Since the financial crisis of 2008, pre-pack administration has been widely used as a way to save jobs and reduce the impact of insolvency on economic growth. Its controversial nature led to the Insolvency Service attempting to increase transparency, however, and reassure creditors that their needs were being met.

Also known as ‘phoenixism,’ pre-pack administration involves a new company being formed using assets purchased from the insolvent business. The fact that these assets are often bought by directors of the old company, is where much of the controversy lies.

What are the main ethical issues within pre-pack?

Involvement of directors

One of the main issues surrounding pre-pack is the involvement of existing directors. Their right to purchase and use the assets to set up a new company, which often trades along the same lines as the failed business, attracts suspicion and mistrust.

Lack of transparency

A general lack of transparency has clouded the process in the past, and led to scepticism among creditors who feel a sense of exclusion and that their interests are not being optimised.

Valuation methods

Non-professional valuation of assets has been a further cause for complaint – low valuation can impact directly on the level of creditor returns.

Inefficient marketing

Lack of open/efficient marketing has also been a cause for concern. The insolvency practitioner negotiates and agrees the sale of business assets before their official appointment as administrator. The sale then takes place quickly, to preserve value.

Viability in the future

Creditors have expressed concerns about the future viability of businesses set up following pre-pack administration. They believe that, under the same leadership, a ‘newco’ is more likely to fail in a similar way.

Increasing confidence in the system

In an attempt to improve the public’s perception of pre-packs, and to increase transparency, the Insolvency Service introduced a variety of amendments to the Statement of Insolvency Practice 16 (SIP 16) in November 2015.

SIP 16 guides insolvency practitioners undertaking pre-pack administrations. Although IPs are not legally obliged to follow these guidelines, they could face regulatory action if they don’t.

Under the amendments, proof must be provided that:

• All other options were considered: pre-pack must offer the best returns for creditors.
• Assets were professionally valued: the basis for valuation and details of the valuer (including their professional qualifications) has to be provided.
• Marketing was effective: a broad range of prospective purchasers must be informed of the sale over a suitable length of time, and an explanation given if sufficient marketing has not been carried out.
• Directors paid a fair price for the assets: a fair market price should be placed on the assets.

Directors can also now consult a ‘pre-pack pool.’ This is a group of experienced business people who have volunteered to examine cases for pre-pack administration. They give their opinion as to whether pre-pack is a ‘reasonable’ option, and can help in supporting a case.

The conflicting demands placed on directors during insolvency make it a challenging time, and creditors point to morality and integrity as the main ethical issues of pre-pack. SIP 16 now goes some way to addressing these concerns, and gives struggling companies with a viable underlying business the chance to thrive once again.

Written by Keith Tully, Partner at Real Business Rescue (part of the Begbies Traynor Group). Keith is a leading corporate insolvency specialist with over 25 years’ experience advising company directors on formal restructuring procedures such as pre-pack administration.