[Originally published in the September 2014 issue of the Australian Insolvency Journal, and reproduced here with permission]
One of the regular discussions among insolvency and workout professionals is whether we need the capacity to undertake pre-packs in Australia, with the UK experience often used as a reference point. Unavoidably but unfortunately, most of that debate has been undertaken in the absence of meaningful data.
Now, following the June 16 release of the Graham Review Report[i] which is supported by a large scale study undertaken by the University of Wolverhampton, we have hard data. As a consequence we now have far greater insight into the background and outcomes of the pre-pack process.
The Graham Review
In mid-2013 the UK government commissioned a review of pre-packs by Teresa Graham CBE to assess the usefulness and impact of pre-packs and consider any aspects or practices which cause harm, with special attention to the position of unsecured creditors. A prominent accountant, Graham was the former head of the Business Advisory practice for accounting firm Baker Tilly and has been appointed to a number of advisory and statutory boards.
Critics of pre-packs in the UK point to a lack of transparency, with limited details provided to creditors only after a sale has been concluded. Pre-packs involving sales to connected parties come in for particular criticism as at best they allow ‘bad businesses’ with poor business models to continue to operate and that at worst they are a sham to avoid debt i.e. a phoenix.
What is a Pre-Pack?
Although UK legislation does not make any reference to pre-packing it is universally accepted that pre-packing is permitted by the law, and since 2009 it has been the subject of a guidance note issued by the insolvency regulatory authorities: Statement of Insolvency Practice (SIP) 16.
SIP 16 defines a pre-pack as ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, his appointment.’[ii] The practitioner has a level of involvement with the company prior to his or her appointment which in Australia would probably amount to ‘a professional relationship’ in the two years prior to appointment, sufficient to prevent the practitioner from accepting the appointment under the ARITA Code of Conduct – but which is acceptable in the UK.
According to Graham, around 3.5 percent of the around 20,000 insolvency procedures each year in the UK are pre – packs.
Since 1 January 2009, SIP 16 has required the administrator to provide creditors with specific information including the price obtained, details of valuation of the assets, and whether the purchaser was connected. These SIP 16 statements are sent to creditors after the sale and provided to the UK Insolvency Service. It is this disclosure which provided the base data for the quantitative analysis by the University of Wolverhampton.
The University of Wolverhampton research
The Graham Review commissioned this research into data extracted from SIP 16 statements for a sample of 499 pre-packs implemented in 2010.
That research found that the typical pre-pack:
- Was a small business (81 percent having turnover below £6.5m), at least five years old (a median age of 8.6 years), with median debt of £565,000 (about $1.02m at the time of writing).
- Was not marketed by the Insolvency Practitioner – with either no marketing at all (39 percent) or marketing conducted prior to the IP’s involvement (21 percent).
- Was sold to a connected party (in 63.3 percent of cases), [iii] probably for less than £100,000 (60 percent of cases) which was often part- deferred (more than 50 percent of cases).
- Was almost always tested against an independent valuation (91 percent of cases) however those valuations were often desk-top valuations, and limited to tangible assets only.
- Provided unsecured creditors with a ‘paltry benefit’ – no distribution in 60 percent of cases and a median return of 4.3 percent for those where a distribution was made.
- Survived for longer than three years (76 percent of cases). Notably, connected party purchasers had a failure rate almost twice the rate of that with an unconnected purchaser.
The Wolverhampton University research team expressed concerns about the quality of information about marketing, describing the standard of reporting as ‘very variable,’ with practitioners sometimes doing nothing more than accepting the view of directors that there was no ready market for the business without testing that assumption.’
Report Conclusions and Recommendations
Graham made a number of recommendations to improve the pre-pack process, most noteworthy:
- A voluntary process by which connected parties would be required to provide details of their offer to a member of a panel of experienced business people. After a review that would not exceed half a day, the panel member would provide an opinion that would be included in the SIP 16 statement. Critically, a negative opinion would not block a deal.
- Marketing should comply with six principles identified by Graham, with any divergence to be detailed in the SIP 16 statement.
- Greater detail about the valuation process should be disclosed in the SIP 16 statement, with a firm requirement that valuers hold professional indemnity insurance.
Graham did not recommend any regulatory change – but this was only because there is already a separate review into the regulation of insolvency practitioners and their remuneration underway[iv] and she noted that absent that review she would have made further recommendations.
Overall Graham was reasonably positive about pre-packs: she found that there were ‘significant’ cost advantages of a pre-pack over formal procedures, and said that although the SIP 16 information regarding employment preservation was ‘often poor’ she was able to conclude that they helped to preserve employment.
Pre-packs Down Under?
The picture presented by the University of Wolverhampton research is that of a process which provides a moderate enhancement to the recoveries of secured small business lenders in the 3 percent to 4 percent of formal insolvency procedures where they are deployed.
Tangible assets are sold for a price close to their standalone value without any deduction for auctioneers costs and commission, and the insolvency practitioner’s fees are minimised. Unsecured creditors typically won’t see a return – but they would not have received a dividend anyway.
UK practitioners have raised queries about the practical working of the panel referral process, but have welcomed Graham’s views that a pre-pack option should continue to be available.
Using the UK experience as a template, pre-packs are certainly one option to facilitate the relatively quick and inexpensive sale of a small business. A key point however is that almost two-thirds of sales are made to connected parties. Given the widespread concern and black and white views around phoenix transactions in Australia, a change to a process that accommodates sales to connected parties may meet stiff resistance, and require careful justification and management.
Postscript – 16 August 2017: SiN reports Moves afoot to propel pre-packs onto political agenda
[i] Both the report and the statistical analysis are available at (see: Graham Review into Pre-pack Administration).
[iii] The connected party sale rate is remarkably consistent with a the 62 percent rate reported in a 2007 study ‘A preliminary analysis of pre-packaged administrations’ by Dr Sandra Frisby (available at http://www.r3.org.uk/publications) and 65 percent reported in a 2010 survey conducted by the Association of Business Recovery Professionals (65 percent) available at http://www.r3.org.uk