Pre-packs: saviour or stitch-up?

With the Statement of Insolvency Practice 16 on pre-packs coming into force on 19 January this year, the legality of pre-pack administrations appears to be beyond serious argument.

However, with the likes of Jon Moulton, of Alchemy, declaring that some of them seem more like "stitch-ups", and Christine Elliott, the chief executive of the Institute for Turnaround, seeing a "huge risk", is the moral argument still open?

Pre-packs are the business administration equivalent of a quickie divorce — once a decision has been made to do the deed, do it with the minimum of fuss — but does the ease of divorce (or administration in this case) make the deed more likely, whereas a different route may have been taken in the past?

Much of the furore about pre-packs is centred on phoenix operations, where some or all of the old company and new company owner/managers are the same and appear to have continued in the same business, but simply managed to dump their previous debt (often together with the employees' rights).

When this accusation is levelled at these arrangements, consideration should be given to the alternative: if an old-style administration was undertaken, would the results be better or worse? The proponents of pre-packs would say (with some justification) that the results are much better within this fairly new and increasingly popular breed of arrangements, in which 98% of employees on average keep their jobs.

If a business is going to fail, but could be rescued via an administration, then the administrative process should be carried out in such a way as to give the best outcome for all stakeholders of the business. So is the phrase "stitch-up" valid, or is it an expression of emotion towards the owner/managers continuing in a business that has failed under their stewardship, without seeming to bear any penalty for this failure? One should first consider administrations in general. Administration should be seen as an action of last resort, not of convenience.

The statutory objectives of an administration are to rescue the company as a going concern, achieve a better result for the creditors than they would achieve in a winding up, and realise any property in order to make a distribution to secured/preferential creditors. Unsecured creditors rarely see more than a token pay out, if anything at all.

Employee rights fall under Transfer of Undertakings (Protection of Employment) (TUPE) regulation 8(7), where there has been a terminal insolvency. In many cases, there is no downside to pre-packs (particularly with the tightening of guidance and rules on insolvency practitioners) and a quick sale safeguards asset values, the biggest of which is often the people in small owner-managed businesses. But there are valid concerns. The sense that this is an easy, pain-free route will encourage some businesses that are inherently unhealthy or badly run to undertake a pre-pack, thus putting themselves at an unfair advantage to a better business, which has survived and is weathering the current storm. The fact that the process "feels" very different from a conventional administration may cause directors to approach such arrangements as merely a restructuring, rather than an action of last resort, failing to understand the gravity of the action, or the damage that will almost certainly be caused to other businesses.

A director of a small pub company, which was recently pre-packed, was quoted in an industry newswire as stating that the company was "continuing to trade", on the same day that creditors were receiving letters from a firm of accountants, explaining that they had been appointed as administrators.

This comment understandably caused some upset among creditors who knew nothing of what had been planned, and who will have to write off considerable amounts owed to them by the company.

As the rate of business failures continues to climb, bringing with it much needed adjustments to asset values, the insolvency profession must come down hard on unscrupulous practitioners. A pre-pack should aim to avoid the loss of value that can go with insolvency, not be used as an opportunity to earn fees to line the pockets of the directors, or hide their actions from proper scrutiny.

There is also some ambiguity over the transfer of employment rights. Although these fall under TUPE regulations, Section 218(2) of the Employment Rights Act 1996 provides for there to be a continuity of employment where there is a transfer of a business — more case law to come here no doubt!

If properly understood, executed and explained, and then only as a measure of last resort, the pre-pack offers better results than conventional administrations — but as is often the case, the guidance and regulations are only being introduced after the public have lost confidence in the idea.

Richard Miles, is finance director of Milestone Licensed Trade Accountants​