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The Secret FD’s moral dilemma over pre-pack administrations

ALTHOUGH I have liquidated several dormant subsidiaries and made an acquisition of a financially defunct but otherwise great business, I have no direct experience of insolvency except as an innocent and voiceless creditor when one of my key customers filed for Chapter 11 Bankruptcy protection in the US.

This involved a form of pre-packaged administration which, since the Enterprise Act of 2002, has become popular in the UK. Of the 2,365 UK businesses that entered administration in 2013, almost 600 were pre-packs sold by the administrators as going concerns to purchasers who had been identified before the administrators had been appointed. Many were sold to the existing management teams that had presided over their financial demise. Recent examples include Game Group, Internacionale, DTZ and a host of other, lesser-known names.

This practice raises a number of questions, not least the obvious issues of morality and integrity. Directors of businesses that are heading towards insolvency are legally obliged to prioritise their responsibilities away from the shareholders and towards the creditors, but the agendas within the management teams and the conflicting demands of all stakeholders make these decisions almost impossible. Many pre-packs are designed to enable businesses to walk away from their creditors but continue to trade as going concerns with clean balance sheets, and this option must surely place temptation in harm’s way.

Scrutiny of the actions of directors and insolvency firms has always been a danger area, and one example is the referral to the accounting regulator of the liquidators who oversaw the closure of Comet over concerns of conflicts of interest. Is the average FD knowledgeable enough in these areas to stay out of trouble?

Unsurprisingly, Vince Cable has become involved as part of the ‘transparency and trust agenda’ and commissioned the respected accountant Teresa Graham CBE to conduct a review, the findings of which have recently been published. The Graham Review identifies positives for pre-packs, such as protection of staff, less expensive administration, higher speed of transaction, benefits to the UK economy, and better achievement of deferred purchase consideration obligations. But the negatives include lack of transparency, inefficient marketing of the business, imperfect valuation methodology and inadequate consideration of the future viability of the business.

The review makes six recommendations – including improved regulation and voluntary measures – which, although backed by the Association of Business Recovery Professionals (R3), have been criticised as an example of government policy potentially going too far and as a blunt set of tools. The government expects to evaluate the success of these recommendations over the next three years, and will ‘legislate if necessary’ – ie, it is certain to do so.

Not all pre-packs are self-serving for the management or punitive towards the creditors. When Cobra Beer entered administration in 2009, it was immediately sold to a JV with Molson Coors under a pre-pack deal which enabled that great and popular brand to continue while preserving many jobs. Initially, the creditors stood to lose £75m. However, Lord Karan Bilimoria, the founder and chairman of Cobra honourably undertook to ensure that all creditors would be paid in full out of the future profits from the JV.

Most FDs will, mercifully, never be confronted with the need to consider a pre-pack, but for those who do, the moral dilemmas will be testing, and the long-term reputation and career-defining consequences of getting it wrong must be frightening. What do they put on their CVs? ?

Last month the SFD visited Glasgow for Scotland’s Culture 2014 at a series events just before the start of the Commonwealth Games

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  • MarkC

    A telling part of the review is the comment that it is not by the pre-pack itself that creditors lose money but that their money is normally lost at the point that they extend credit. That may well be right in many cases by the constant path towards reduced financial disclosure by trading businesses and lack of care around detailed accounts and reduced audit thresholds make many sets of accounts of companies practically worthless in assessing whether to give credit.