Prepack Administration, Rescue Procedure or Creditor Rip Off

Administrations are intended to be one of the Insolvency Act's business rescue procedures, but given the impact they have on Administration creditors they are often perceived as simply another insolvency process; whilst the increasing use of prepack administration has also given rise to controversy. This article outlines what an Administration is and how they, and in particular prepacks, work.

What is Administration?

Administration is a Court based insolvency procedure under which a licensed Insolvency Practitioner is appointed with to take over the management of the company and its business from the directors, with very wide powers to both trade the business and to sell its assets if required.

The company or its directors, or secured creditors who hold a 'qualifying floating charge' (one which has been created since 15 September 2003), can appoint an Administrator without a Court order or hearing simply by faxing the appropriate forms to the Court. Where there is a secured creditor in place with this type of charge, the company or directors have to give them five days' notice of their intention to appoint as the lender is entitled to then appoint their own choice of Administrator which can happen if they are unhappy with the business's choice.

Other creditors can apply to Court for an Administration order but this approach requires a Court hearing.

The appointment of the Administrator (who is technically an office of the Court for this purpose and has a duty to look after the interests of all creditors, whoever has appointed them), automatically imposes a moratorium on creditors taking action against the company for unpaid debts. It therefore provides powerful protection for the company.

As this protection is so strong, to prevent abuse, the legislation says that Administration can only be used for a number of stated objectives in the following order:

1 The rescue of the company as a going concern has to be the primary objective, which may be achieved for example by arranging for the approval of a Company Voluntary Arrangement.

2 The second objective is to obtain a better result for the creditors than would be the result of an immediate liquidation, and this can be pursued if the first objective is not achievable or if the second is in the best interests of the creditors as a whole. Typically this will be by way of selling the business as a going concern, either immediately as a result of arranging a 'prepackaged' sale or prepack, or after a period of trading and marketing the business.

3 If neither of these is achievable then the Administrator can look at selling property and assets to make distributions to secured and/or preferential creditors.

Once the Administrator is appointed, the directors will be required to prepare a Statement of Affairs. This is a document which sets out the business's assets at the values that it is estimated they will realise, and its liabilities including details of all its creditors. This document is included in the notice of the Administrator's proposals which is sent to all creditors. The Administrator must hold a meeting of creditors within ten weeks of their appointment to seek approval of their proposals.

Most Administrations last for a year although there are provisions under which they can be extended, and the IP has a duty to file a report on the directors conduct which can lead to proceedings against them for disqualification.

What is a 'Prepack'?

In a prepackaged Administration, or prepack for short, a funded buyer has been arranged for the business in advance so that the sale can be completed immediately after the appointment of the Administrator.

The idea behind prepacks is that by avoiding the uncertainty, and costs, of a period of Administration trading while a buyer is sought, the value obtained for the business and its goodwill, and the potential return to creditors, will be maximised. However, against this, creditors will often be concerned that the value of the business has not been properly tested in the marketplace, and this becomes a particular concern when the business is bought back by its existing management or shareholders.

To help deal with this issue the insolvency profession has introduced a standard called Statement of Insolvency Practice ('SIP') 16 which provides a list of information that the Administrator must present to creditors in his report so that the transaction is as transparent as possible. This ranges from how the Administrator was first introduced to the Directors, through why a prepack was considered necessary, and on to whether the Directors had given any personal guarantees and whether the new company is being funded by the same lender as the old one.

It is also worth remembering that buying a business back through a prepack has its own potential problems for incumbent management.

Some banks refuse to support a sale of the business back to related parties. Where such a bank is involved, they will therefore have to be replaced in order to allow the deal to proceed. Newco needs to forecast on the assumption that it will have to purchase for cash for teh forseeable future as it will usually have difficulty getting credit terms. It will therefore need to have sufficient funds to be able to trade on a cash basis for purchases. This position is often exacerbated by 'ransom' creditors who will demand payment of their old balances before dealing with the company at all, and sometimes where the Crown has suffered a loss it will also ask for the new company to pay over a deposit in respect of future PAYE/NI or VAT liabilities. Some customers will also be wary of dealing with the Newco and some larger organisations have policies that they will not deal with such businesses until a specified periods has elapsed after the event.

So if considering a prepack, it is important to get the best possible professional advice and to ensure that you really have the funding available both to do the deal and to support the working capital and restructuring costs afterwards.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.