Very simply, a pre-pack Administration facilitates the quick sale of the assets of an insolvent business.
The struggling business sells all or some of its assets to a new company. The new company can have the same directors as the original company or be a completely separate business that has an interest in purchasing the insolvent company’s assets.
Read on to learn more about this useful insolvency process.
What is a Pre Pack Deal?
The sale of the assets from the insolvent company is pre-arranged by an insolvency practitioner.
Once the sale has been arranged, the company is placed into Administration and the insolvency practitioner (now the Administrator), will oversee the sale. Importantly, this allows the assets to be sold very quickly so the disruption to trade is minimal.
That makes pre-pack Administration a very effective way to save the viable aspects of a business and many of the jobs of those working for the old firm.
The administrator must be able to justify the sale as producing an appropriate outcome for the administration, and will typically support that with an independent valuation and evidence of the marketing carried out, rather than relying on a single fixed market-value figure.
Any assets owned by the original company that are not sold as part of the pre-pack Administration will be realised by the administrator. The company then normally moves into creditors’ voluntary liquidation if there will be a distribution to unsecured creditors, or is dissolved if there is nothing left for them.
How does a Pre Pack Administration Process Work?
There are six key steps involved in the pre-pack administration process:
(1) Seek Advice From Insolvency Practitioners
If you are concerned about the financial position of your business, you should contact the insolvency practitioners here at AABRS® immediately. We will discuss your situation with you and provide confidential, no-obligation advice. At this point, we will explain every available option to you, including refinancing, a company voluntary arrangement (CVA), administration, creditors’ voluntary liquidation (CVL) and a pre-pack administration. If a pre-pack Administration looks like a potential solution for you, the directors can explore it in more detail with the insolvency practitioner. A formal board decision is needed when the directors decide to appoint the administrator.
(2) Create a Business Plan for the new Company
If the business of the old company is to be sold to a new company, the buyer will usually need a business plan. No law requires one, but the administrator and any funder will want evidence that the new company can survive. It should include cash-flow, profit and loss and balance sheet forecasts to give an indication of the viability of the new company. The insolvency practitioner (IP) will use this evidence to determine whether a pre-pack sale could go ahead.
If the business is to be sold to an existing third-party company, the IP will need to see management information and accounts from the buyer to assess whether that business is viable.
(3) Marketing the Business
At this stage, the IP will obtain a formal valuation of the assets, the goodwill and any intellectual property of the company by an independent, suitably qualified valuer with adequate professional indemnity insurance. The business can then be marketed to potential buyers through advertisements in local or national newspapers, website listings and sales letters to potential buyers. If there’s no interest, the business can be sold to the new company or a pre-arranged existing company. If there is interest from other parties then their offers will be considered by the insolvency practitioner.
(4) Financing the acquisition of the new company
You now need to think about how you’ll finance the acquisition of the business and its assets. There are specialist lenders who may be willing to provide finance through asset-based lending, factoring and bank facilities. Venture capital firms may also be a potential source of pre-pack funds as part of a ‘buy and build’ strategy. As a director of the new company, you may be asked to provide personal guarantees to access these funds.
Potential finance providers will want to see a business plan and financial forecasts. They will also want to know how their security needs will be met and test the independent valuations.
(5) The Pre Pack Sale can take Place
Once the funding is in place, the appointment documents are prepared and any qualifying floating-charge holder is given the notice they are entitled to. The appointment itself is usually made out of court, by filing a notice of appointment, rather than by applying for an administration order.
If the buyer is connected to the company, there is a further statutory step before the sale can complete: either the creditors approve it, or an independent evaluator provides a qualifying report. That requirement is set out below, and it is not optional.
(6) The old Company will be Closed
The final step is close down the old company’s trading activity. The company’s books and records will be moved to the Administrator’s office and any remaining assets will be realised. Once the Administrator is happy there are no outstanding matters, the old company can be dissolved or liquidated to allow for distribution to its creditors.
