Pre-packs – improving a bad reputation?

Pre-packs involve the pre-determined sale of a business before it enters administration, allowing a sale within days of an administrator's appointment.

Examples of pre-packs include Dreams, JJB Sports and stockbroker Seymour Pierce. Pre-packs are a useful tool for the insolvency profession allowing businesses to be sold before being unduly damaged by the insolvency process, often saving jobs that might otherwise be lost. However, they have attracted a bad reputation with some labelling them as an opportunity for incompetent and greedy connected parties to resurrect businesses bound to fail, whilst offloading debt and "stitching up" unsecured creditors.

In the latest report on pre-packs a number of recommendations have been made to address this bad reputation, particularly where sales are made to connected parties. The report identifies transparency and the valuation / marketing process as key concerns, making 6 recommendations including transferring the monitoring of SIP 16 statements from the Insolvency Service to registered professional bodies.

The report lists a number of criticisms of pre-packs: lack of approval from creditors, small distributions to unsecured creditors, subsequent failure of the new company following the pre-pack, prevalence of deferred consideration, no or insufficient marketing and inadequate valuation of assets. The statistics quoted in the report refer to 30% of sales to connected parties failing compared to 18% where the party was not connected. The report's statistics also provide that the likelihood of a pre-pack failing is 3 times higher when a sale is made to a connected party and 16 times higher for sales involving deferred consideration.

The recommendations are intended to address these criticisms.

1. The pre-pack pool. This is a proposed voluntary procedure whereby connected parties can approach a pre-pack pool of experienced business people for a fee, before creditors are made aware of the sale. A statement will be issued by the pool member in a prescribed format commenting on whether or not the connected party's proposals are reasonable. A negative statement does not mean that the pre-pack cannot proceed.
2. Viability Review. On a voluntary basis a connected person can complete a ‘viability review’ of the new company stating how it will survive for at least 12 months. There is no proposal for the administrator to comment on the viability review.
3. Marketing. 6 broad principles of marketing are recommended, including broadcasting the sale of the business as widely as possible and marketing the sale for an appropriate amount of time. An administrator must explain his/her marketing strategy to ensure it achieves the best outcome for all creditors.
4. Valuation. A valuer with professional indemnity insurance must conduct a valuation of the business and, if not, the administrator must explain why.
5. SIP 16. A number of amendments to SIP 16 statements are recommended to take into account the various recommendations, including appending any statement from the pre-pack pool or viability statement to the SIP 16 statement. It is also proposed that the regulation of SIP 16 moves from the insolvency service to the registered professional bodies.

The recommendations have been met with a mixed response by the insolvency profession with some measures labelled “unworkable”. The proposals for a pre-pack pool and viability statement, although aimed at addressing the core criticisms of pre-packs, appear to propose an additional layer of oversight. An insolvency practitioner already considers whether or not a pre-pack is appropriate, why is there a need for the further expense of an additional review?

That said, the proposals may be good news for insolvency practitioners: if an independent business person has agreed the reasonableness of a pre-pack sale why should the insolvency practitioner face any criticism if the pre-pack goes ahead? However, faced with a negative statement from the pre-pack pool and no viability statement, will insolvency practitioners shy away from pre-packs in case they face criticism at a later date?

It is unclear what will happen next in the pre-pack debate. So long as pre-packs fail to shed their bad reputation no doubt we will see further proposals with the threat of legislation regulating pre-packs the likely next step.