Creditors are burnt as troubled companies rise from their ashes

The boom in pre-pack administrations is breaking the unwritten rules of decency
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Concerns are mounting over the number of businesses being short-changed as figures reveal that more and more failing companies are opting for controversial pre-pack administrations.

Pre-packing allows companies with large deficits to agree a deal to sell the business before it goes into administration. It can be used for the original owners to buy back the business, dumping its debt and leaving creditors often significantly out of pocket.

Analysts say the recent rise in pre-pack administrations was driven by the recession. "The figures we have show that there has been an explosion in the number of administrations in general from 2007 to 2008, onwards," said Tim Carter, the head of insolvency at law firm Stevens & Bolton.

Insolvency Service figures show that at least 29 per cent of the 1,311 administrations registered in the first two quarters of 2009 were pre-packs.

"It is fair to assume, therefore, that the number of pre-pack administrations has shot up since the recession started to bite," said Mr Carter.

And it is mainly small businesses which are being left to foot the bill. While secured creditors – usually the banks – get back any money they are owed, unsecured creditors are often left with nothing.

"Pre-packing is in fashion at the moment," said Mark Andrews, the head of restructuring at law firm Denton Wilde Sapte. "There is a lot of concern that some small and medium-sized companies are just going through a process of dumping creditors. It is a form of phoenixism – companies rising from their own ashes. There is no other word for it.

"Like going through a car wash, a debt-laden company can come out gleaming and looking brand new with the same person in the driving seat at the end of the whole process. That does happen and it is a worry. Pre-packs are most prevalent where the company's value is mainly the talent of the owner."

Analysts said that the fundamental justification for pre-packs should be to preserve the business and the jobs. "These issues must be looked at in the round. Jobs that are saved at one company could be jobs lost in another," said MrAndrews. Indeed many creditors' complaints are not that any law has been broken, but that unwritten rules of decency had been infringed.

The Insolvency Service reported that, in the first quarter of 2009, there were nearly 5,000 liquidations in total in England and Wales – an increase of 7.1 per cent on the previous quarter and a rise of 56 per cent on the same period a year ago.

"A lot of the criticisms surrounding pre-packs are in reality frustrations with the UK's insolvency regime and the Government's handling of the economic crisis generally," said law firm Jones Days' Adam Plainer, who handled the second pre-pack of Ennstone, a public limited construction and building-supply company.

And creditors agree. "This is most certainly part of the culture which sees the people at the top rewarded for failure," said Daphne Tilley. "Bankers are drawing bonuses when their businesses are failing, if the owner of a failing company can jettison his debts and stay in his job, is that any different?"

An all-party parliamentary group, chaired by Labour MP Natascha Engel, was set up last month to look at insolvency practices as a response to the rise in administrations. The MPs, among them Liberal Democrats Treasury Spokesman Vince Cable, will examine pre-pack administrations as a consultation process is launched by the Insolvency Service which may recommend an amendment to the law.

Under the new plans based on the American "Chapter 11" rules, companies in trouble would be able to borrow the money they needed to see them through a period of administration from a different lender, whose investment would be secured.

Adopting a similar system, said Mr Andrews, would make it easier for firms to go through a standard administration process. "That could lead to fewer pre-packs going through," he said. "There is a problem with perception. There is a belief that any period of time in insolvency is value-destructive. That is just not true. One firm, [Michigan-based motor industry supplier] Federal Mogul , kept trading profitably for six years while in administration."

But analysts have also warned that political pressure to change the law could lead to disaster. "There is a danger of a backlash against pre-packs, most likely in the legislative arena," said Mr Andrews. "And this would be bad for the industry, as it could see us lose a useful tool."

Packaged – and offered up for sale - to the former owners

*Tom Aikens Diners at Tom Aikens' restaurants could have been forgiven for not noticing the difference. Indeed very little changed. The doors never closed and Mr Aikens is still in the kitchen. But creditors were all too aware of the transformation that his company underwent - it cost them more than £3m. Mr Aikens, along with two investors, put his ailing company through one of the highest profile pre-pack administrations last year. In doing so, they saved the jobs of almost all of his staff. But creditors say they had to lay off their own.

*Cobra Beer Earlier this year, entrepreneur Lord Bilimoria put his business, Cobra Beer, through a pre-pack administration, leaving creditors with a reported £70m of unpaid debts. He has said that he lost £20m of his own money, but he retains a 49.9 per cent stake in the company. Lord Bilimoria, a former government adviser ennobled in 2007, has also said he is committed to paying back as much of the money as possible.

*Laurel Pubs The company which owned Slug and Lettuce and Yates pubs went through a pre-pack administration last year. Two companies controlled by its previous owner, property magnate Robert Tchenguiz, bought back 293 of the 383 pubs, saving jobs but leaving creditors with liabilities of as much as £133m. Former Laurel Pubs executives were appointed to run the two new companies, Town & City Pubs and Bay Restaurants.

*USC The clothing retailer USC was placed into administration last year as it struggled to cope with the recession. Sir Tom Hunter, who controlled the company, bought it back via an investment vehicle, keeping the 43 most profitable stores open. However around 300 staff lost their jobs as the remaining 15 stores closed.

*Lombok Furniture chain Lombok was bought last month in a pre-pack deal which saved 124 of the 161 jobs at the retailer. The new consortium was led by Lombok's management team and turnaround specialists Privet Capital and Paradigm. Fourteen stores remain open but five outlets will close.

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James Moore: Pre-packs are not all they're wrapped up to be

Analysis

Pre-packaged administration deals are causing huge controversy as their number booms during the economic chill – and it's no wonder. For a bad business to go into administration only for management that ran it into the ground to be able to immediately buy it back shorn of its debts by using a "phoenix company" will strike many as an injustice.

All too often, creditors are left high and dry by such arrangements and often the phoenix company ends up as ashes too, so a new set of creditors also gets burnt.

But pre-packs do have undeniable advantages. If handled correctly, they offer some sort of result for creditors while at the same time preserving a business's goodwill, brand and much of its workforce. This is surely better than letting potentially viable businesses go to the wall. The problem is that the rules, as they stand, are too easily abused and reforms designed to give creditors more clout and to prevent back-room deals are not working well.

What created pre-packs was the fact that when a business goes into administration it also triggers a range of termination clauses with suppliers and other parties. These can fatally wound a business and the result is usually a fire-sale. Reforming this is fraught with pitfalls, but given the abuses we've seen with pre-packs, it has to be worth a look at.

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