salvation?
Published: 06 January, 2009
With pre-packs on the up, Hannah Prevett delves into the issue causing creditors to kick up a stink.
Barely a day seems to go by without another high street stalwart going bust. Adams, Zavvi and Woolworths have all fallen victim as the credit crunch continues to bite. But there is hope for some. Despite the sounding of the death knell, tea shop Whittard of Chelsea, fashion retailers USC and menswear chain The Officers Club, were pulled back from the brink of insolvency in pre-pack administration deals, saving legions of jobs. However, not everyone is a proponent of pre-packs, as the morality and even the legality of the practice is called into question.
Pre-packing a business is nothing new. In this kind of deal bosses agree to break up and sell the business prior to the company being placed in administration. When it goes into administration its valuable assets are then purchased immediately – often by the previous company’s directors – while the loss-making parts of the business are jettisoned.
On paper, pre-pack deals have their advantages in businesses that are unlikely to find a buyer. If insolvency practitioners are to be believed, settling for a pre-pack will save jobs – according to R3, the UK’s leading trade association for insolvency, business recovery and turnaround specialist, in 90 per cent of pre-pack cases, 100 per cent of jobs are saved – recouping costs for some, if not all, creditors.
Yet, in practice, these deals can leave a bitter aftertaste for any creditors who are left out of pocket as either suppliers to or landlords of the assets left behind. There is certainly a stigma attached to pre-packing a business, especially when it is re-launched by the same bosses, and it is hard to shake the mental image of company directors hammering out a cosy deal in a smoke-filled room, or at least that is the accusation.
Yet insolvency specialist and president of R3 Nick O’Reilly says many companies are turning to pre-pack deals as a result of the challenging economic climate. “In a perfect world you’d want to trade a business on for three or four weeks, place an advertisement very quickly in the Financial Times and after a four-week period you would set a deadline for final offers and then sell to the highest bidder.” But, as O’Reilly himself concedes, it is far from a perfect world as there is a dearth of both buyers and available credit.
Pre-packing a business is not a decision that can be taken lightly. In fact, the stigma is such that O’Reilly admits “it’s not in our interests to do a pre-pack.” It is also becoming more difficult to justify. As of 1 January 2009, administrators are legally required to be more transparent about the sale process. In particular they must reveal why a pre-pack was the best option, provide details of rival bidders, the price paid and any connections the new directors had with the former company which should hopefully put the creditors’ minds at rest.
“What’s good about it in my view is that all the creditors can look over the information that’s provided and decide for themselves if they feel they can accept the explanation that they are being given,” explains Sandra Frisby, a lawyer and academic in the area.
Despite the new legal backbone it looks unlikely that any legal challenges will be brought by creditors aggrieved by a pre-pack deal. In a recent case, landlord Sunberry tried to go down the legal route after foods distributor Innovate was bought in a pre-pack deal by YHL. While YHL did not want to continue the lease on an ongoing basis they wanted to use the premises for the next three months. As occupation by YHL was required for the purposes of realising substantial sums for the creditors, the court decided to reject Sunberry’s request to pursue court proceedings provided that rent was paid as an expense of the administration.
This was a landmark case which is likely to dissuade aggrieved landlords and suppliers from seeking legal action. Nonetheless, the legality of pre-packs themselves is something that has been repeatedly called into question. Private equity boss Jon Moulton was recently quoted in the Mail on Sunday as saying “it is not a procedure that has any legal basis. It has grown up as a practice and no
one has yet had the enthusiasm to contest it.”
One thing that’s certain is that the tightening of legislation can only be a good thing, but it remains to be seen whether it actually has any teeth. A spokesperson for the British Property Federation (BPF) agreed. “We’re in challenging times and there will be an inevitable shift in the retail market, but we would implore that these transactions are done in the most transparent ways and where there are perceived inadequacies in the practices, that the relevant regulators step in.”
