Pre-packs can be best for businessess in difficulties

Using a pre-pack must not be used as a sticking plaster which delays an inevitable collapse. Picture: Getty

In Victor Hugo’s novel The Hunchback of Notre Dame, Quasimodo is feared and misunderstood, but in time he is revealed to be a kind-hearted, hard-working and useful member of society, acting as guardian angel for his beloved Esmerelda.

He is misunderstood, and this too is true of “pre-pack” administrations – for companies which, while in financial distress, have at their heart a viable business.

Owing to a small number of cases where they may have been misused, “pre-packs” are viewed by some as the dodgy road to phoenix companies, where errant managers are able to write off debts before starting again with a new name. But, when used properly, pre-packs can provide a lifeline to both staff and the supply chain, while getting as much value for creditors as possible.

The UK government recently commissioned a review into pre-pack parameters and practice. The Graham Report, released in August this year, returned a number of key recommendations. It has been largely welcomed by insolvency practitioners and implementation of the advice is moving forward swiftly.

In using a pre-pack as the means of business restructuring, it must be compared to other insolvency processes to show that they would be more damaging to the business and to the returns to creditors who inevitably suffer. Crucially, the process must not be used as a “sticking plaster” which delays an inevitable collapse.

A well executed pre-pack should produce a fair price for the rescued business. In this way liabilities for buyers of the new company – whether existing backers or new third-party purchasers – are minimised. When a pre-pack is used, the primary reason that process achieves the best value for creditors is that it achieves a seamless transition between seller and buyer so that the business can continue trading at minimal damage to customer and supplier relationships.

A tricky aspect of pre-packs is the decision about marketing the business for sale. Current guidelines state that practitioners must explain what marketing activities were carried out, and if a decision was made not to market the business, the practitioner must explain why. It is cases where no marketing has been done, and a business is sold through a pre-pack back to management (the so-called “phoenix”), that have attracted the most scrutiny and adverse publicity.

The Graham Report found that where no marketing is carried out, pre-packs return less money to creditors, and commented that the quality of marketing of business that intend to pre-pack needs to be improved and sets out principles of good marketing. The report also recommends forming a “pre-pack pool” of experts which should be approached before the pre-pack is implemented, to bolster trust and confidence that the pre-pack was the best option for the business and its creditors. Where a business is pre-packed to connected parties (eg management), then there should be a viability review carried out to ensure that the new company will present a viable future for the business and its employees.

Although pre-packs to existing owners or managers have attracted the strongest criticism, the evidence of the Graham Report is that sometimes the existing owners or managers can provide best value as against the external market. This group of stakeholders knows firsthand what went wrong and needs to be avoided, and importantly what the true value of the business really is. They may have the passion, knowledge, and personal investment which attracts a premium to the price.

The UK insolvency system is not based on a “one size fits all” approach, offering different solutions for different situations. Pre-packs are shown to be beneficial in the right situation, but are not a panacea. If using a pre-pack feels like squeezing a square peg into a round hole, it’s time to think again.

The prospect of calling in the administrators is an owners’ worst nightmare but when the bell tolls a warning for an otherwise successful business, the use of pre-packs can save the best for future trading.

Quasimodo died unhappy, but it didn’t have to be that way. It never pays to be misunderstood and the existence of pre-packs paves the way to very many potential happy endings.

• Tim Cooper is a corporate recovery partner at HBJ Gateley. www.gateleyuk.com