notably in relation to post-Enterprise Act administrations.11 It was estimated in 2006–7 that at least a third and perhaps half of all going concern sales during an administration involved a pre-pack.12

Advantages and concerns

Efficiency

As indicated above, the proponents of pre-packs would point to a number of advantages produced by the device.13 As far as efficiency is concerned, prepacks are said to be rescue-efficient in so far as they offer low-cost and speedy routes to recovery, they often involve repaying trade creditors in full, they keep legal and other professional costs low14 and they allow firms to implement recovery plans before they lose the funding that allows turnarounds to be executed. It might also be claimed that pre-packs are associated with better records of job preservation than business sales without pre-packs.15 The pre-pack offers support to incumbent management and provides a way to retain key employees who might leave the company if not confident that a sale can be agreed in the short to medium term – a step that is often essential if value is to be maximised.16 A pre-pack may prove particularly useful if the

11S Frisby, ‘Unpacking Pre-packs: The Story So Far’ (2007) Recovery (Autumn) 25.

12See S. Davies QC, ‘Pre-pack – He Who Pays the Piper Calls the Tune’ (2006) Recovery (Summer) 16 at 17. Frisby, R3 Analysis (p. 15), suggests a figure of 35.5 per cent, but Frisby quotes estimates elicited in interview at from 50 per cent to 80 per cent.

13See e.g. Vilaplana, ‘Pre-pack Bankruptcy Primer’, pp. 34–5.

14Vilaplana cites an example in which Anglo Energy filed twice for Chapter 11 protection. The cost with a pre-pack was $1 million, without $12 million: see ibid., p. 34. See also Walton, ‘Trick or Treat?’; J. Ayer, M. Bernstein and J. Friedland, ‘Chapter 11 – “101”: Out of Court Workouts, Pre-packs and Pre-arranged Cases: A Primer’ (2005) 24

American Bankruptcy Institute Journal (April).

15The Frisby R3 Analysis suggests that business sales involve 100 per cent transfers of staff in 65 per cent of all cases but that pre-packs save all staff in 92 per cent of cases. Whether this superior performance is due to the process used or because pre-packs tend to be used where prospects of rescue are brightest is a separate issue. It can be argued that there are not the opportunities for opportunistic lay-offs of workers in a pre-pack that exist in a straight administration (which will give more scope for dismissals that will not be deemed legally unfair): see Frisby, R3 Analysis, p. 72. The relative success of the prepack in preserving jobs in the short term may, however, have to be set against the higher subsequent failure rates of pre-packs as compared to business sales (39 per cent failure compared to 35 per cent).

16Cranston, ‘Pre-packaged Business Disposals’; D. Flynn, ‘Pre-pack Administrations – A Regulatory Perspective’ (2006) Recovery (Summer) 3; Frisby, R3 Analysis notes (p. 32) that staff retention figured strongly in reasons for using a pre-pack. Other cited reasons included: protecting book debt collections; ensuring continuity of insurance cover or a contract; and preserving goodwill.

volume of creditors makes negotiations impractical or if a significant minority of these are liable to hold the majority to ransom in the hope of extracting an improved return for themselves. The High Court has, moreover, upheld a prepacked sale of a solicitors’ business entering administration, in the face of opposition from the major creditor, on the grounds that the pre-packaged sale minimised disruption to clients and was the best way to protect jobs.17

It has also been argued that pre-packs usefully help to counter the holdout problems associated with the growth of ‘vulture funds’.18 Holders of such funds are prone to engage in holdouts in the hope of a better deal since they purchased their claims at a deep discount. A prepack in the USA allows such holdouts to be defeated since US law provides that a plan of reorganisation will bind dissidents so long as two-thirds in amount and more than half in number of those voting have approved the plan.19

The speed of the pre-pack process may be particularly valuable in sectors or businesses where a protracted, public restructuring would dramatically affect corporate value – as, for instance, in a regulated sector (where possibilities of retaining licences, franchises and other valued positions may be affected) or where a business is built on human rather than physical assets (where there are dangers that the best staff will be lost to competitors), or where a brand or portfolio would be damaged by adverse publicity or public uncertainty.20 The pre-pack offers the prospect of a seamless transition to turnaround that minimises disruption and reduces the risks of declines in markets, reputations, assets or business partner relationships.21 It has also been suggested that the

17DKLL Solicitors v. HM Revenue & Customs [2007] BCC 908.

