What is a “pre-pack” sale?
A “pre-pack” sale is the process through which a company enters administration and its business and assets are immediately sold by the company’s administrator under a sale that was arranged before the administrator was appointed.
In this article, Chris Radford discusses the widespread use of pre-pack sales in administrations.
What is the “typical” pre-pack sale?
A typical pre-pack sale in a company administration would involve these steps:
- A company’s directors recognising that the company has no reasonable prospect of avoiding an administration or an insolvent liquidation.
- The company’s directors taking advice from an insolvency practitioner about an administration or an insolvent liquidation and the directors concluding that a pre-pack sale within an administration is a viable option.
- The insolvency practitioner helping the company’s directors plan and carry out an accelerated sale process (if it is necessary to “test the market” to establish the value of the company’s business and assets).
- Offers being received for the company’s business and assets, which demonstrate that the best outcome for the company’s creditors will be achieved by the company appointing the insolvency practitioner as the company’s administrator, so that the insolvency practitioner can complete the pre-pack sale as soon as he is appointed as the company’s administrator.
- The parties agreeing the terms of a sale and purchase agreement for the company’s business and assets, and any other relevant ancillary documentation, before the administrator is appointed.
- Undertakings being given, which come into effect as soon as the administrator is appointed, and which are designed to cause the sale and purchase to complete moments after the administrator is appointed.
- The appointment of the administrator and the completion of the pre-pack sale.
To read more about what company administration is, read our article here.
The main advantage to the company’s directors of the administrator completing the pre-pack sale is that it is the administrator’s decision to complete the sale, and not the directors’ decision. The directors’ powers are suspended when the administrator is appointed. If the directors were to complete the pre-pack sale before they appointed the administrator, then they could expose themselves to allegations of breaches of duties and claims. If the company’s creditors are unhappy about the pre-pack sale, then they will normally need to challenge the administrator’s actions, rather than the directors’ actions.
What to expect in the sale and purchase agreement?
The sale and purchase agreement will distinguish between the assets which are included in the sale (for example goodwill, plant and machinery, customer contracts and stock) and the assets that are excluded from the sale (for example book debts, claims and prepayments). The assets that are included or excluded vary from sale to sale and sometimes the same asset class will be divided into included and excluded assets (for example profitable customer contracts may be included, but unprofitable customer contracts may be excluded).
The sale and purchase agreement will almost always exclude any liability, on the part of the buyer, for most of the seller’s debts and other liabilities (except where the buyer, as a matter of law, is made responsible for the seller’s liabilities, for example under TUPE.
In order to maximise realisations in the seller’s administration, the administrator may ask the buyer to agree to meet a limited number of the seller’s existing obligations (for example to honour warranty claims where this would help the administrator collect in book debts). However, in general terms, in a typical pre-pack sale the buyer acquires the assets that the buyer needs in order to run the business (free of claims in respect of the seller’s liabilities) and the seller retains the assets that the buyer does not need (for example book debts) and the seller’s liabilities.
In all other respects the sale and purchase agreement will be drafted to favour the seller and the seller’s administrator. It will be drafted on the basis that all representations and warranties are excluded, and all risks associated with the transferred business and assets are risks that are to be assumed by the buyer. The justification for this is that the administrator has little knowledge of the business and the assets, and that the administrator needs to be able to distribute the sale proceeds to the seller’s creditors. He cannot cause the seller to give representations and warranties, because this would restrict his ability to distribute. An additional justification is that the price for the business and assets has been agreed by the parties in the knowledge that the buyer will be accepting all relevant risks.
Clearly, the seller’s existing directors and/ or shareholders may be in a much better position to value the seller’s business and assets, and to assess any risks associated with the business and assets and the pre-pack sale, than a third party. Therefore, it is quite common for the seller’s existing directors and/ or shareholders to outbid third parties during an accelerated sale process.
The benefits of a pre-pack sale strategy
The benefits of a pre-pack sale strategy depend on the exact circumstances, but can include:
- A pre-pack sale can result in a quick and relatively smooth transfer of a company’s business and assets to a new owner. A sale negotiated over a period of weeks after the company has gone into administration can result in a worse outcome for the company’s creditors, due to the disruption the insolvency process causes and the costs of trading the company’s business while a buyer is found and the terms of the sale are agreed.