Selling to a Connected Person: the Rules That Apply
If the buyer is you, or anyone connected to the company, the sale is not simply a commercial decision for the administrator. Since 30 April 2021 it has been regulated, and the requirement applies to the transaction most people mean when they say “pre-pack”.
The rule bites where there is a substantial disposal to a connected person in the first eight weeks of the administration. Each of those terms does some work:
- Substantial disposal means a sale, disposal or hiring out of what is, in the administrator’s opinion, all or a substantial part of the business or assets. It expressly covers a disposal made through a series of transactions, so the rule cannot be sidestepped by splitting the deal.
- Connected person is drawn widely: any director, other officer (including the company secretary) or shadow director, and their non-employee associates. Associates include a spouse or civil partner, relatives such as parents, brothers, sisters and wider family, business partners, trustees, and companies they control, control meaning one third or more of the votes. A company is also connected where a person is or has been a director, officer or shadow director of both it and the insolvent company. A management buy-out through a newly formed company is squarely within it.
- Eight weeks runs from the day the company enters administration.
Where it applies, the administrator cannot complete the sale unless one of two conditions is met.
- The creditors approve it. Available, but it takes time, and time is the thing a pre-pack exists to save. In practice it is rarely the route chosen.
- An independent evaluator provides a qualifying report. This is the usual route. The buyer obtains the report, and it is the buyer who pays for it.
What the evaluator does, and what happens if they say no
The evaluator gives one of two opinions: that the consideration and the grounds for the disposal are reasonable in the circumstances, or that they are not. There is no middle option.
A negative opinion does not veto the sale. The administrator may still proceed, but must then send creditors a statement setting out the reasons for going ahead. That is worth thinking about before you commission a report: a disposal completed over an adverse evaluator opinion is a matter of record, and it is the first thing anyone reviewing the case will read.
This replaced the voluntary Pre-Pack Pool referral, which was never compulsory and was little used. If you have been told that independent scrutiny of a connected sale is optional, that advice is out of date.
Separately, the administrator must give creditors a detailed disclosure of the transaction under SIP 16, covering how the business was marketed, how the assets were valued, what alternatives were considered and why a pre-pack sale produced the better outcome. Sources: the Administration (Restrictions on Disposal etc. to Connected Persons) Regulations 2021 and the GOV.UK guidance on independent scrutiny of connected-person disposals.
Advantages of a Pre Pack Administration
There are a number of compelling advantages associated with a pre-pack administration. That includes:
- The speed of the sale – The process allows you to free up cash quickly to pay your creditors and settle your debts. The sale of assets can take place as soon as the business enters Administration, which helps to reduce the administrator’s fees.
- Business continuity – The fact that the old business is sold quickly and as a going concern allows operations to continue largely undisrupted under a new business name. This can contribute to the success of the new company and helps to protect relationships with customers, clients and suppliers.
- The directors maintain a degree of control – The directors keep control of the business while the pre-pack deal is prepared. Once the administrator is appointed, they cannot exercise management powers without the administrator’s consent. Directors stay in control in a CVA or a moratorium, but not in liquidation.
- A second chance at success – If the existing directors or management team are the buyers, they will be able to learn from the mistakes they have made in the past and have a second chance to make a success of the business without being encumbered by historic debt.
- Brand image is maintained – A quick sale at a fair price ensures creditors are repaid more quickly and helps to preserve the reputation of the business and the goodwill it has built up. It can also help to save jobs, which further reduces the damage to public perception.
- You avoid compulsory liquidation – A pre-pack Administration allows you to avoid the unpleasant compulsory liquidation process, which can cause serious damage to creditor-debtor relations
- Unwanted contracts stay with the old company – Leases and equipment hire agreements the buyer does not want stay with the old company and do not pass to the new business. The landlord or hire company claims against the old company as a creditor, and any personal guarantee a director gave for those contracts still stands.
