House of Commons - The Insolvency Service - Business and Enterprise Committee

The Insolvency Service - Business and Enterprise Committee Contents

3 Confidence in the Insolvency Regime

12. Administration has become the main insolvency procedure aimed at rescuing a company's business. During an administration the company is controlled by a private sector insolvency practitioner, known as the administrator, whose powers and responsibilities are set out in the Insolvency Act 1986, Schedule B1. A pre-pack administration describes the situation where a company's business and assets are sold on terms that were negotiated between the buyer and the administrator before the company formally entered administration. The sale is often then carried out privately and rapidly by the administrator with limited disclosure or control available to creditors. Pre-packs are not new and have been used commonly where commercial pressures require urgent action in order to save the value of a company's business.[10] There is, however, a growing body of evidence that the number of pre-packs has increased since the Enterprise Act 2002 made it simpler for companies to enter administration.[11] Recent high profile examples include the sale of The Officers Club, Whittard of Chelsea, and MFI.

13. There is controversy over the balance between the benefits and the drawbacks of pre-packs, including their susceptibility to abuse. While research is still continuing, the Insolvency Service states that: "A pre-pack may offer the best chance for a business rescue, preserve goodwill and employment, maximise realisations and generally speed up the insolvency process."[12] This view is shared by many other witnesses, including the Recognised Public Bodies (RPBs) that license insolvency practitioners and even some of those who have lost money as creditors of a failed business.[13] For instance, R3 state that pre-packs are a frequently misunderstood tool and their potential benefits must not be "lost in the debate over their perceived impact on creditors".[14]

14. We accept the logic that more value will be recovered from the sale of a company's business and assets where it continues to trade than where it is broken up. Research by academics such as Dr Sandra Frisby of the University of Nottingham indicates that secured creditors do particularly well, recovering an average of 42% of debts as part of a pre-pack compared to 28% in a business sale.[15] Although a full understanding of pre-packs is some time away, early signs also indicate that higher numbers of staff are transferred to the new company than would happen otherwise.[16] This appears to be especially true in the case of larger pre-packs resulting from negotiated agreements with creditors.

15. There is, however, evidence that unsecured creditors fare worse during a pre-pack, recovering 1% of their debts on average compared to 3% as part of a standard business sale.[17] Moreover, there are suggestions that pre-pack administrations adversely affect competitors, who will continue to carry costs which the phoenix company has shed.[18] Criticisms of pre-packs are at their sharpest where existing management buy back the business following private negotiations with an insolvency practitioner and then continue to trade clear of the original debts through a new "phoenix" company. This means that unsecured creditors are initially kept in the dark and then left empty handed. The phoenix company may also have some advantage over competitors who honour their financial obligations. The anecdotal evidence in media reports and confidential letters to the Committee suggest that "phoenix" pre-packs affecting smaller companies with high levels of unsecured trade creditors cause particular concern and are more likely to damage the supplier base without corresponding broader benefits to the overall economy.

16. The views of many unsecured creditors are reflected by one individual who stated: "Of course it is good news that many jobs have been saved but it seems to be at our expense. We are unable to borrow on those bad debts so are facing grave difficulties in trading as a direct result of the rescue of our client company… this pirate's charter will surely make this particular downturn even more painful for the small business".[19] John Moulton, the head of a private equity firm, Alchemy Partners, is also reported as saying "Pre-packs could be very easily abused. Bad management can plan for a pre-pack months in advance, line up an administrator — and then be back running the business immediately."[20] The Association of British Insurers is particularly concerned that a lack of transparency and notification to unsecured creditors is causing an increasingly serious problem for both small and medium-sized enterprises (SMEs) and credit insurers.[21]

17. These general concerns have not gone unnoticed by the Insolvency Service. It is responsible for regulating the insolvency profession and for advising the Government about any changes that need to be made to the insolvency regime. It has acknowledged that pre-packs can be carried out without sufficient market exposure, that creditors can be denied the opportunity to participate in negotiations, that there can be a lack of transparency and accountability, and that the "phoenix" phenomenon can cause utter disbelief among those who lose out: "consumer and small trade creditors can find it particularly baffling that this is allowed or at least not barred by the legislation."[22]

