A sign of the times, pre-pack administrations have become a popular solution for failing businesses. But are they ‘legalised robbery’, as some in the industry claim? Amy Shields reports.

After one of the most dismal trading periods in history, pre-pack administrations have increasingly been employed to restructure and relaunch troubled retailers.

The mechanism has been used at Whittard of Chelsea, Officers Club and USC, among others. But some pre-packs have attracted fierce criticism and even notoriety as the downturn has bitten.

The procedure has been branded “legalised robbery”, “shabby” and “quickie bankruptcy”. So controversial have pre-packs become that on January 27, a committee of MPs will meet insolvency experts to thrash out concerns over the potential misuse of the process.
The practice of finding a buyer for a beleaguered business ahead of putting it into administration has been criticised for effectively wiping it clean of its previous liabilities and sometimes allowing poor management to retain control.

Chairman of Parliament’s Business and Enterprise Committee, Conservative MP Peter Luff, will address fears that pre-packs are being used by some as “a way to get out of their debts and other obligations”.

The meeting follows the Insolvency Service’s tightening of guidelines, which came into force on January 1. Administrators now have to ensure that creditors have greater access to information about the behind the scenes dealings when a business is going through the pre-pack administration process.

However, not all believe this goes far enough to allay concerns that the system is open to abuse? In a poll on Retail Week’s website, 70 per cent of those who voted thought pre-pack administrations were unfair.

All insolvency practitioners have a duty to maximise value creation for creditors, says Price-waterhouseCoopers partner in business recovery services practice Mike Jervis. “Pre-packs were created because generally they should preserve value for all creditors, because the business is maintained and a deal reached outside of insolvency, which is a much better place to get value for a business,” he says. “In insolvency, a business can suffer dramatic loss of confidence, brand devaluation and actions by suppliers or landlords.”

However, private equity firm Alchemy’s boss Jon Moulton believes that the “presumption should be against a pre-pack” – which he has referred to as a “quickie bankruptcy” – because this allows below-par management to continue to run a business after passing off its debts.

“There is a legitimate reason for concern. Some pre-packs seem to have a reason; others feel more like a stitch-up than an administration,” says Mouton. “Pre-packs can be done appropriately and inappropriately using existing management.”

Moulton argues the practice cannot be in the best interest of creditors if they are not fully consulted or made aware of the intricacies of the process because of the speed with which they happen.

He also maintains that while the new guidelines – which aim to ensure greater transparency of the process – are a welcome move, they are not enforceable by law. “It would be better if it was all out in the open. Where a pre-pack happens, there should be a detailed account of how they did it. If there is, it is often created after the event,” he explains.

Daylight robbery?

One retail chief who has been through a high-profile pre-pack administration process instigated by lenders slams the process as “legalised robbery”, particularly when it comes to leaving suppliers in the lurch.

In another instance, the pre-pack administration of Stead & Simpson last year left suppliers up in arms. The retailer – since acquired by Shoe Zone – allegedly continued to accept deliveries shortly before it hit the buffers.

“Pre-packs were put in to protect a business and are now being flagrantly abused,” says the retail director. In some cases, he argues that administrators do not make enough effort to search for potential purchasers other than the buyer that has already been lined up

He says that landlords – who may have already made concessions on rent to try to help out a troubled retailer – are often inclined to “take the path of least resistance” in the event of a pre-pack administration. That means that leases revert to previous leaseholders – often other retailers that are already hard-pressed by tough trading conditions.

When administrators create a new company following a pre-pack deal, that business is granted a licence to trade out of the property but the administrator can negotiate the rent and even stop paying it. That is why landlords invariably pass the problem on to the previous holder of the lease.

“We accept that when we get out of a property the lease might come back,” says one retailer. “The new company may trade out of the site but we will pay the rent.”

He adds that the leaseholder then has to go to the courts to obtain the right to evict the new company, a process that can take months.

In December, the two sides of the issue were highlighted when retail entrepreneur John Kinnaird bought Envy out of administration. “Now we have no leases, we can start having constructive conversations with landlords,” he said at the time.

