Judicial support for pre-pack administrations

United Kingdom

A landmark case highlights that the courts are willing to permit the "pre-pack" type insolvency process where it can be shown that the sale of the business as a going concern will (i) preserve more jobs than in a liquidation and (ii) cause the minimum of disruption.

Background

The case concerned a solicitors’ partnership, which owed a significant tax liability to HM Revenue & Customs ("HMRC"). Negotiations to settle this proved unsuccessful and HMRC served a statutory demand on the partnership.

However, some of the partners were interested in acquiring the business and assets of the partnership through an administration sale. Together with the proposed administrator, they argued that a better result for the creditors would be achieved through an administration, for the following reasons:

  • the value of the assets and goodwill would be maximised;
  • approximately 50 employees’ jobs would be preserved. (This would result in a reduction in the preferential claims which in a liquidation, would be paid in priority to the claims of unsecured creditors, including HMRC); and
  • there would be a continuity of service to the clients.

HMRC argued that where the court knew that the major creditor opposed the pre-pack, that creditor should be able to veto the administration sale.

Decision of the Court

The court rejected the oppositions by HMRC to the sale of the business by way of an administration, arguing that it should take into account not just the majority creditor’s view, but that of all stakeholders, including employees and clients.

The judge stated that he was "particularly influenced by the fact that through the proposed sale 50 jobs would be preserved and that the sale would result in the affairs of the partnership’s clients being dealt with, with the minimum disruption".

On the facts, if a winding-up order had been made, it is likely that the Law Society would have intervened to protect client’s interests. This would get rid of any remaining value in the business, as any realisations would first be applied to the costs of the intervention. It would therefore be unlikely that the creditors would receive any return.

Analysis

The pre-pack mechanism has met considerable controversy, as it is viewed as a somewhat artificial mechanism whereby debts owed to creditors are written off, and the new owners are the same as the old.

Recent research commissioned by R3, however, has shown a significant increase in the use of pre-packs since the Enterprise Act 2002 and this case validates the pre-pack as a legitimate rescue tool.

The judge placed significant reliance on the expertise, experience and impartiality of the insolvency practitioners who were the prospective administrators. If they are of the opinion that the purpose can be achieved, very clear evidence will be required to overturn this. The majority creditor’s view of itself cannot prevent the implementation of the proposed administrator’s proposals.

In addition, practitioners argue that with a people-business that depends upon its reputation, a quick administration sale is essential.

Click here to view the full case.