Thursday, 3 September 2009

Roll Up - Get Your Pre-Pack Here

Pre-Pack - the very term engenders malice aforethought.

Pre-Pack means a pre-packaged administration, a sort of fast track way to ensure a deal is lined up to buy a business before it goes into administration, so allowing to quickly carry on its trading. It seems like a utopian dream as it means many jobs can be saved while nasty creditors can be sidelined as the business can be restructured in advance of going belly up in order to separate the nasty bits from the profitable bits which the new owners want to keep. The term 'Phoenix' is applied as very often the same individuals end up managing the newly invigorated business while the creditors are left with smelly bits having dealt with the same people. Until recently, just to add to creditor angst, the same insolvency practices could represent both the old company and the new.

There have been many high profile pre-packs, not least Lord Bilimoria whose famous Cobra beer brand was saved by one, which have helped household names survive. In this month's Director magazine from the IOD, there is a very good case study of the boutique and quirky furniture supplier, Lombok. The story is a compelling one for many reasons, not least as the CEO, Alex Cresswell-Turner, cites many lessons learned in the process. For sure, one such lesson was to choose investors carefully as when he needed more cash to survive, his investors turned him down and the process of dealing with private equity, which is fast trying to become a vogue way of financing small businesses, was too demanding as he had to contact many individuals who were not easy to track down let alone get a concensus on a new capital or loan decision. But the private equity firm puts a very different spin on it - there is no point putting good money after bad, you have to know when something is a dead duck rather than a lame one.

The other lesson is that pre-packs do in fact preserve jobs. At the height of his business he had some 185 staff and he still has many left. Further, his suppliers in Indonesia had around 500 people employed, all of whose jobs were saved by Lombok's continued purchasing. Now Lombok has risen phoenix-like from the ashes and is focusing on selling its furntiture via the web. Given the slightly quirky and limited appeal of the designs and looks, it seems a pretty high risk avenue to pursue, but what would I know about such things - good luck to them.

What it does illustrate is how the commercial world is divided on the concept of the pre-pack administration. Good insolvency practices would ensure all other avenues are pursued, allegedly, before they use the pre-pack, which is a stipulation of the process. Also, under the Statement of Insolvency Practice (SIP) 16 launched in January, they have an obligation to relate all details of the pre-pack to all creditors including the involvement of existing managers. Theoretically, the administrator should be working for all creditors, even unsecured ones. In practice, this does not always seem the case.

In the same magazine issue, there is a debate between KPMG and Atradius (the credit insurance agency) on the merits of pre-pack and the opinions are polar. KPMG offers 'restructuring' and so is for the pre-packs, citing that the ability for companies to offer continuity of trade is key as well as preserving more jobs as benefits to the scheme. Meanwhile, Atradius homes in on the tendency by pre-packs to leave unsecured creditors high and dry while seeing the owners or board rise again almost without skipping a beat - Atradius sees this as 'morally reprehensible'.

KPMG do acknowledge the system is open to abuse and this is Atradius' beef. There is the potential, and it actually happens, that directors simply pile up too much debt and trade credit and then use pre-pack to get a 'get out of jail card free' - which is where the 'phoenix' term comes from. The new SIP 16 regulation should guard against this as there should be more transparency but in practice this is not always the case.

No names, no pack drill and I have blogged on the same company before. This company surrendered to a pre-pack but was owned by another company, housed in the same building, same directors. It employed several people, some of whom had been made redundant for lack of performance (always a dodgy issue) and a few of those had raised some serious grievances against the company. The same company had clocked up a great deal of debt, thankfully most of which was to its parent company but it also had a long term lease on its premises. They used the insolvency practice of their own accountants to take a pre-pack, leaving their current premises, en masse (all the 4 companies residing in the space leased by the one subsidiary) and moved to a new office literally overnight. They migrated the existing staff of the failed company over, as well as all the customers and started trading as normal the next day, leaving the lease unpaid and hopefully the aggrieved redundant employees with no one to pursue their claims with.

Now, it is worth noting that the insolvency practice involved was no fly-by-night organisation. Indeed, they are a large, well known firm one of whose Caribbean partners was interviewed on TV recently about a high profile fraud. So we are not talking about companies who do not know what they are doing or generally flaunt the law. But this pre-pack stinks. The only merciful aspect to it is that the flow of ownership does go upwards so the clever solicitors representing the aggrieved redundant employees can follow the trail, as can the landlords. But in other cases, such a pre-pack would have gotten the directors off scot free to trade again. True, jobs may have been preserved, customers may be happy but creditors would have been left high and dry.

What insolvency practioners suitably ignore (another case of denial?) is the knock on effect of pre-packs - and their accountancy arms would be advising the exact opposite of not to trade with companies with high trade credit exposure. If creditors are not paid, then the sum has to be written off. While big building landlords may be pension funds and so the pain is not so great, many creditors will be office cleaners, computer resellers, telecom companies, and other general trade creditors, some of whose companies may not even be as large as the company using the pre-pack. The one thing they will all notice with great anger is that the directors will feel very little pain, perhaps a dent in their pride and shareholding, but no loss in salary. In the case I have illustrated, one of the creditors who would certainly not have felt pain, would have been the accountants who actually administered the whole thing, who remain in place after the event and will duly carry out the firm's annual audit as usual. The term 'conflict of interest' springs to mind but this is the grim and grubby world of pre-packs and multi-strand accountancies who conventiently separate their practices with different companies.

So while the jobs of the 'Phoenix' company are preserved, thanks to the newly re-invigorated cashflow and perhaps some restructuring money made available to the positive bits, the creditors will have to take the hits. Atradius have a point to make. Each such hit it a small business takes, directly damages its own ability to seek new funds, loans or overdrafts or get credit insurance on other customers. The world of unsecured trade creditors is the one at most risk and will bear the greatest cost of pre-packs and it those companies that will shed the jobs in order to pay for 'Phoenix' firms to survive. So 'Restructuring' arms of accountants like KPMG conveniently forget that sums do not add up in such scenarios. The creditors directly lose money and they have to take the hit, so someone actually loses out possibly with their job(s).

There is no good news about pre-pack and it is horribly open to wide abuse and there are plenty of horror stories to prove it is not a great system. So when you have your next chicken vindaloo at your local Indian restaurant and raise a glass of smooth Cobra beer, just think about who has paid the price to get that delicious beer to you. Then again, you probably don't care.

Welcome to the world of pre-packs.

No comments: