Category Archives: Insolvency

Considering a pre packed sale? Know your legal responsibilities

What is a pre pack?

Before we start, let’s be clear exactly what a pre pack sale is. A pre pack sale is a sale of a business that has entered into Administration, with the sale being effected almost immediately after the Administrators have been appointed – in most cases, this is usually the very same day. The term “pre pack” is used, given that virtually all of the negotiations to buy the business are completed pre the appointment of the Administrators. Once the Administrators are formally appointed, they then have the legal powers to complete the sale.

Sounds all a bit odd? Not really – in most such cases, speed is absolutely vital in ensuring the survivability of the business, especially with one that has significant financial problems. In such circumstances, very few if any prospective Administrators like trading on – the risks are just too great. There are exceptions – BHS, Woolworths etc. – those companies had huge amounts of stock that could easily be sold through their own retail outlets.

The pre pack time lines

Let’s look now at the mechanics and key issues to consider when thinking about a potential pre pack Administration. The time line works something like this:

  • The company directors recognise the company has problems and seeks out the help of a reputable insolvency practitioner. Alternatively, the company’s bankers/lenders decide that the directors need advice and recommend that an Insolvency Practitioner should consult with them.
  • The directors and IP meet so that the IP can get a better understanding of what the company does, what its problems are, and what solutions are available.
  • Assuming that a pre pack sale of the business is the most viable option, and the one that returns the most to creditors, then the planning for this process begins.
  • The IP will organise a valuation of the company’s assets, whilst the directors look to secure the funding to buy the assets back and then to continue trading.
  • Once the valuations and funding are finalised, the IP will arrange for his solicitor to send to the directors’ solicitor, a draft sales agreement – usually referred to as the SPA – sale and purchase agreement.
  • Once the terms are finalised in draft, the IP will then assist the directors in completing the relevant forms to formally appoint the IP as Administrator.
  • As soon as the Administrator is appointed, he will then immediately complete the sale of the business.
  • Depending on the size of company and its complexity, pre packs are usually completed within two to three weeks of the IP first being consulted.

The legal considerations

The main legal requirement of any pre-packaged sale, is that it must be the deal that returns the most back to creditors. However, there are some transactions where that simply will not be possible, given that after paying secured creditors and the costs of the Administrator, there will be no surplus funds available.

When the Enterprise Act came into force , it abolished the right of HM Revenue & Customs to be preferential creditors. To partially compensate for this and also, to try and return some funds to unsecured creditors, the provision dealing with the “prescribed part” became law. Basically in all Administrations, the Administrator has to put to one side a proportion of the sales proceeds in order that a dividend can be paid to the unsecured creditors. This is worked out by reference to the “net property”. The net property is the amount realised for none charged assets, after the costs associated with the realisation have been deducted. The Administrator must then take 50% of the first £10,000 of net property and 20% of the balance up to a maximum of £600,000, and use this to pay a dividend to unsecured creditors. Let’s say that the Administrator has realised £100,000 for stock, and other assets that are not charged. His costs amount to £20,000, so the net property is therefore £80,000. The prescribed part is therefore £19,000, being 50% of the first £10,000 (£5,000) and 20% of the next £70,000 (£14,000).

Another key consideration are the SIPs that any IP must work with – Statement of Insolvency Practice. These are effectively best practice guidelines that all IPs must follow. The two key SIPs that affect pre pack Administrations are SIP 16 and SIP3. SIP 16 deals with all of the relevant issues affecting how an Administrator goes about effecting a pre pack sale. SIP 16 covers the following key points:

  • The IP must be clear as to his role in giving advice to the company pre appointment and his role post appointment in acting as Administrator.
  • The IP must inform the directors of the existence of the pre pack pool and recommend that the directors submit their proposal for pre pack sale to the pre pack pool. The directors are under no legal obligation to submit their plans to the pre pack pool, although doing so does help with the issue of transparency.
  • Independent professional valuations of the company’s assets should be organised by the IP.
  • The IP/Administrator must demonstrate that he has marketed the business to the widest possible audience – the guidelines on this are fairly strict and are given in an appendix attached to SIP 16.
  • The Administrator must within 7 days of the transaction completing, issue a comprehensive report to all creditors explaining why the pre-packaged sale was in the best interest of creditors.

SIP 13 deals with transactions with connected parties – as most pre packs are with existing directors, then this SIP will usually also apply. This SIP is not as detailed as SIP 16 and the key issue is that the Administrator must demonstrate that, by completing a sale of the business back to the directors, that he has acted in the best interests of the creditors.

General considerations

Most of the onus for ensuring that a pre-packaged sale complies with statute and the relevant SIPs, falls mainly on the IP/Administrator. That said, you do need comfort that the IP/Administrator has complied with all relevant statutes/SIPs etc. to ensure that there’s no comeback later on. The best way to ensure that you are protected is to engage a suitably qualified lawyer to act on your behalf – ideally, one that has some insolvency knowledge.

For most directors looking to complete a pre-packaged sale, the most important issue is finance – how to fund the actual acquisition of the business and then how to fund trading in the new business until cash flow kicks in. These issues are best addressed with your own accountants. It is an issue though, that you must have resolved before contemplating a pre-packaged sale/purchase – very few Administrators give credit!

Richard Saville is a Licensed Insolvency Practitioner with Corporate Financial Solutions. He has over 40 years of experience helping companies large and small who may be experiencing financial problems. Richard takes pride helping to save struggling businesses and return them to profitability. He has an extremely broad knowledge across most industries having effectively dealt with pretty much every type of business around!