18Vilaplana, ‘Pre-pack Bankruptcy Primer’. On ‘vulture funds’ and the stress that the fragmentation and globalisation of credit imposes on informal processes such as the bank-controlled ‘London Approach’ see ch. 7 above; J. Flood, ‘The Vultures Fly East: The Creation and Globalisation of the Distressed Debt Market’ in D. Nelken and J. Feast (eds.), Adapting Legal Cultures (Hart, Oxford, 2001) p. 257.

19See US Bankruptcy Code s. 1126: in the USA pre-packs are voted on, while in the UK the pre-pack involves no formal voting arrangement.

20Harris, ‘Decision to Pre-pack’, p. 27; Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’, p. 16. The very announcement of insolvency proceedings usually provokes a precipitous decline in goodwill: see G. Meeks and J. G. Meeks, ‘A Gouldian View of Corporate Failure in the Process of Economic Natural Selection’ (Mimeo, Centre for Business Research, University of Cambridge, 2002).

21Cranston, ‘Pre-packaged Business Disposals’. On survival rates a comparison of administration business sales and administration pre-packs reveals that the latter are slightly more likely to fail – but it is said to be difficult to draw a certain conclusion that survival rates differ significantly: see Frisby, R3 Analysis, pp. 76–7.

Enterprise Act 2002 significantly encouraged the use of pre-packs by introducing the streamlined system of out-of-court routes into administration and simpler means of exiting administration.22 Martin Ellis, a partner at Grant Thornton, has argued that five reasons underpin the steady growth in popularity of pre-packs:23

*The increased incidence of consignment stocks and valid reservations of ownership claims.

*The impact of TUPE24 and the risk that a sale may not ultimately be achievable.

*Demands for ransom payments by monopoly suppliers.

*Increased professional costs.

*The inherent risks of trading.

Sceptics, however, may worry that pre-packs will not always deliver the above goods and may prove less cost-effective than proponents would suggest. A concern that has been voiced in the USA25 relates to cost-effectiveness and is that, from the debtor’s point of view, the prepack may involve considerable legal risks. A bankruptcy court, for instance, may find a disclosure statement inadequate. If this happens, the statement will have to be amended or redistributed. The debtor will then have to re-solicit acceptances and this may produce lengthy delays in confirmation.26 An opportunity to vote will have to be offered or else such claimants may be well placed to mount a legal challenge to the prepack. In either case, delays, uncertainties and additional expenses will be generated. Where objectors delay or derail the proposed plan, the anticipated benefits of the pre-pack are liable to be lost.27

Such worries are reinforced by evidence from other sources. In LoPucki and Doherty’s study of 1991–6 reorganisations in, inter alia, Delaware and New York (covering ninety-eight reorganisations), the

22See Flynn, ‘Pre-pack Administrations’. See also ch. 9 above.

23Ellis, ‘Thin Line in the Sand’.

24See the Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246); J. McMullen, ‘An Analysis of the Transfer of Undertakings (Protection of

Em ployment) R egulatio ns 2 006 ’ ( 20 06) 35 Industrial Law J ournal 11 3; see fu r below.

25See Plevin, Ebert and Epley, ‘Pre-packaged Asbestos Bankruptcies’, pp. 888–9.

26Ibid.; and see In re City of Colorado Springs 177 BR 684, 691 (Bankr. D. Colo. 1995).

27See Plevin, Ebert and Epley, ‘Pre-packaged Asbestos Bankruptcies’, who cite the instance of two asbestos industry pre-packs that failed to include the insurers whose policy proceeds were to fund the trust under the plan. The resulting litigation deprived the debtors of the benefits of the pre-pack (p. 889).

authors found that debtors who reorganised by way of pre-packs had lower post-bankruptcy earnings than those who reorganised without pre-packs.28 By this measure, they suggested, ‘pre-packaged organisations are more likely to fail than non pre-packaged organisations’.29 The speed of pre-packs could also be exaggerated, argued LoPucki and Doherty. The evidence suggested that pre-packs were, at an average of 21.6 months, only 25 per cent shorter than traditional Chapter 11 cases (at 28.5 months).30 Speed, moreover, inversely correlated with success in the LoPucki and Doherty study, which concluded: ‘Faster reorganisations are significantly more likely to fail than slower ones.’31

As to the reasons for the higher failure rates of speedy or pre-packaged bankruptcies, LoPucki and Doherty admit that they can only guess – but they do surmise that this may be because such processes can stand in the way of parties coming to grips with the challenges that corporate troubles present:

We speculate that at the core of this market failure is the parties’ desire to appear to reorganise without in fact doing so. Effective reorganisation is unpleasant. Managers must at least acknowledge their past failures and perhaps also resign their positions. Creditors must accept substantial reductions in the amounts owed to them. The interests of shareholders must be finally and permanently extinguished … But no party wants the firm to actually face up to its problems.32

Fairness and expertise

If the pre-pack procedure is compared to a normal Chapter 11 filing, it is more likely in a pre-pack that there will have been a failure to solicit relevant parties and to provide a voting opportunity to all persons asserting claims.33 If there is an absence of such a chance of voting, this

28 L. LoPucki and J. Doherty, ‘Why are Delaware and New York Bankruptcy Reorganisations Failing?’ (2002) 55 Vand. L Rev. 1933, 1972.

