Pre-pack can prove better for everyone than a fire sale

Recent, high profile cases have cast a critical light on a process used by most, if not all, insolvency firms operating in the corporate market in Scotland– the “pre-pack”.  In short, this is where a deal to sell the assets of a failed company is agreed prior to insolvency, and then it is completed immediately after the appointment of administrators or receivers.

Many of the negative perceptions of the pre-pack process stem from the fact that it can sometimes appear as if a business is failing and the next day, it is being run as a new company with no liabilities, sometimes by the same individuals.  Creditors and shareholders then assume that the insolvency practitioner (IP) and the directors have pushed through a quick deal which means that they win while creditors lose out.

IPs have perhaps not done enough to explain what goes on behind the scenes before the sale and the many circumstances where there are instrumental in ensuring the pre-pack process delivers value for creditors and shareholders, as well as management.

Often, the 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.  These days, more often the not the business is a service company, most businesses lease or finance their assets and intellectual property might vest in a few key employees.  If a company waits for insolvency, there would be nothing to sell, and all the jobs would be lost.

In a pre-pack situation, the IP and his or her firm are engaged by the company or its stakeholders for a number of weeks prior to the sale taking place.  During that time, the IP takes on a role which 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. 

A recent case PricewaterhouseCoopers worked on was Adams Childrenswear.  Adams was the largest specialist retailer of children’s clothing in the UK, turning over more than £250m from over 300 stores.  Approaching the end of 2006, it had suffered a severe downturn in trade, and no-one was prepared to fund ongoing losses.

The company’s shops were primarily leased and much of its stock would be subject to retention of title. The value of the business was in its brand and brands can offer suffer during insolvency. 

PricewaterhouseCoopers was instructed to market its business over an intensive period of several weeks.  Despite the uncertainty in the retail sector, the 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 facing huge uncertainty about their jobs over Christmas, 3,200 people kept their jobs and had the chance to re-build a viable, ongoing business.  Of course 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 IPs is to get better at explaining the circumstances where a pre-pack can be the best means of preserving value for the business, creditors and shareholders, and their role in the process.

Contact details
Email: Bruce Cartwright
Tel: +44 (0)131 260 4087