Scope of this article
This article sets out what a pre-pack is, and why pre-packs remain a very popular mechanism of selling or buying a financially distressed business.
What is a "pre-pack"?
The term "pre-pack" is used, in the context of administration, to describe the process through which a company is put into administration and its business or assets (or both) immediately sold by the administrator under a sale that was arranged before the administrator was appointed.
Pre-packs are not a new restructuring strategy but their use has become fairly widespread.
Often a pre-pack involves the sale of a company's business on a going concern basis. However, sometimes a pre-pack will just involve the sale of some or all of the assets of the company. The rest of the company's assets or the business may be sold off in a separate transaction, or the company may be put into liquidation.
They are fast paced transactions, often completing in a few days of instructing lawyers.
Advantages of a pre-pack
The advantages of a pre-pack strategy depend on the individual specific circumstances, but can include the following:
- A pre-pack sale can result in the quick and relatively smooth transfer of a business to a new owner, compared to a sale negotiated at length after the insolvent owner goes into administration. This can minimise the erosion of price caused by the fact of a seller's insolvency, and also reduce the costs of the administration process, which ultimately results in a better return for creditors.
- Pre-packs can minimise the erosion of the confidence of a business' suppliers, customers and employees that is inevitably caused by insolvency proceedings over the owner of the business.
- Pre-packs can potentially save more jobs than an administration that attempts to continue to trade the business pending a later sale or other type of restructuring.
- If there is no funding available, it may not be possible for the administrator to continue to trade the business until it is sold at a later date or otherwise restructured. The alternative here would be liquidation and the immediate cessation of the company's business.
Disadvantages of pre-packs
The main criticisms of pre-packs are:
- Unsecured creditors often do not realise that a pre-pack sale is going to happen and so have no opportunity to protect their interests by considering and voting on the pre-pack proposal.
- Pre-packs do not necessarily always maximise returns for unsecured creditors. The value of a business could be destroyed if its financial difficulties are leaked. As a result, an administrator selling the business and/or assets of a company in a pre-pack will not necessarily be able to test the market value of the business by wide advertising for interested buyers. This means that businesses or assets sold by way of a pre-pack are usually sold with limited marketing compared with a normal administration. Although to address this criticism, Statement of Insolvency Practice 16 now contains more demanding standards for advertising a business for sale in the context of a pre-pack.
- Pre-packs are seen as similar to the outlawed practice of creating "phoenix" companies. This outlawed practice involves a company being put into liquidation by its management, before the same business is transferred to a new "phoenix" company, but without the debts of the old company. Creditors tend to be most suspicious about pre-packs when the business is sold back to the original shareholders or directors of the now-insolvent company. There are now however significant disclosures that need to be made to creditors, where a sale is to a connected party, to address this criticism.
- Writing off liabilities using a pre-pack is a short-term remedy. A pre-pack sale of a business and assets doesn't subject the business being sold to a restructuring, which is often necessary if the business is to survive in the longer term.
Pre-packs have been, and remain, a subject of some controversy - but they are still popular and widely used in the UK.
The burden is on the buyer to take what steps it can to expand on the limited information contained in the sales brochure prepared by the Administrators. It is on the basis of that information, and its own investigations, that the buyer will be able to calculate the price it is prepared to pay for the assets and business offered for sale. It is often the case that the information the buyer subsequently discovers, is so significant that it seeks to alter the price that it has already offered during the course of the pre-pack transaction.
The advice to a buyer in this situation is to seek to undertake as much due diligence as is commercially possible in a time pressured environment and to understand the nature of what they are buying and the risks involved. The price is generally lower than full market value, to reflect the distressed nature of the business and the inherent risk of buying assets in a few days rather than several months.
The Corporate team at Thomson Snell & Passmore has many years of experience of acting for commercial clients who wish to acquire financially distressed businesses from Administrators in a pre-pack sale as part of their growth strategy, where negotiation of the sale takes place before the seller enters into administration and the deal completes on or shortly after the appointment of Administrators.
For further advice and assistance in connection with pre-packs please contact Joanne Gallagher, Head of Corporate & Commercial, email: firstname.lastname@example.org