29Ibid.; Vilaplana, ‘Pre-pack Bankruptcy Primer’, p. 41, argues that pre-packs ‘are not useful for companies that have fundamental problems such as major contractual disputes, asbestos problems or pension fund issues’. The usual pre-pack involves a basically healthy company that is over-leveraged.

30See E. Tashjian, R. Lease, J. McConnel et al., ‘Pre-packs: An Empirical Analysis’ (1996) 40 Journal of Financial Economics 135, 142.

31LoPucki and Doherty, ‘Why are Delaware and New York Bankruptcy Reorganisations Failing?’, p. 1976.

32Ibid., p. 2002.

33All persons whose claims are ‘impaired’ by the plan are entitled to vote on it: see Plevin, Ebert and Epley, ‘Pre-packaged Asbestos Bankruptcies’, p. 889.

raises concerns not only about the costs and uncertainties associated with potential challenges but also regarding procedural and substantive fairness. Plevin, Ebert and Epley, a trio of Washington, D.C. practitioners in bankruptcy, have written that the pre-pack bankruptcy is seen by many troubled companies as a panacea in the asbestos litigation world, but: ‘Such bankruptcies have drawn rigorous objections by persons claiming that pre-packaged asbestos bankruptcies, as currently practiced, violate the Bankruptcy Code and Rules, improperly treat some claimants more favourably than others, and disregard the con-

tractual rights of the insurers expected to fund the payment under the plan …’34

In the UK also there have been similar worries about pre-packs.35 One practitioner has argued that the rapid growth of pre-packs has given rise to ‘unpleasant practices’ in which directors and shareholders of troubled companies are offered ways to shed their creditors and buy back their businesses at very modest cost.36 The danger, according to this argument, is one of unfairness in so far as administrators, banks and directors have strong incentives that may not serve all creditors well:

The organising administrator has a clear conflict of interest as typically he wants to get the appointment and the management can influence that – such a pre-pack is a good idea for practice development for him and for advising lawyers.37 It may suit a bank as it can allow it to participate in the equity going forward in a controlled way or provide it with an assured return potentially at the expense of other creditors. Administrators generally like helping banks.38

Stephen Davies QC has raised issues of expertise alongside that of fairness in arguing that a small number of ‘professional bad apples’ who operate via pre-packs facilitate phoenix trading: ‘not withstanding the considerable antipathy of both the profession and the courts towards phoenix operations, insolvency sales to unscrupulous

34 Ibid., p. 923. 35 See Frisby, R3 Analysis, pp. 8–9.

36 Moulton, ‘Uncomfortable Edge of Propriety’. The typical pre-pack in the UK is said to involve an MBO: see Cranston, ‘Pre-packaged Business Disposals’; A. Sakoui and S. O’Connor, ‘Clampdown on use of Pre-Pack Rules’, Financial Times, 31 December 2008.

37On fears of lack of objectivity on the part of those organising pre-packs see Davies, ‘Prepack – He Who Pays the Piper Calls the Tune’, p. 16; Moulton, ‘Uncomfortable Edge of Propriety’.

38Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’.

management still occur and the pre-pack is the jemmy in the burglar’s jacket’.39

As for the incidence of Newco being owned and controlled by the same people as Oldco, Frisby’s 2007 study suggests that administration prepacks involve a slightly higher proportion of sales to connected parties (59 per cent) than is the case with all business sales (52 per cent). The trend also seems to be towards more connected sales after the Enterprise Act. The figures for sales to connected parties in preand post-Enterprise Act administration pre-packs are 53 per cent and 62 per cent respectively.40 These compare with a figure of 51 per cent in post-Enterprise Act administration business sales.41 The post-transfer survival rates of businesses transferred to connected parties appear also to be lower than is the case in transfers to unconnected parties. The respective rates, in the case of sales, are 58 per cent to 71.9 per cent and, in the case of pre-packs, 51.4 per cent to 71.5 per cent.42

Critics who are concerned about the fairness of pre-packs are liable also to argue that, with such arrangements, the market will rarely have been properly tested,43 some interested parties may not have been made

