ShareSoc has been actively involved in consulations with government regarding pre-packaged administrations. It has been a frustrating process, dominated by insolvency practictioners with a vested interest.
We have today sent the following letter to Norman Lamb, Minister for Employment Relations, Consumer and Postal Affairs, who chaired the last meeting. The letter sets out why we feel change is needed:
Dear Mr Lamb,
Regarding the recent meeting on the subject of Pre-Pack Administrations. It would be unfortunate if you took my comments on your chairmanship of the meeting in a negative way. But as I saw it, to try and deal with such complex issues in so short a meeting, particularly when the representatives of the Insolvency Service seemed to have already decided that substantial reform of the system was unnecessary (and possibly briefed you accordingly beforehand), is rather to trivialise a very important subject.
In addition it was very annoying to see representatives of the Insolvency Practitioners community give some quite misleading information about the procedures that are followed by “reputable” practitioners and the impact/outcomes of pre-pack administrations. Their view seemed to be that it was a few disreputable firms who were operating at the lower end of the market (i.e. in smaller firms), that were the sole problem and that a few changes to regulations such as SIP16, or to the complaints procedure, could resolve these problems. This is a grossly mistaken point of view.
In reality the whole system is riddled with unethical practices by the nature of the process followed. It is also based on unsound moral principles and any pre-packs are effectively executed in secret and are beyond legal challenge.
Let me explain the last point. The whole objective of a pre-pack (even though there is allegedly some “marketing” of the business – more on that below) is to keep the process secret until it is ready to be crystallised. By such means, suppliers and customers are kept in the dark so they continue to trade with the business.
When the pre-pack is ready to be crystallised, the administrator is appointed and a few minutes later sells the business to the contracted buyer. The assets are effectively transferred at that point and any legal challenge to this transfer becomes very rapidly untenable. In practice, the pre-pack cannot be challenged in law before it takes place simply because nobody knows about it and there would be no legal basis to do so even if it was known one was pending. Challenging it after the event is impossible because it is simply too late to unwind, so anyone prejudiced by the pre-pack has a very difficult legal case to pursue and no clear target, plus little chance of adequate rectification.
Of course insolvency practitioners prefer pre-packs because it makes their life easier in many ways over a conventional administration. No lengthy administration, no extensive marketing required, no negotiating with multiple prospective bidders for all or parts of the business, etc.
Pre-packs may be preferable for insolvency practitioners, and for the secured creditors who are typically banks, but they are extremely prejudicial for other creditors because the value of the business is not maximised. In addition, in public companies the shareholders (who are not technically creditors in insolvency law at all and have no rights in an administration) are extremely prejudiced because whereas the business may have been capable of being refinanced and thereby continued, with a pre-pack they automatically lose any financial interest in almost all cases.
In addition pre-packs permit incompetent managers to continue trading via “phoenix” companies, and competitors of the original company that would prefer to have seen such businesses become defunct continue to have to compete with them when they are often intrinsically unviable and will go bust again in the future (this has happened in a number of cases – for example Allied Carpets is one example).
Often arrangements are made with the connivance of the company’s directors or bankers which are not in the interests of creditors or shareholders. These arrangements are often made in secret with no public knowledge and then put into place in a matter of a few hours after formal appointment of the administrator.
I had experience of this process some years ago in the case of Torex Retail Plc (although it is worth emphasising that I have never had any personal interest in any pre-pack administration and my hatred of this process stems from representing other people who have been affected). Torex Retail was a company that got into financial difficulty after an alleged fraud and claims of false accounting. The directors arranged to sell the business via a Pre-Pack Administration to some private equity investors – this mainly was to the advantage of the bankers who protected their loans to the company but also obtained a stake in the on-going business. This meant that shareholders were left with nothing, and creditors were presented with a fait-accompli. Torex was in essence a sound business that could have traded out of its problems given a short period of stability and some protection from short term creditors.