18. This led to the Insolvency Service (and other RPBs that license insolvency practitioners) introducing a practice statement, known as Statement of Insolvency Practice 16 (SIP 16). Mr Horne explained that for the first time it will require insolvency practitioners "to give details of how they were introduced to the company, what work they did prior to their appointment, what marketing they did at the company, what valuations they took of the business, really to explain to creditors why they felt that a pre-pack was the best thing for them".[23]

19. SIP 16 has been welcomed by some, but there is general agreement that its impact must be monitored closely. The Insolvency Service has committed to doing so as a matter of priority.[24] In particular, the Service has committed to check each pre-pack administration to ensure compliance with both the letter and spirit of the new rules. The British Printing Industries Federation (BPIF) argue that if monitoring uncovers ongoing problems then tougher legislative alternatives should be considered.[25] Further, the Insolvency Practitioners Association has called for the Insolvency Service to clarify that transparency takes priority over any duty of confidentiality owed by the administrator to the pre-pack purchaser.[26]

20. Others believe that SIP 16 will not prove sufficient and favour immediate changes to the law. For instance, the Association of British Insurers (ABI) argues that it is "a step in the right direction, but only deals with the situation after the pre-pack. The Government should act to address these problems by, for example, imposing minimum disclosure and transparency requirements."[27] Another alternative has been suggested: "explanations after the event are little help to suppliers. And when a business is saved, critical partners such as lenders and suppliers should share the benefits… The rules must be changed to give at least the biggest creditors a say".[28] Some unsecured creditors have gone so far as to call for pre-packs to be banned outright.

21. In some jurisdictions it would not be possible for pre-packs to operate behind closed doors. For instance, Chapter 11 proceedings in the United States require proposals to be approved by the court before being implemented. While the Insolvency Service has committed to learning lessons from elsewhere, it has argued against this kind of restriction because of its concerns that it may prevent businesses from being rescued:[29]

the administrator needs to be left alone to get on with the urgent restructuring actions that are necessary with minimum cost and delay; this is the best way to ensure that jobs are saved and value is not lost. Imposing additional requirements to seek court approval is likely to jeopardise a rescue by diverting the administrator from that critical restructuring activity. It may also create unnecessary and lengthy delays and will certainly dissipate what limited funds there may be on legal and professional fees.[30]

22. The former head of Woolworths, Sir Geoff Mulcahy, has questioned whether the existing regime does, in fact, ensure that profitable parts of a struggling company are restructured with a view to retaining jobs and promoting the rescue culture. In relation to the example of Woolworths he stated:

I am sure the Board, the Banks, the credit insurers, and the administrator would all have acted within the necessary rules, regulations and applicable laws, which raises the issue as to whether these processes have worked in the overall public interest… Whilst each case is unique, there is a pattern of events from the apparent failure of corporate governance to the eventual liquidation of the business which deserves examination to see if lessons could be learnt.[31]

23. Mr Speed has highlighted that administrators act in accordance with strict statutory duties, including to rescue the company wherever possible.[32] More generally: "the jury is still out as to whether [the regime introduced by the Enterprise Act 2002] is in fact increasing rescue rates and increasing returns to creditors, and we will certainly need to carry on evaluating it."[33] But the Insolvency Service is optimistic for the future: "Protections already exist to deal with misconduct on the part of both directors and administrators and the recent introduction of SIP 16, whereby the Government has put in place arrangements to improve transparency where a pre-pack sale has been effected, will help further."[34]

24. Mr Horne accepted that small creditors find it difficult to protect their interests by challenging pre-packs at court. However, he added: "they can raise it with the administrator, they can raise it with the administrator's professional body, they can raise it with us. Government is often approached in these cases as well. HMRC are often a creditor and I think they can have a proactive role to play in this."[35] The Service has provided details of its hotline which can be used to report instances of suspected abuse: enforcement.hotline@insolvency.gsi.gov.uk or 0845 601 3546.

25. Public confidence in the insolvency regime is being and will be further damaged. Prompt, robust and effective action is needed to ensure that pre-pack administrations are transparent and free from abuse. Unsecured creditors tend to be kept in the dark and recover even less than they would in a normal administration. This causes particular outrage where the existing management buy back the business and continue to trade clear of the original debts. Pre-packs of this kind fuel understandable concerns about illegitimate, self-serving alliances between directors and insolvency practitioners. The interests of unsecured trade creditors must take a higher priority, especially in "phoenix" pre-pack administrations. The insolvency system, the Insolvency Service and the insolvency profession all risk real reputational damage if the situation is not addressed. More worryingly, many SMEs appear to be suffering unreasonable financial harm with no corresponding benefits to the wider economy. Where there are good reasons for an insolvency practitioner agreeing to a pre-pack, which there can often be, this must be explained clearly and fully. Where there are no good reasons for entering a pre-pack, this must be exposed before the damage is done.