39Ibid., p. 17. See Insolvency Act 1986 s. 216: this section is aimed at countering the ‘phoenix syndrome’ – a term used to describe an abuse of the privilege of limited liability whereby a company would be put into receivership or voluntary liquidation at a time when it owed large sums to its unsecured creditors. The receiver (frequently appointed by a controlling shareholder who had himself taken a floating charge over the whole of the company’s undertaking) would sell the entire business as a going concern at a knockdown price to a new company incorporated by the former directors of the defunct company. Thus, what was essentially the same company would rise phoenix-like from the ashes of the old and the business would be carried on by the same people in disregard of the claims of the first company’s creditors, who effectively subsidised the ‘birth’ of the new company debt-free: see L. S. Sealy and D. Milman, Annotated Guide to the Insolvency Legislation (10th edn, Thomson/Sweet & Maxwell, London, 2007) vol. I. See ch. 16 below.

40Frisby, R3 Analysis, pp. 42–5.

41Frisby suggests that the movement towards sales to connected parties via pre-packs may be due to Enterprise Act changes in entry into administration and that director-led entry may be a driver: ibid.; see also ch. 9 above.

42Frisby, R3 Analysis, p. 79.

43On failure to market as a central worry see Flynn, ‘Pre-pack Administrations’, p. 3. Frisby’s R3 Analysis (p. 49) states that in only 7.9 per cent of pre-packs was the company marketed, in comparison with a figure of 55.6 per cent for business sales without prepacks. She argues (p. 38) that if the business has not been exposed to market forces ‘the complete lack of control rights and an inadequate provision of information on the part of the practitioner to unsecured creditors effectively disables them from calling upon the practitioner to demonstrate that he has paid due regard to the statutory scheme for protecting their interests’.

aware of the sale44 and the business may have been undersold.45 Further objections are that certain creditors may have been left out of consultation processes so that they feel ‘frustrated and impotent’ when informed about events,46 and the advisers may have been too aligned with certain interests – which may be those of well-placed creditors or involved managers.

What may make the position worse regarding fairness is that in the period before a pre-pack the directors may seek to build up stock at the expense of trade creditors – perhaps in anticipation of purchasing the business at an advantageous price from the administrator.47 Often, it is alleged, the ‘victims’ of pre-packs are the general creditors who see assets sold at undervalue but have difficulty in proving this. Such victims, moreover, face a difficult choice: do they sue the company (with its empty pockets), the directors (who may have concealed their transactions) or the administrator (who is a well-informed repeat player)?48

As for fairness and substantive returns to creditors, the figures available indicate that returns to all creditors49 are no less in pre-pack

44See Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’; S. Mason, ‘Pre-packs from the Valuer’s Perspective’ (2006) Recovery (Summer) 19: Mason notes the role, in pre-packs, of specialist independent valuers of property, equipment and stock.

45See G. Rustling, ‘Pre-packaged Sales via Insolvency Processes’, Barclays Bank Protocol (Barclays, London, 10 November 2005), arguing that last-minute approaches to support a pre-pack are ‘unlikely to demonstrate that best commercial value of a business is being achieved’.

46See Davies, ‘Pre-pack – He Who Pays the Piper Calls the Tune’, p. 16. On disenfranchisement being an issue that is not confined to pre-packs see Frisby, R3 Analysis, p. 35, who argues that considerations of speed and business continuity lead to considerable disenfranchisement in non-pre-pack business sales in administration. In T&D Industries plc [2000] 1 WLR 646, [2000] BCC 956 it was held (pre-Enterprise Act 2002) that an administrator had the power to sell the assets of a company prior to obtaining creditor approval – though the court stressed the importance of placing the proposals before creditors as soon as reasonably possible. See also Re Transbus International Ltd [2004] BCC 401 which also recognised that sometimes substantial actions have to be taken in administration without prior creditor approval: see S. Frisby, ‘Judicial Sanction of Insolvency Pre-packs? DKLL Solicitors v. HMRC Considered’ (2008) 27 Company Law Newsletter 1.

47See Flynn, ‘Pre-pack Administrations’, p. 3.

48Moulton, ‘Uncomfortable Edge of Propriety’, p. 3. On IPs and repeat player control of processes see e.g. S. Wheeler, ‘Capital Fractionalised: The Role of Insolvency

Practitioners in Asset Distribution’ in M. Cain and C. B. Harrington (eds.), Lawyers in a Post Modern World: Translation and Transgression (Open University Press, Buckingham, 1994).

49Frisby, R3 Analysis, p. 50, puts pre-pack administration returns to all creditors at 22.7 per cent on average compared to 22.8 per cent for business sales without pre-packs.