However, in an earlier pre-pack deal for Faith spearheaded by Kinnaird, some rival retailers found themselves paying rent on shops operated by Faith after the leases reverted.

Step in the right direction

Another retailer says: “There is a time and a place for pre-packs but it can be open to abuse. It is being exploited by some using it as a way to get rid of their poorest-performing stores.” He thinks that the new guidelines are “a step in the right direction” but that “the proof will be in the pudding”.

Jervis insists that there are “a lot of safeguards” to prevent the abuse of pre-pack administrations. He says that the new guidance, known as SIP 16, “codifies what has been best practice over the last two or three years and hopefully will improve the transparency to creditors of the actions that insolvency practitioners take when they sign up for a pre-pack insolvency sale”.

However, Jervis concedes that some administrators “could communicate more fully” the circumstances surrounding a pre-pack administration. He says: “When a business is sold on a pre-pack basis, the insolvency practitioner has to be convinced professionally and commercially that they are achieving the best price for the business. The fact that they have only had a short time with the business is not an excuse for not getting the right price.”

Zolfo Cooper Europe partner Peter Holder says that pre-pack administrations are often confused with phoenix practices, when creditors are ditched and the business bought back without a significant restructuring. “They don’t go through the steps to test the market and evaluate the business, so we shouldn’t be surprised that people ask questions,” he says. “Pre-packs are not the same.”

He explains: “A pre-pack only works if it gets the best value for creditors if there is a restructuring of the business – for example, store closures or a change of management. Otherwise it risks not being in the best interests of the business.”

He maintains that the controversial sale of businesses back to previous directors can be in the best interests of creditors if the right price is achieved. While administrators have a duty to examine the conduct of directors within six months of their appointment, it is not their first priority.

“Your job as an insolvency practitioner is to get the best value for the business, not to look to the future,” he says. “Looking to the future and making an assessment about its future, the administrator is going to have to do a lot more work and the creditors are, ultimately, going to pay for that.”

Holder adds that following the credit crunch, a number of banks are refusing to fund pre-pack administrations if there has been bad management in place. But he believes pre-packs can maintain the value in a business and retain confidence in its prospects, enabling it to continue as a going concern.

As the number of administrations continues to rise – by more than 50 per cent year on year in England and Wales in the third quarter, according to The Insolvency Service – the use of pre-packs looks set to continue.

However, if some directors are perceived to be using the process unfairly and fears of “legalised robbery” continue, increased political scrutiny and public outrage could derail the genuine benefits of the pre-pack.

When a business breaks down

  • Administration order
    An order made by a court to arrange and administer the payment of debts in respect of a company that appoints an administrator to take control of the company. A company can also be put into administration if a floating charge holder, or the directors of the company itself, file the requisite notice at court. Administration protects a company from legal action and keeps it running as a going concern before going into liquidation.

  • Pre-pack administration
    This refers to an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator. The administrator completes the sale immediately upon, or shortly after, appointment.

  • Liquidation
    This occurs when a company cannot continue as a going concern. It involves the realisation and distribution of the assets and usually the closing down of the business. Companies in administration cannot be forced into liquidation.

  • Receivership
    The process where an insolvency practitioner is appointed by a lender or other creditor to realise a company’s assets and pay preferential creditors and the debenture holder’s debt. Legal actions can still be brought and liquidators appointed.

Some of the past year’s pre-pack administrations

  • Fashion chain USC, which was repurchased by Scottish billionaire Sir Tom Hunter
  • Discount menswear retailer Officers Club, bought by a company backed by chief executive David Charlton
  • Sofa chain ScS, bought by private equity firm Sun European Partners
  • Furniture retailer MFI, rescued from administration by management, before hitting the buffers again
  • Whittard of Chelsea, acquired by private equity firm Epic
  • Fashion retailer Envy, bought back by owner John Kinnaird
  • Shoe retailer Faith, sold to John Kinnaird and investor Agilo
  • Ethel Austin, bought by entrepreneur Elaine McPherson
  • Shoe retailer Stead & Simpson, acquired by Shoe Zone