Pre-pack insolvencies used to avoid liabilities, says independent panel

Out-Law News | 26 Nov 2018 | 3:00 pm | 2 min. read

Some businesses are using pre-pack insolvency arrangements to avoid tax liabilities, according to a member of an independent panel.

Stuart Hopewell, co-director of the Pre Pack Pool, told the Financial Times that he had seen cases where businesses were using pre-packs to avoid liabilities.

Hopewell said the panel, which was established to monitor the use of the sale of businesses or its assets to connected parties in a pre-packaged sale, was unable to stop the process in such situations, and described this as “disappointing”.

However insolvency expert Nick Pike of Pinsent Masons, the law firm behind, said pre-pack insolvencies can be positive for businesses.

“Pre-packs have been the focus of a malaise which seems to be pervading UK insolvency - creditors feel cheated when a business which owes them money goes into an insolvency process and immediately gets sold on without anyone other than the purchaser having a chance to put a bid in. Worse, that purchaser is often the insolvent company’s former owner or management,” Pike said.

Pike said a pre-pack in such a situation almost certainly ensures the survival of at least part of the business, and with it the jobs of employees.

“There may be little practical alternative - the business might be haemorrhaging cash and there simply may not be the funds to enable it to continue to trade. In other words, if the business isn’t pre packed, it may just shut throwing all out of work,” Pike said.

“Even if it were able to trade while in administration, the type of business may be such that critical employees may leave thus removing much of the enterprise value. Or, customers might just tear up contracts and seek a new supplier, again damaging the value of the business,” Pike said.

Pike said a pre-pack was less disruptive than closing a business down, as it can continue trading, enabling orders to be fulfilled and customer debts collected. That gives rise to an increased return to creditors.

“Whilst it may seem unfair to let the previous management buy the business, the reality is that they know it best and therefore probably will pay the most for it,” Pike said. “Most pre-packs are preceded by informal marketing, and the fact is that frequently management offer more than anyone else, often considerably more. It would be hard to justify the sale to an unconnected party at a lower price.”

Pike said there were regulations in place to avoid businesses being sold through a pre-pack for unlawful reasons.

“The appointed insolvency practitioner is under a regulatory requirement to be able to justify a pre-pack to creditors, and will suffer sanction by his or her regulatory body if he or she sells a business improperly by way of pre-pack,” Pike said.

The UK government produced new rules designed to improve rescue opportunities for companies in financial distress and put more emphasis on directors’ duties earlier this year, following a consultation on insolvency and corporate governance.

The Pre Pack Pool was set up in 2015 on the back of recommendations made by Teresa Graham in her review of pre-pack administrations.

In its 2017 annual review (7 page / 228KB PDF), the pool said the rate of referrals dropped from one in four in its first period of operation to one in 10 last year. It said this was because there were no regulatory penalties against connected parties for not making a referral, and little pressure from suppliers and customers to approach the pool for its opinion on whether it is appropriate to proceed with a pre-pack sale.