Potential insolvency in the legal sector: the unique factors at play

Insolvency in the legal sector can be caused by a number of factors that pose unique problems for the firm’s partners and the insolvency practitioners.

No industry is fully protected from the pushes and pulls of economic movement, but while some sectors consistently feature at the top of the breakdown of insolvencies by industry, such as construction and manufacturing, others seem to live a more sheltered life.

The legal sector is protected from downturns in economic conditions to a certain degree thanks to the scarcity of the skills and knowledge in question. But, like any other business, all it takes is the loss of a major client, a law suit, or a missed payment for it all to ‘come tumbling down’.

When things do go wrong in the legal sector and firms become insolvent, there are complexities specific to this industry that can make the process particularly problematic for insolvency practitioners and the partners of the firm involved.

In this article, we’re going to look at some of the challenges associated with the insolvency of a limited liability partnership (LLP) law firm. We’ll also look more closely at the potential causes of financial difficulties in the legal sector and the implications of regulation by the Solicitors Regulation Authority (SRA).

Common causes of insolvency in the legal sector

The factors that lead to financial instability in the legal sector are much the same as you would expect to see elsewhere. Increased competition, lack of demand, missed and late payments, and the insolvency of clients all feature prominently. This is in addition to:

  • Overdrawing by partners who do not understand the difference between profit and cash in the bank. Partners will often maintain the same levels of drawings despite cash-flow pressures;
  • High levels of tier 2 and tier 3 lending to fund expenses such as rent and VAT payments;
  • A lack of proper cash-flow planning.
  • Increasing cost of Professional Indemnity insurance.

These issues could similarly be cited as the causes of financial stability in any number of professional services firms. However, there are also a number of other contributory factors that are specific to this sector. That includes capital adequacy requirements, professional indemnity insurance and the presence of a major stakeholder in the form of the SRA.

Capital adequacy requirements

One driver of insolvency unique to law firms is the high level of capital adequacy requirements. Capital adequacy is the amount of cash a law firm needs to keep in reserve to ensure it can meet its financial commitments at any given moment, but also to survive and thrive in the future.

Fixed rules have not been imposed by the SRA in England and Wales, so the onus is on law firms to implement a self-regulatory regime of the highest standards. The financial failure of a law firm presents the greatest risk to its clients, so it’s essential steps are taken to protect them by putting sufficient levels of capital in place. However, this can put a significant strain on a law firm’s cash-flow, and potentially lead to failure further down the line.

We have had calls from many professionals agonising about their future trying to decide ‘is it all worth it?’ Should they simply merge with another practice; sell out the practice and become an employee? Of course there is no simple answer and there is a lot of pride and professional standing to be lost by the wrong decision.

Professional indemnity insurance

Firms operating in the legal sector must also provide the right level of protection to their customers in the form of professional indemnity insurance. This is a significant additional expense that drives up the costs of the legal firm, and therefore the prices for customers.

There is no doubt in my mind this has been a major contributing factor in pushing otherwise solid professional business models to the financial limit. However with conveyancing for example in some areas using a good old fashioned lawyer for selling your home has almost been wiped out.

For small firms, this additional burden can push prices to such a level that they are unable to compete with larger firms with more proportionate professional indemnity costs. The result is that an increasing number of legal firms, particularly conveyancing lawyers, are being put at risk.

Online Competition

The move online for the likes of Rightmove and Zoopla amongst others in finding a house to buy is worryingly more and more eyeing up conveyancing. To be fair to Zoopla and Rightmove providing information about conveyancing is a logical next step. Even providing leads to conveyancing lawyers will eat into already squeezed margins.

Conveyancing is not the only where margins are getting squeezed. Barristers and lawyer networks may generate leads but can also reduce profit margins. Unfortunately the mentality of the online buyer means the buyer usually wants something for nothing or at very little cost.

Specialisation may provide an answer, but for those who have no specialism to fall back on, time may be running out.

The impact of SRA regulation

The SRA has statutory powers to intervene in insolvency matters. Client and office accounts can be frozen, offices can be closed, employees can be dismissed and the clients’ files can be retrieved. The SRA will then seek to recover the cost of making the intervention from the firm’s partners personally. And as you’d probably expect, these amounts can be frightening.

Although it has yet to be tested in the courts, the SRA maintains that its statutory charge should be settled ahead of a bank’s security and before the insolvency practitioners are paid. This also puts the costs of administering the insolvency process in question and leaves the firm’s creditors with little chance of seeing any meaningful return.

The insolvency practitioner appointed to administer the process must also maintain close contact with the SRA throughout. Unlike insolvencies in other sectors, the insolvency practitioner has to appoint a ‘solicitor manager’ who will report to the SRA on the progress of the administration or liquidation. The insolvency practitioner must also present a Regulatory Framework Agreement for SRA approval, the purpose of which is to ensure clients’ interests are being protected.

There’s no doubt that insolvencies will continue in the legal sector. As well as seemingly ever-present economic uncertainty, partners also have to deal with the high costs associated with professional indemnity insurance and capital adequacy requirements. There’s also a powerful regulator that can step in to protect clients from a struggling firm. Thankfully however, despite the worry over future failures, the current outlook in the industry is generally considered to be bright.

Written by: Mike Smith, Senior Consultant, Company Debt www.companydebt.com

Mike Smith is Senior Consultant and Managing Director of Company Debt (www.companydebt.com) and has been advising small, medium and large companies for over 37 years. Company Debt is a leading Turnaround and Insolvency Consultancy firm. Mike has acted as trouble shooter for the board of Sun Alliance, Business Development Director for Legal & General and Head of Develoment for Laser UK (BNP Pariba).

Pre-pack administration: an ethical minefield?

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.