Take care in changing insolvency rules

INSOLVENCY experts are warning that proposed changes to the rules surrounding pre-pack administrations could cause new issues as well as addressing the perceived problems that creditors may have with the present system.

Linda Farish, chairman of the North-east arm of insolvency trade body R3 and director of Recovery & Insolvency at Newcastle-based accountants RMT, was speaking after new Government proposals of the reform of the pre-pack system were unveiled.

A pre-pack is an agreement for the sale of an insolvent company’s business and assets which is put in place before the company goes into a formal insolvency process, usually administration.

The proposals include the introduction of a three day notice period for pre-pack sales to connected parties.

Whilst welcoming changes which bring greater transparency to the pre-pack process, Linda Farish believes this notice period could mean greater numbers of unsecured creditors lose out on the money they’re owed, as more businesses are simply liquidated instead of being pre-packed.

She says: “Any measure that boosts confidence in the pre-pack procedure is to be welcomed, but it is important to note that the reason a pre-pack is chosen is due to the speed of the procedure which helps preserve the value of the business.

“In-built delays see value depreciating quickly, and if funding is not available to allow trading, for even a short period, it will jeopardise the possibility of an effective rescue.

“Three days is a long time in business without working capital and if a company is unable to trade in that period, it is at severe risk of losing key staff and customers.

“When faced with this option, directors may simply decide that liquidation is a better route, and this would reduce returns to both secured and unsecured creditors and result in considerably fewer jobs being saved than under a pre-pack.”

The announcement of the new Government proposals coincides with its annual report on insolvency practitioner compliance. In 2010 only 1.7% of cases were referred to the Recognised Professional Body for disciplinary procedures.

The Government’s monitoring report on pre-pack compliance indicates that there is ‘no reliable evidence to suggest that misconduct by directors is any more prevalent in pre-pack cases than in conventional administrations.’

Linda Farish continues: “Sales to connected parties, which occur in 40% of all business sales, tend to happen because there is simply no other buyer at the table, especially in situations where these parties are central to a company’s operations, but It is important to note that pre-pack sales are also often made to third party purchasers.

“It would be beneficial to the business rescue culture if the Government looked at ensuring suppliers are bound in the event of a formal insolvency or were prevented from making what we call ‘ransom payments,’ which are inflated prices for services they were supplying before an administration began.

“We have put these ideas to Government as part of our ‘Holding rescue to ransom’ campaign, and if the new proposals are taken forward, we advocate that our ideas are also brought into statute to help businesses remain trading during the three day period.”

Insolvency practitioners estimate that the change in legislation for which the government is calling would reduce the number of pre-packs by more than a fifth.