Advantages & Disadvantages of a Pre-Pack Administration
A pre-pack administration facilitates the quick sale of a business in insolvency. Negotiations for the sale of underlying business assets take place prior to an Administrator being appointed, after which time the sale generally goes through very quickly.
Assets may be bought by a third party or trade buyer, but it is often the case that directors of the failed business purchase the assets and trade under a new company name. One of the requirements of going down the pre-pack administration route is that it must be in the best interests of creditors and, therefore, proof of the decision-making process has to be made available.
One major advantage of pre-pack administration is the speed of sale, which often results in higher returns for creditors when compared with alternative routes into insolvency. Transparency is key in this process, however, which is is why it is imperative to seek the services of an experienced Insolvency Practitioner.
Begbies Traynor understands the requirement for an ethical approach when using pre-pack administration, and are available nationwide for appointment as Administrators.
Apart from the speed of sale, what are some of the other advantages of this type of insolvency procedure?
Being sold as a ‘going concern’ means that business operations continue largely unabated. The value of ‘work in progress’ is protected, along with customer goodwill. This contributes hugely to the success of the new company, as well as preventing losses that would adversely impact creditor returns.
Brand image is maintained
Pre-pack administration often avoids the adverse publicity that results when other forms of insolvency procedure are chosen. If public perception of the business ‘brand’ remains positive, jobs may be saved and, with improved cash flow, the new company stands a better chance of being able to pay suppliers on time. All this contributes to increased sales and long-term growth for the new business.
Focus is on the future
Investment can now be used to build the new company rather than being swallowed up by historic debt. Additionally, contracts associated with the hire of equipment and property that were not working for the old company can be terminated, freeing up valuable working capital for building the new business.
Reduced costs of administration
Due to the speed of a pre-pack administration, the costs involved are often less than if a standard administration procedure had been chosen. Due diligence is carried out before the company’s financial problems become apparent, which helps to reduce costs.
A degree of control is maintained by directors
Directors keep some control over the business during this type of administration, which is not the case with other types of insolvency procedure. Selling the company to people already familiar with the processes and procedures of how the business is run increases its chance of success.
If lessons have been learned regarding the areas where the business failed, acting on these can only be of benefit to the company. Additionally, some continuity and peace of mind is offered to members of staff who may be worried about their job situation.
Pre-pack administration is sometimes seen as a controversial route out of insolvency for companies in financial distress. The view that company directors are trying to avoid their responsibilities and ‘short-change’ creditors is commonly held, but pre-pack administration is widely used in the UK, and is governed by strict regulations.
Here are some of the disadvantages of the process:
Directors’ conduct will be investigated
Once business assets have been sold, it is likely that the old company will be liquidated. The Liquidator compiles a report for the Department for Business, Innovation & Skills (BIS) as part of this procedure, detailing the conduct of company directors leading up to the insolvency. Even if these directors have formed a new company, they will still be open to investigation and even prosecution should their conduct be deemed improper.
Also as a result of this report, HMRC may disallow VAT registration by the new company if misconduct has been uncovered. The newly-formed company may have to pay a bond before they can register for VAT and recommence business.
There will be no change in employees’ rights
The Transfer of Undertakings (Protection of Employment), or TUPE legislation, applies to pre-pack administration where roles are preserved by the new company. In these cases, contracts of employment are transferred to the new employer, protecting employee rights and safeguarding jobs. This can represent a huge liability for the new company from the outset, and a significant monthly outlay in terms of wages and other employment costs.
Viewed as unethical
Pre-pack administrations are often viewed as unethical because debts are written off, but the fact is that alternative routes into insolvency may provide no better return for creditors.
The practical ramifications of this public perception of pre-pack administrations include loss of goodwill from customers if they hear about what has happened, difficulty in obtaining credit from suppliers, and a potential loss of trade due to the bad publicity. Renegotiation of supplier contracts may also be hampered by a feeling of mistrust.
Directors will need to find the necessary funds with which to buy the business assets. One of the Administrator’s duties is to sell them at a fair market value in order to realise as much as possible for the creditors. They have a responsibility to ensure assets are not undervalued. Consequently, it can be a significant financial undertaking for directors to access the funds needed, and it may take some time to gather the necessary monies together.
Pre-pack administration is intended to preserve the goodwill of a business so that a smooth transition to new ownership is possible. Begbies Traynor has a long history of insolvency experience serving clients nationwide, and we understand the complexities and potential ethical problems of pre-pack administration.