Employee Rights and TUPE
The rights of employees during a pre-pack administration are governed by the Transfer of Undertakings (Protection of Employment) Regulations 2006, known as TUPE, under which employees assigned to the part of the business being sold transfer to the buyer automatically (regulation 4), on their existing terms and with their continuity of service. Because the seller is in administration, some debts owed to them, such as arrears of pay and holiday pay up to the statutory limits, stay with the old company and are paid from the government’s insolvency fund rather than by the buyer (regulation 8). Terms can also be varied by agreement with employee representatives where regulation 9 allows. That protects their contracts. It does not guarantee every job. Under regulation 7, a dismissal because of the transfer is automatically unfair unless the reason is an economic, technical or organisational one entailing changes in the workforce, and a reason of that kind can justify job losses. The protection applies only to employees with the qualifying service needed to claim unfair dismissal.
However, as the old company was not trading profitably, it’s likely that the structure of the new company will be changed, and that could lead to certain teams and departments being downsized or closed altogether. Redundancies may follow. For employees who transfer, the buyer bears the cost of any redundancies it makes after the sale, and their service carries over. Who bears the cost of dismissals made before the sale depends on the facts. The Redundancy Payments Service pays only limited sums, within the statutory limits.
Redundancy
Importantly, a pre-pack Administration cannot be used to avoid the cost of redundancies for those employees taken on by the purchaser. Employees taken on by the purchaser keep their continuity of service, which counts towards any later redundancy payment, because their employment transfers to the new employer. The employer’s liability for debts that the Secretary of State pays from the National Insurance Fund, such as arrears of pay and holiday pay up to the statutory limits, does not transfer and stays with the old company. If their employee rights are not taken into account then they could make a claim for unfair dismissal against the new company.
How Much does a Pre Pack Cost?
One of the biggest advantages of a pre-pack administration is its relatively low cost when compared with a standard administration. As the due diligence is carried out before the administration and the sale of the old company is completed as soon as the administration begins, there is no requirement to pay the administrator’s fees for a prolonged period. That typically makes it cheaper than a standard administration procedure.
The costs of a pre-pack administration include:
- The pre-pack set-up costs
The first costs the company will incur is the time spent by the insolvency practitioner dealing with matters before the Administration can take place. A lot of involvement is required before the appointment of the Administrator to ensure a pre-pack is an appropriate insolvency solution. An initial meeting with the IP is usually free. The work that follows, before the administrator is appointed, is chargeable. The basis of that charge should be agreed in writing before the work starts, and you should know whether the company pays it before the appointment or it is claimed afterwards. Pre-administration costs still unpaid when the company enters administration can be paid from the company’s assets only once they are approved under the insolvency rules, and they must be disclosed to creditors.
- Valuing the old company’s assets
The administrator will normally rely on a valuation of the old company’s assets by an independent valuer with adequate professional indemnity insurance, and must explain to creditors if no valuation was obtained. The cost is usually either paid by the company before the appointment or claimed afterwards as a pre-administration cost, which needs approval before it is paid from the company’s assets. Once the valuation has taken place, a sale and purchase agreement will also have to be drawn up.
- Funding the purchase of the old assets
The purchase of the old company’s assets should be made from the new company’s account. These funds will come from the directors of the new company or, if funds are limited, it might be possible for the new business to borrow the money it needs by securing the loan against the assets.
- Liquidation of the old company
The final cost of a pre-pack administration is the closure of the old company, following the company entering liquidation or dissolution.
For a small or medium-sized business, a pre-pack administration will typically start from around £15,000+VAT.
Challenging a Pre Pack Sale
For creditors fearing that the pre pack will yield them a poor return, there is always the recourse to take legal action. A creditor can apply to the court if the administrator has acted in a way that unfairly harms its interests, and the court decides what relief, if any, to give.
As such, insolvency practitioners have to be extremely cautious in these matters to demonstrate their ‘duties of reasonable skill and care.’
Want Immediate Advice?
At AABRS® , we will discuss the pre-pack administration process with you and help you understand whether it could be a viable option for your business. Get in touch with our team for a free, no-obligation initial consultation.