The main advantage of a pre-pack is that the business can be sold quickly.

What is a Pre-pack?

Neither the Insolvency Act 1986 nor the Insolvency Rules 1986 mention pre-packs. 

SIP 16 is a set of guidelines on disclosure to creditors in respect of a pre-pack sale. 

 These Guidelines refer to a “pre-packaged sale” as “an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, his appointment”. 

The main advantage of a pre-pack is that the business can be sold quickly as a growing concern to maximise the value for creditors.  Maximum value is obtained as a quick sale ensures that:-

1.Goodwill is preserved as customers and suppliers are given the impression that nothing substantial has changed (this is subject to it being possible to transfer the old company’s contracts to the new company);

2.Employees are more likely to be retained as they are less likely to leave if the company avoids liquidation (this is important for continuity and for retaining skilled employees);

3.The danger that funding will run out and therefore affect the value of the business is reduced;

4.The costs of administration are lower.

By their very nature, pre-pack sales are completed as quickly as possible and with limited disclosure.  Accordingly they attract suspicion particularly from unsecured creditors and disenfranchised shareholders.  Secure creditors are less likely to be suspicious as they will have been involved in the process due to the need for them to approve any sale. 

Pre-packs are criticised for the following reasons;-

1.The business has not been marketed sufficiently and therefore the best price has not been achieved;

2.Unsecured creditors are not kept informed and are not given the opportunity to consider and vote on proposals (as would be the case in a normal administration); 

3.It is common for the business to be sold to the management of the insolvent company giving them a second chance at the expense of disenfranchised stakeholders (the “phoenix” company scenario);

4.Administrators can have a conflict of interest as they are sometimes introduced to the company by its directors in the context of a proposal that the business be sold to them.
 
Although current insolvency legislation does not mention pre-packs, the Courts have confirmed that, where the circumstances of the case warrant it, an administrator has the power to sell assets without the prior approval of the creditors or the permission of the Court.  However, administrators must remain vigilant as they do not have carte blanche to act as they please and can be brought to task by the Court on the application of a variety of interested parties including the creditors.
 

SIP 16

SIP 16 was issued in response to the criticisms of pre-packs and took effect on 1 January 2009. It provides administrators with professional guidelines when involved in a pre-pack. It is not law and is best practice only.  It stipulates information that should be given to creditors so that they are provided with a detailed explanation and justification of why a pre-pack sale took place and that the administrator has acted with their interests in mind. 

Examples of the information that should be disclosed to creditors are:-

1.The marketing activities conducted by the company and/or the administrator;

2.The valuations of the business or of the underlying assets obtained by the administrator;

3.Why the Administrator considered a pre-pack would represent the best outcome for creditors;

4.The identity of the purchaser;

5.The price paid; and

6.Crucially, any connections that the new directors have with the insolvent company.   

This information should be provided in all cases unless there are exceptional circumstances and, if this is the case, the reason why the information is not provided should be stated.  If the sale is to a connected party it is unlikely that considerations of commercial confidentiality would outweigh the need for creditors to be provided with this information.  Unless it is impractical to do so, this information should be provided with the first notification to creditors (i.e. the letter informing them that the company is in administration) or, at the very least, as soon as practicable after the administrator’s appointment.

If the information is not provided when the creditors are informed of the administration and subsequent pre-pack sale, they are able to ask questions of the administrator in regard to all the issues that SIP 16 was drafted to deal with. There are questionnaires in circulation for creditors to amend and adopt for this purpose.

The Insolvency Service Report on the first six months’ operation of SIP 16

In July 2009, The Insolvency Service published a report on the first six months’ operation of SIP 16.  It reported that in 65% of cases, insolvency practitioners were providing information that complied with SIP 16.  However 17 cases were reported to the practitioners’ disciplinary authorities.  As a result, The Insolvency Service identified some potential amendments to SIP 16 and vowed to continue to monitor its operation.  In October 2009, it issued guidance on SIP 16.  
 

Report on the Operation of SIP 16 (July – December 2009)

The Insolvency Service recently published its report on the second six months’ operation of SIP 16.  The report revealed that insolvency practitioners were not adequately complying with SIP 16 in 38% of the 497 pre-packs in the second half of 2009.  This could be due to something reasonably insignificant such as the SIP 16 report not being sent in a timely fashion or something more significant such as the level of disclosure being insufficient.  Only 7% of cases were deemed to be a serious enough breach to warrant the reporting of the insolvency practitioners concerned to their authorising bodies. 

The Insolvency Service has also claimed that it has evidence that the true extent of pre-pack sales is being under represented with their being a number of instances when creditors have complained about an administration where a pre-pack sale has taken place, yet no SIP 16 report was sent to either the creditors or The Insolvency Service. 

The level of non compliance has led to the following options for change being discussed:-

1.Putting SIP 16 on a statutory footing with penalties for non compliance;

2.Following a pre-pack administration, provision for automatic scrutiny of the directors’ and administrator’s actions by the Official Receiver (a trusted and independent public official);

3.Making it impossible for the person advising on a pre-pack to become the administrator;

4.Requiring Court or creditor’s sanction for pre-pack sales involving connected parties.

However, no Government investigation has yet been scheduled and given the current economic climate and the imminent general election it may well be that the Government does not wish to risk raising unemployment by introducing measures which temper the use of pre-pack sales.  Even if this proves not to be the case, any proposed changes are unlikely to make it onto the statute book before 2011. 

In any event, insolvency trade body R3 is sure that SIP 16 can be made to work and that confidence in pre-packs can be built. 

It does not agree with the way pre-packs have been reported by The Insolvency Service and believes that the provision of “pro-forma” examples of SIP 16 reports for insolvency practitioners to follow would greatly improve compliance rates.  SIP 16 has only been in place for a year, with clear guidance only coming from the Insolvency Service at the end of October 2009 and, given that The Insolvency Service’s report states that there have been “significant improvements” in the “quality and timeliness of information” provided by insolvency practitioners, R3 believes that the system should be given a proper chance to show it can be effective.