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When a company hits financial difficulties - the pre pack explained
When a company has financial problems, there are invariably losers, and the recent decision of Bradman Lake - which has a factory in Norwich - to go into administration for 12 minutes via a so-called pre-pack agreement has left feelings among its creditors running high.
On the one hand, as in the case of Bradman Lake, a business can be sold and 260 jobs preserved. On the other hand, creditors remain unpaid and feel left outside the process.
Chris Williams (pictured right), a partner at business rescue and insolvency specialists McTear Williams & Wood and a counsel member for R3, the Association of Business Recovery Professionals, looks at the issues involved.
As an insolvency practitioner and adviser to struggling companies, I need to find the best solutions for a particular problem.
In doing so, it is useful to look at the worst possible option and then consider better options to see if the position of particular “stakeholders” (a common phrase recognising that different parties have different interests in a particular situation) can be improved by another solution, and what the effects and risks of that solution will be on the different stakeholders.
There are a number of ways of dealing with a struggling company.
The least disruptive is to effect a turnaround without resort to a formal insolvency process.
This will inevitably mean some changes in direction, processes, management or finances.
Our firm runs a network of turnaround interim managers and a network of financiers that we can draw upon to help manage or refinance the turnaround process.
Where the situation is severe, a formal insolvency process may be necessary, the least intrusive of which is a company voluntary arrangement (CVA), whereby the business usually remains in the control of the existing shareholders but may include new directors or management to help bring about the necessary changes.
The company will need to repay a substantial part of the old debt as part of the deal to benefit creditors.
This payment can be viewed as an alternative to the price of actually buying the business outright.
CVAs have advantages but can be slow to get off the ground and the terms may be too much of a burden on the company going forward.
Where creditor pressure is extreme, administration or even liquidation may be necessary to control the position, but both can be very disruptive to the running of the business.
A CVA can sometimes follow administration but it is rare; more commonly the business, or part of it, is sold in its entirety or broken up and sold off piecemeal and its employees are made redundant.
In order to avoid the disruption of administration, the pre-pack sale has been developed and, although it is not new, it has gained in popularity since the Enterprise Act 2002.
So, what is a pre-pack?
A pre-pack is a deal for the sale of an insolvent company's assets, which is arranged and put in place before the formal insolvency process and completed by the administrator shortly after appointment.
Its principal advantage is the preservation of the business and, usually, jobs.
It doesn't have the disruption and costs of a formal insolvency but can provide a better result for the company's stakeholders.
What are the legal issues?
In law, an administrator must perform his functions with the objective of rescuing the whole company (not just its business and assets) unless he believes that is not reasonably practicable or that a sale of the business and assets will provide a better result for the company's “creditors as a whole”.
An administrator owes a similar (although not identical) duty to the company, as does a director.
So in doing a pre-pack deal so shortly after his appointment, the practitioner will want to be satisfied that the deal is in the interests of the company's creditors as a whole.
In a recent case which came to court in September, the judge allowed the pre-pack to go through against the wishes of the major creditor because he saw the benefit to the business as a whole and to the employees.
What are the pros and cons of a pre-pack?
Pros
The principal advantage is minimum disruption. The insolvency practitioner and his team can work on the case for several weeks beforehand without the pressure of running the business in administration.
Many businesses these days lease or finance most of their assets; intellectual property and goodwill is effectively vested in a few senior staff and many businesses are service companies without substantial underlying assets, in which case much of the value may evaporate the day an administrator or receiver is appointed.
Pre-packs can enable jobs and employment rights to be maintained, new funding obtained and, in certain circumstances, loss-making divisions closed down.
Value is often enhanced by a quick deal rather than having the reputation and name of the company dragged through an insolvency process.
Cons
The disadvantages include perceived secrecy and suspicion, especially where the sale is to existing owners, plus the perceived misuse of the technique in cases where insufficient “research” has been done to find potential buyers before a sale is completed.
In addition, there is a danger of a further build-up of debt while the company trades in an insolvent position, which may give rise to wrongful trading by the directors in that period.
Conclusions
R3 - the business recovery trade body - has commissioned a report on pre-packs from Sandra Frisby, lecturer in company law at Nottingham University, and it will be interesting to see what her final views are.
Creditors have nagging doubts which must be addressed. As a firm, we are cautious with pre-packs because of the difficulty in exposing the business to the market and knowing whether the best price is going to be achieved.
As part of the rescue culture, and done properly, a pre-pack is a good thing, but the insolvency profession needs to be more open and justify the recommendations and decisions in reports to creditors.
We are always looking for better ways of exposing the business to the market in order to ensure the best result.
It is not good enough to show only that a price better than break-up value has been achieved.
At the end of the day, the administrator is an officer of the court and must form the view that a pre-pack sale is the best deal for creditors as a whole.
Returning to my worst-case scenario, the pre-pack result has to be compared with what creditors might have got in another process: if they would have got nothing and they still get nothing in a pre-pack, then they are no worse off.
Indeed, they may be better off by having a new company to deal with and sell their goods to.
If other creditors, such as secured creditors (normally banks), are better off, then creditors as a whole are probably better off.
Likewise, if jobs are saved, then employees are probably better off.
Like many firms, McTear Williams & Wood has used pre-packs to good effect and we would be pleased to discuss the opportunities that these or other restructuring techniques present. On the other hand, if creditors ever feel concerned about the effects of pre-packs, we would be happy to discuss the issues with them.
Eastern Daily Press