Before the Administrator was officially appointed, I tried on behalf of shareholders to arrange an alternative refinancing which would have protected shareholders and other stakeholders’ interests, but the directors ignored our approach. We then requisitioned an EGM to remove the directors and replace them, but the Administration was pushed through that pre-empted this move. In essence there was no approach by the Administrators to the open market, no consideration by them of alternative offers, and the whole deal was stitched up behind closed doors before most people knew anything about it.
Technically this pre-pack probably abided by the rules and was done by one of the larger insolvency practitioners. But this was surely not how Administration was conceived as working when it was put in place by the original legislation. Regrettably legal precedent has been established that condones the practice of pre-packs by what I consider to be a very perverse legal judgement and now companies left, right and centre are using it to evade their debts and create new “phoenix” businesses from the ashes of companies in financial difficulties. The directors or parent/related companies often being the beneficiaries of these arrangements.
Another example was covered by Alistair Blair in Investors Chronicle – namely of Axeon. This was an AIM company that was put into administration via a “pre-pack” arrangement at the behest of its main lender who was also a shareholder (Ironshield). The company was sold to AG Holding, a new company specially set up for the purpose by Ironshield about one hour after it entered administration. In effect, as with all pre-packs, the whole deal had been arranged some time before. In this case it seems even more outrageous than normal as the company’s press release said that “creditors would be unaffected”, so only the shareholders were deprived of their interest in the business.
Special Offer: Invest like Buffett, Slater and Greenblatt. Click here for details »
There have no doubt been many other cases of small companies that are listed on AIM suffering the same fate (SCS Upholstery is another one that springs to mind, and Brinton Carpets is another example of shareholder prejudice by those who own the debt). This system is pernicious and the only real beneficiaries are the insolvency practitioners. It needs full scale reform, not the putting of a sticking plaster on a failed system.
I have covered above just a few public companies where our members’ interests were prejudiced. But the situation in smaller companies is even worse (and there were representative groups for businesses in sectors where small companies are common present at the last meeting). Here there are very widespread abuses, with companies repeatedly doing pre-packs to avoid their debts and their creditors. Indeed the latest Insolvency Service report notes that 79% of pre-packs were to connected parties (up from 72% in 2010, so the problem is getting worse rather than better). This is prima facie evidence of gross abuse.
It is claimed in that same report that administrators undertook some marketing in 51% of cases, but what does such marketing consist of? In reality the business cannot be advertised as being for sale in any normal manner because of the necessity for secrecy as explained above (and certainly not advertised or promoted as would take place with a normal administration).
So the suggestion that there are minor abuses of the system that can be rectified by tightening up SIP 16 slightly or enforcing that regulation more fully is simply mistaken. Doing so will not solve the problems inherent in pre-packs. As I said to you at the meeting: “ask the people representing those damaged by pre-packs whether minor changes will fix the problems”. They will almost certainly say NO.
Neither will improving the complaints procedure help because in most pre-packs, despite the prejudice they have created, there would be nothing technically to complain about – certainly shareholders cannot do so because they are not creditors, but others cannot either. It is also very unlikely that anyone will complain in any case because it would be very time consuming, involve creditors dealing with a complex area of law with which they are not familiar, and ultimately not lead to any recompense of their losses. Why should they bother?
In summary, if nothing more substantial is done to reform this system the abuses will continue and five years down the road we will still be discussing the same problems with no resolution in sight.
Reform is not going to be easy, but the present system only keeps businesses alive when they should perhaps have been killed off, maintains employment in businesses at enormous cost to creditors and competitors, and in my view, is a designed by Insolvency Practitioners primarily for their benefit (as it promotes more administrations) rather than the benefit of the wider business community.
I therefore ask you again to tackle this problem in a substantial way and not trivialise the issues or put it aside on the basis that it is too difficult to handle.
If the Insolvency Service is not able or willing to take a fresh look at this matter, then I suggest it be taken out of their hands and given to someone else to tackle this problem within the BIS. It is very obvious that the Insolvency Service sympathise too closely with insolvency practitioners, presumably because they come from similar backgrounds and otherwise have close ties. But they are not looking at these issues from the point of view of those most affected by the problems created by pre-packs.
Yours sincerely
Roger W. Lawson
Chairman
Filed Under: Regulation,
Disclaimer:
