Pre-pack proves better than a fire sale

When an ailing business falls into the hands of an insolvency practitioner (IP) and seemingly overnight is transformed into a new company with no liabilities, and occasionally even run by the same people who managed its now-defunct predecessor, it can raise eyebrows.

And when creditors and shareholders assume that the IP and directors have pushed through a quick deal to the determent of creditors, it’s not surprising that the media and politicians ask questions.

But this seemingly dubious process is a ‘pre-pack’ and  is often  the best option for everyone, including the creditors, and a real alternative to  receivership, liquidation and the resulting fire sale where everyone is a loser.

The pre-pack is a process used by most insolvency practitioners and is simply an agreement to sell the assets of a failed company, prior to insolvency, and which  is then completed immediately after the appointment of administrators or receivers. It is this rapid – and often literally overnight – transition from collapse to regeneration, that surprises and sometimes alarms observers. The truth is that IPs have not done enough to explain what goes on, both  behind the scenes before the sale and how, time after time, pre-packs are instrumental in  delivering value for creditors and shareholders, as well as management.

Often, an ailing company or its stakeholders have realised for some time prior to administration that there may be trouble ahead.  They may also have concluded that insolvency would result in the break up of the business and the loss of much of its value for stakeholders. That is particularly the case in the growing number of distressed service companies, where assets are leased or financed and intellectual property is vested in a few key employees.  If a company like this waits for insolvency, there will be nothing to sell, all the jobs will be lost and the creditors may be left empty-handed.

However, in a pre-pack situation, the IP is engaged by the company or its stakeholders when it is clear that the situation is serious, but often weeks ahead of a likely administration.  During that time, the IP takes on a role that is usually the remit of the corporate finance function – researching interested parties, preparing an information memorandum, agreeing confidentiality letters, seeking initial offers, undertaking due diligence and negotiating a contract.  The only differences between this and a standard corporate finance deal are that it is typically done much quicker and an insolvency process commences immediately before the contract is completed. 

One good example of how a pre-pack delivered real stakeholder value was PricewaterhouseCoopers’s involvement with Adams Childrenswear.  The UK’s largest specialist retailer of childrens’ clothing, Adams, with 300 stores delivered annual sales of more than £250m.  But, by the end of 2006, a severe downturn in trade meant no-one was prepared to fund ongoing losses. Adams’ shops were primarily leased and much of its stock was subject to retention of title and beyond the reach of creditors. The only real value of the business was in its brand, but brands often suffer during insolvency. 

PwC was instructed to put the Adams business on the market. Over an intensive period of several weeks and despite uncertainty in the retail sector, the PwC team carried out a discreet, rapid marketing process and ultimately put together a deal to secure the sale of 273 shops to John Shannon, the retail entrepreneur, via a pre-pack administration.

Instead of the total collapse of a major retailer and thousands of redundancies virtually on the eve of Christmas, 3,200 people kept their jobs and had the chance to re-build a viable, ongoing business.  Some creditors lost out – as is inevitable in these events – but they had an opportunity to recoup losses by dealing with a reborn business.  The speed of the sale from insolvency meant that the business suffered minimal disruption with its brand remaining largely untarnished by the turmoil.

If the business had entered a traditional insolvency, this would have resulted in disruption, uncertainty and a real prospect that the business would fail, meaning losses for all stakeholders.  However, an accelerated disposal process, which ends in a pre-pack insolvency transaction, means a smooth transition with enhanced realisations for creditors and preservation of value for a business’s goodwill and brands.  In addition, employees are also almost invariably better off.

Naturally, if a sale process is rigorous, you cannot exclude directors from bidding to buy the business.  After all, the job of an IP is to test the market as thoroughly as possible as well as to carry out due diligence, which means that you must involve the senior team.  There is nothing inherently wrong with people associated with the business acquiring it via a pre-pack, providing it is the right deal for creditors.

A pre-pack is neither good nor bad in itself – what makes the difference is what goes on behind the scenes to ensure the transaction pays off for all stakeholders as far as possible.  The majority of IPs will put in a huge amount of effort to make sure they are signing the right deal, well before anyone outside the process is aware of the sale.  The challenge for all of us insolvency practitioners is to get better at explaining the circumstances where a pre-pack is better than a fire sale and is the best means of preserving value for the business, creditors and shareholders, and their role in the process.

Contact details
Email: Garth Calow
Tel: +44 (0)28 9041 5462