Regulator asked to investigate pre-pack insolvency practices

Rules governing the controversial practice of pre-pack company administrations are being abused and need overhauling, the Association of British Insurers (ABI) has said in a letter sent to the Insolvency Service last week.

Use of pre-packing – a practice that allows companies to quickly enter into administration, wipe out debts and be sold on, often to the company's original management – has soared during 2009, with 1,250 companies using the procedure. Firms that have ditched creditors by using the controversial practice include the likes of retailer USC, the tea firm Whittard of Chelsea, and, just last month, LomBok, the upmarket furniture chain.

But in a letter to the regulator on 30 July, the ABI's director of general insurance, Nick Starling, warns that use of pre-packs is increasing rather than curbing financial distress and is causing serious unfair prejudice to creditors.

"The current approach may have the unintended consequence of increasing the overall number of insolvencies and job losses from the economic downturn, by spreading financial distress from insolvent buyers to their supply chain," Mr Starling says.

In a detailed seven-page letter, he writes that in many instances it "is impossible for unsecured creditors to be sure their interests have been fully taken into account" under the current regime. The widespread marketing of pre-packs by insolvency practitioners as a "magic solution by which any company in difficulty can re-invent itself at the expense of creditors" was a cause for concern.

Mr Starling writes that changes made to the pre-pack system by the Insolvency Service in January, forcing advisers working on pre-packs to offer detailed explanations of their actions to creditors, are not being observed in a large number of cases. The ABI has proposed a raft of changes, including attaching liability to advisers that don't adequately explain their actions during a pre-pack.

"Solutions," he says, "are needed to protect small firms from suffering potentially fatal losses from events that have not been caused by them."