26. In view of this, we welcome the introduction of the new practice statement, Statement of Insolvency Practice 16, which aims to increase the transparency of pre-packs. We also welcome the Insolvency Service's commitment to monitor its implementation. This is a responsible first step, but the recession makes this a matter of considerable urgency. There must be systematic monitoring of the situation by the Insolvency Service and the Department. If the new practice statement does not prove effective then it will be necessary to take more radical action, possibly by giving stronger powers to the creditors or the court. In the meantime, we urge anyone who suspects the abuse of pre-packs to contact either the Insolvency Service or the body that licenses the insolvency practitioner concerned. We also encourage large creditors, in particular Her Majesty's Revenue and Customs, to take an active role in rooting out abuse.

Insolvency practitioners fees

27. There is a general and enduring perception that insolvency practitioners charge unduly high and occasionally opportunistic fees for administering the estates of insolvent individuals and companies. Mr Speed explained that the Insolvency Service does not have direct responsibility for professional fees and stated his belief that they are generally in alignment with the legal and accountancy professions.[36] He emphasised that the onus rests on creditors to take action whenever they are concerned that fees are excessive:

Once the relationship has been established the people who need to take control of what is happening in relation to fees are the creditors. We do not live in a society in which we regulate prices; we have to rely to some extent on competition, but creditors do have powers, for example, to object to fees that administrators are proposing and they can and sometimes do get the administrators changed.[37]

28. Mr Speed accepted, however, that more could be done: "creditors need to be better educated and better facilitated to use the opportunities that they already have in law to get together and decide what it is that they want to pay for in the administration."[38] His deputy, Mr Horne, made a constructive commitment to monitor the current practice statement on remuneration:

The point about fees is that they have to be approved by creditors. There is a SIP [Statement of Insolvency Practice]… which says the insolvency practitioner must explain to the creditors why the fees are how they are. I think what we also need to do, in the light of the current circumstances, is check that that is being adhered to by insolvency practitioners as well; that they are giving the creditors enough information for the creditors to make an informed view as to whether or not they will approve these fees."[39]

29. It may be inevitable that insolvency practitioners' remuneration is perceived as unduly high by many creditors. There must, however, be sufficient opportunity and information to allow creditors to ensure that fees are reduced where that perception is justified. We therefore welcome the Insolvency Service's commitment to monitor whether insolvency practitioners are complying with the current practice statement governing the approval of their fees. We urge the Insolvency Service to make its findings publicly available. We also urge the government to respond to these findings and to consider the case for strengthening control - possibly through independent arbitration - of insolvency practitioners' remuneration beyond the limited power to do so currently exercised by creditors.

10 Association of Business Recovery Professionals, Pre-packaged sales briefing notes, available at https://www.r3.org.uk/uploads/documents/Pre-packs%20briefing.pdf Back

11 Ibid Back

12 Enterprise Act 2002 - Corporate Insolvency Provisions: Evaluation Report, January 2008, at p147, available at http://www.insolvency.gov.uk/insolvencyprofessionandlegislation/legislation/EA02CorporateInsolvencyReport.pdf (hereafter referred to as"Evaluation Report") Back

13 Further information on RPB's is available at Ev 19, paras 22 to 23 (The Insolvency Service) Back

14 Association of Business Recovery Professionals, Pre-packaged sales briefing notes, available at https://www.r3.org.uk/uploads/documents/Pre-packs%20briefing.pdf Back

15 Ibid Back

16 Association of Business Recovery Professionals, Pre-packaged sales briefing notes, available at https://www.r3.org.uk/uploads/documents/Pre-packs%20briefing.pdf Back

17 Association of Business Recovery Professionals, Pre-packaged sales briefing notes, available at https://www.r3.org.uk/uploads/documents/Pre-packs%20briefing.pdf Back

18 Ev 52 (Jonathan Williams) Back

19 Q52 Back

20 Daily Mail Online, Pre-pack deals risk cheating creditors, 5 January 2009, available at http://www.dailymail.co.uk/money/ Back

21 Ev 27, para 2 (Association of British Insurers) Back