What does administration mean?
It can be the case that a limited company is a viable economic entity, but finds itself unable to meet liabilities temporarily because time is needed to restructure debt, or reorganise trading activities. Equally, part or all of the underlying business may well be sustainable and can be sold on as a going concern in order to avoid formal insolvency proceedings incepting.
An administration procedure offers benefits that can help a business to deal with the immediate financial challenges and become profitable again. A significant benefit is the moratorium period that provides protection from creditor action, and enables the administrator to rescue the business without being diverted by creditor action.
Eligibility for the process
Administration can be initiated by order of the court, a qualifying floating chargeholder, the company or its directors. Being eligible to consider administration means meeting the following conditions:
- The company is insolvent (see “is my company solvent?).
- The company owns significant assets which are capable of being sold, redeployed, or otherwise used to finance administration.
- There are predicable cash inflows which allow an administrator time to act.
Why consider administration?
The administrator works on behalf of all the company’s creditors and aims to achieve a successful outcome to one of three goals, in the following order of priority :
- Rescue the company as a going concern.
- Achieve a better result for creditors than if the company was liquidated without entering administration.
- Realise property in order to provide a distribution to one or more secured or preferential creditors.
Upon appointment, the administrator assumes control of the company, analyses business operations, and assesses whether or not all or part of the company can continue to trade in order to either achieve a successful outcome or enhance asset realisation prospects.
In some cases, a Company Voluntary Arrangement may be negotiated as an exit from administration because it allows the company to trade its way out of difficulties. In other instances, a pre-pack administration may be viewed as the best option.
It is not uncommon for liquidation to follow administration in order to contain costs, allow the IP access to certain powers within the insolvency legislation, and to facilitate closure of the process.
Should I consider pre-pack administration?
A pre-pack administration involves the agreement to sell an insolvent company’s business and/or assets shortly before the appointment of an administrator and for the sale to be completed almost immediately after the appointment is made. Proceeds from the sale are retained by the administrator for the benefit of the company’s creditors.
Creditors are notified once the sale is complete and provided with a detailed report which explains why the pre-pack took place, why it was a better option than alternatives, and how the business or assets were marketed before the sale.
Pre-packs take place when :
a) A company is insolvent, and;
b) An IP agrees that a pre-pack is the means of achieving the best possible return for the company’s creditors. The pre-pack sale is handled by the administrator who is responsible to a company’s creditors body as a whole i.e. neither the directors nor a particular creditor.
A pre-pack may involve a sale to someone connected to the insolvent company and the directors will often seek prior approval from the pre-pack pool. Such pool is a group of independent and experienced individuals who offer an opinion on the proposed pre-pack i.e. help to validate the transaction (www.pre-packpool.com).
Why use a pre-pack?
- Pre-packs will invariably operate to protect the value of an insolvent company’s business or assets. For example, once it becomes public knowledge how much difficulty a company is in, asset values fall, staff may leave, customers may tends to cancel orders because they lose confidence, and any brand name may be tarnished. The speed and discretion of a pre-pack serves to protect value for creditors. In order to be used, those involved in the process must be satisfied that a pre-pack will generate a better financial return for creditors than any alternative. The administrator must explain to creditors why a pre-pack was the best option in the prevailing circumstances.
- Pre-packs are designed to allow a business to recover from financial difficulties and save jobs because, for example, business failure and redundancies can have a negative impact on local economies.
- Pre-packs are quick and shown contain costs compared with other insolvency procedures i.e. more money available for dividend purposes.
How do pre-packs work?
- A company is insolvent and seeks advice from a licensed IP. It is decided that a pre-pack offers the best financial return for the company’s creditors.
- The IP observes the requirements and principles of Statement of Insolvency Practice 16, which governs pre-packs. SIP16 includes rules for protecting creditors, and marketing and valuing a company’s business/assets prior to a pre-pack. SIP16 is one of many regulatory protocols established by the insolvency profession. Click here for a full list of current SIPs.
- The company’s business or assets are valued and marketed in line with SIP16 and a sale organised. In some cases, it may be that a sale to a connected party such as the previous owners creates the best financial outcome for creditors.
- The company enters administration and, as arranged, the business and/or assets are sold immediately.
- All creditors are dealt with by the administrator who observes a dividend hierarchy in accordance with insolvency legislation as follows :
- a) Secured creditors
- b) Costs of the insolvency process
- c) Preferential creditors : certain employee entitlements such as salary arrears
- d) Floating charge creditors : normally a Bank or other financial institution. A proportion of funds available to floating charge creditors (up to £600,000) can be ring-fenced and distributed to unsecured creditors
- e) Unsecured creditors : trade creditors, HMRC and utility suppliers
- f) Shareholders
The amount paid to creditors depends upon the value realised from the insolvent company’s business/assets.
- The administrator ensures transparency of action/outcome in a report to creditors. A pre-pack report is made within seven days of a sale taking place. SIP16 requires the insolvency practitioner to explain why the pre-pack took place and what steps were taken to comply with SIP16. You can find the reports relating to each company on the companies house website (www.companieshouse.gov.uk).
Are creditors protected in a pre-pack?
- All pre-packs are overseen by the administrator who is a licensed insolvency practitioner, answerable to creditors and acting in accordance with his duty to maximise returns to the general body of creditors pursuant to the requirements of SIP16. Failure to fulfil his obligations can lead to regulatory penalties for the administrator including a fine and the loss of his insolvency licence.
- Creditors can read the administrator’s report for information on what steps have been taken by him in the pre-pack and complain to his regulator if necessary.
- The pre-pack pool can review connected party pre-packs in order to provide independent assurance that the case for the pre-pack has been made. Application to the pre-pack pool is by the director, before the administration incepts. The administrator’s report will provide details of any approach to the pre-pack pool.
- The administrator has the power to investigate a director’s actions and refer any concerns to The Insolvency Service (www.theinsolvencyservice.gov.uk). If a directors is determined not to have acted in creditors’ best interests, he can be disqualified from acting as a director for up to 15 years.
- If creditors disapprove with an administrator’s actions, they can organise a meeting (or a court petition in unusual circumstances) in order to remove him from office. The chances of reversing a pre-pack sale is decidedly remote.