- A pre-pack sale can minimise the erosion of confidence among a company’s suppliers, customers and employees. This is an inevitable consequence of most insolvency proceedings. The pre-pack sale may give the buyer the best chance of maintaining key relationships.
- A pre-pack sale can save more jobs than other insolvency strategies or processes. The employees’ contracts will normally transfer to the buyer under TUPE, with the employees’ existing terms and conditions and length of service preserved. This gives the employees certainty and minimises the risk of key employees leaving.
Also, there is sometimes little choice involved regarding whether to undertake a pre-pack sale:
- If there is no funding available, it may not be possible for the administrator to trade the business until it is sold. In this situation the alternatives are likely to be either to complete a pre-pack sale or to put the company into liquidation, which will result in the immediate cessation of the company’s business.
- It is also common for an essential supplier (for example a landlord or a franchisor) or a key customer to indicate that it is not prepared to deal with anyone other than its own preferred bidder for a company’s business and assets. This may mean that an administrator only has one potential buyer.
Criticisms of pre-pack sales
Pre-pack sales have attracted some criticism over the years. The main criticisms of pre-pack sales are:
- The cause of the seller’s failure may not have been properly addressed by the buyer. The transfer of a company’s business and assets, without its liabilities, to a buyer will almost certainly put the buyer into a much stronger position than the seller was in prior to the administration, but will this address the root cause of the seller’s difficulties? A more significant restructuring may be necessary following the completion of the pre-pack sale, if the buyer is to survive in the medium to long term.
- Often, unsecured creditors do not know that a pre-pack sale is being planned. They may have no opportunity to protect their interests. Secured creditors, on the other hand, are usually involved because they need to consent to the release of their security where assets secured by mortgages or fixed charges are to be included in the pre-pack sale.
- The decision to complete a pre-pack sale is a matter for the commercial judgement of the administrator. Accordingly, the administrator can sell the business and assets of the company before any meeting of the company’s creditors has taken place. The fact that a pre-pack sale has happened will be reported in the administrator’s report to creditors, but the creditors will not have an opportunity to vote on the transaction.
- It is not always possible to “test the market” by advertising for buyers for a company’s business and assets. In some cases, the value of the business and assets would be destroyed if the company’s financial difficulties were to become common knowledge. Competitors could systematically “pick off” the company’s key customers and employees. If no, or a limited, marketing exercise is carried out, then competitors may say that they would have paid more for the company’s business and assets, had they known that a pre-pack sale was planned.
- Creditors may be especially suspicious about a pre-pack sale where the business and assets are sold to the seller’s original directors and/or shareholders. As a result of this criticism, there are now additional steps which need to be taken where a pre-pack sale is being completed with a connected party.
Guidelines and Regulations for company administrators on pre-pack sales
Administrators are officers of the court and have always been subject to strict rules and regulations which govern their conduct. In addition, they are subject to the rules and guidance issued by their professional bodies. These include Statement of Insolvency Practice 16 (SIP 16) which relates to pre-pack sales in administrations (and which is available at www.r3.org.uk).
Also, new regulations (the Administration (Restrictions on Disposal etc. to Connected Persons) Regulations were introduced in 2021. The Regulations are intended to provide greater protection for creditors where there is a pre-pack sale to a connected party and require the administrator to obtain a report from an independent evaluator (which is commissioned and paid for by the connected party) or creditor approval before they complete the pre-pack sale. Given the urgency of most pre-pack sales, the administrator is more likely to obtain the independent report than to seek creditor approval. A report can be obtained for as little as £1,500 (plus VAT) and within as little as 48 hours, so this should not act as a barrier to appropriate transactions. The report will say whether or not the evaluator considers that the consideration being provided by the buyer for the seller’s business and assets is reasonable and a copy of the report will be made available to the company’s creditors.
Our Restructuring Advisory team have the required expertise and experience to assist you with any restructuring challenges you may face. Please contact us if you would like to discuss any aspect of this article or series.