Prepack Administration: will three days prevent a “phoenix”?

The purpose of corporate administration, in order of priority is to effect (1) a rescue of a company in distress, (2) the achievement of a better result for the company’s creditors as a whole than would be achieved if the company were wound up, or (3) the realisation of company property to make a distribution to one or more of the company’s preferential creditors[1]. It is anticipated therefore, that even with an administration not all creditors will necessarily be paid. A mantra has developed that one area of administration, the procedure commonly known as “prepack administration”, facilitates the “phoenix” of a company, to the detriment of the company’s creditors. As you may be aware, a “phoenix” is where a new company carrying on the same or similar trading activities emerges from the insolvent collapse of another company, often with some or all of the same directors and presenting to customers the appearance of "business as usual". Research by Sandra Frisby of the University of Nottingham, established that 58 per cent of prepack sales started between 2001 and 2006 were to connected parties, almost always existing owners or managers. Edward Davey, the BIS minister may have been reacting when announcing an intention to introduce a threeday notice period for prepack sales to connected parties, now part of the new insolvency rules mentioned below. Commenting, he said "We do not wish to outlaw them. But they must be done fairly and reasonably. Particular concerns have been raised about sales of assets back to the current management, or other connected party, something that is often referred to as “phoenixism”.

A counter view

Perhaps the position is not as clear as the mantra suggests. Steven Law, former President of R3, the insolvency trade body commented “it is important to note that a prepack is chosen due to the speed of the procedure which helps preserve the value of the business. Three days is a long time in business, and if unable to trade in that period, [a business] is at risk of losing key staff and customers. When faced with this option [the three day notice period], directors may simply decide that liquidation is a better route, and this would reduce returns to both secured and unsecured creditors and result in considerably fewer jobs being saved than under a prepack.” Mr. Davey’s intention may be to introduce what he calls “greater transparency” however, as further research by Sandra Frisby has established, in over 90% of prepacks all the jobs in the business are saved, compared with only about 60% in other insolvency business sales. Even the Government’s monitoring report on prepack compliance indicated there is “no reliable evidence to suggest that misconduct by directors is any more prevalent in prepack cases than in conventional administrations”. With the above in mind, and contrary to the general perception, a prepack may therefore be a good thing.

Administrators beware

Prepack Administration is a description of the process whereby an administrator completes a prearranged sale of a company’s business very shortly after their appointment.

Because of the prompt completion postappointment, criticism developed as to whether or not prepacks are in the best interests of a company’s creditors, firstly leading to the introduction of the Statement of Insolvency Practice 16 (“SIP 16”). SIP 16 requires the administrator to provide creditors with a detailed justification of the rationale for the prepack as soon as possible after completion of the deal, including:

  • the extent of the administrator’s role before appointment and the source of initial introduction;
  • any valuation that has been obtained; l the marketing process for the business and assets;
  • the efforts made to consult major creditors;
  • any alternative means of selling the business and assets and the likely financial outcomes from them;
  • the reasons why the administrator felt he could not trade and market the business in administration; and
  • the identity of the purchaser.

SIP 16 imposes a heavy burden on administrators, who will need to ensure they have sufficient evidence to enable the Court to determine whether:

  • the prepack achieved the best price for the assets sold;
  • carrying on trading whilst negotiating for a sale to third parties would have reduced the amount payable to creditors (due to increased debts incurred by the Company); and
  • the inability of the creditors to influence the transaction before it completed was outweighed by the benefit to them of the deal achieved.

If administrators considered the requirements of SIP 16 placed a heavy burden on them, the burden is likely to increase if the proposed revised insolvency rules are introduced.

The employees and the economics

The preservation of employment, topical in the present economic climate, may be one of the main justifications for the prepack. The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) protects employees specifically when a business is sold or the services are transferred to another entity. The effect of TUPE is that the contracts of employment (Regulation 4) automatically transfer to the new entity, together with any associated liabilities (Regulation 7). However, Regulations 4 and 7 of TUPE can be modified, or even disapplied entirely, when the business or undertaking involved becomes insolvent. The types of modifications depend on the insolvency proceedings that the business is undergoing.

The recent case of OTG Limited vBarke and Others confirmed the past understanding (previously confused by Oakland v Wellswood (Yorkshire) Limited suggesting to the contrary) that TUPE will always apply where there is a prepack administration.

From an administrator’s viewpoint therefore, if the assets of a business can be sold immediately upon the administrator’s appointment, with existing employees passing to the purchaser under TUPE, then the administrator avoids the cost and expenses of those employees. This can often increase the amount available for creditors within the administration, whilst the retention of employment limits the possible burden on the National Insurance Fund.

New Insolvency Rules

The Insolvency (Amendment) (No 2) Rules 2011 (the “IA2 Rules”) published in draft and intended to be reacted in October 2011, seek to implement Mr Davey’s intention. Noteworthy because of the proposed introduction of the three business day notice period but also, the implementation of wide ranging provisions intended to be applicable to prepack sales to connected or associated parties (in respect of which the IA2 Rules seek to impose an extremely wide definition).

The 2011 Rules seek to introduce a statutory definition of a “prepack sale”. This leaves open the possibility of further questioning as to the applicability of TUPE to prepacks. If there is to be a formal acknowledgement of an intention of an intended administrator to dispose of the “whole or a substantial part of the assets of the company, or the assets needed for continuance of the business” (the definition in Rule 4 of the IA2 Rules), then the introduction of the defined term removes scope for arguing that the primary objective of the administration is the rescue of the company. It was this intention to attempt to rescue via an administration that was relied upon by the Court in reaching their decision in the OTG Limited case.

If the IA2 Rules are implemented in their present form only time will tell whether or not those creditors who are “out of the money” will be empowered by the receipt of notice of intention to effect a prepack to a connected party; but also, one questions whether an administrator would be happy certifying (as they will be required) their opinion that the prepack to a connected party “will achieve a better result for the company’s creditors as a whole than anything else”[2]. A requirement qualified by obtainable in the circumstances and still referring to the interests of creditors as a whole, would surely be preferable from the administrator’s point of view.

The above amongst many other concerns surrounding the IA2 Rules has led to concerns that if introduced the rules will lead to lower offers being received for a company’s assets (due to uncertainty of the 3 business day period and possible claims of creditors), together with the reduction of the value of the business itself whilst a purchaser waits for the period to pass, coupled with an increase in costs to implement a prepack. This may all contribute to a substantial decease in the number of prepack transactions.

Therefore, if Steven Law’s belief is the case and we move away from prepacks and into the sphere of liquidation, with TUPE not applying to “bankruptcy proceedings or any analogous insolvency proceedings”, then a purchaser of assets from a liquidator will acquire those assets may be at a reduced price to the detriment of the creditors as a whole and without being burdened with the transfer of contracts of employment, the UK economy being left to bear the cost of any resulting increase in the unemployment statistics.

For advice on the Corporate aspects of administrations and related business sales, please contact Stephen Blair at stephen.blair@rlb-law.com or on 020 7227 7254

For advice on the Employment aspects, please contact Sejal Raja at sejal.raja@rlb-law.com or on 020 7227 7410.



Footnotes

[1] paragraph 3(1)(a) to (c), Schedule B1, Insolvency Act 1986
[2] Rule 5(1)(b), Rule 5(2), Rule 5(3)(b), Rule 5(4)(b), Rule 6


Disclaimer

This briefing is for guidance purposes only. RadcliffesLeBrasseur accepts no responsibility or liability whatsoever for any action taken or not taken in relation to this note and recommends that appropriate legal advice be taken having regard to a client's own particular circumstances.