Businesses fail during recessions. That’s inevitable. But creditors deserve protection from firms that walk away from debts and immediately restart.
There are now two alternatives to a conventional winding up — the creditors’ voluntary arrangement or CVA and the pre-packed administration. Both allow unprofitable parts of the business to close with the owners continuing to trade, but while suppliers must approve a CVA, they may not hear of a pre-pack until it is completed and their money is lost.
The Barratts shoes and Focus DIY businesses illustrate the difference. Both faced expensive property costs, especially on outlets no longer wanted. Both are still operating but the shoe retailer went into pre-pack administration while the DIY group is implementing a CVA that ends its future liability to landlords on closed shops but pays other creditors in full.
Pre-pack administrations are negotiated between directors and secured lenders with an insolvency advisor who becomes the administrator and instantly sells the good assets under a pre-agreed plan — usually to the old owners or managers. A quarter of this year’s insolvencies have been pre-packs with connected parties buying the assets in 81 per cent of cases. Barratts’ majority shareholder took over 325 of the chain’s shops and 3,000 staff leaving the administrator to close the other 220 outlets, which employed 2,500.
But Barratts’ landlords had rejected an offer of a CVA. Focus was burdened by the £12m annual costs on 38 closed stores but its CVA allows the other 180 outlets to keep trading profitably, saving 4,500 jobs. Landlords of closed properties receive a payment instead of future rents (a pre-pack would have given them nothing) and trade creditors will be paid in full. The private-equity owners have worthless equity but remain in control.
A CVA requires a 75 per cent majority vote by creditors so Focus’s suppliers were involved in the negotiations rather than learning about a pre-pack afterward.
There are always losers in insolvencies and often infighting between classes of creditors. Secured lenders like pre-packs that repay their debts but leave trade creditors out of pocket; suppliers are likely to protect themselves by voting for landlords to lose out. But the rules need changing to protect unsecured creditors.
Pre-packs are popular but are not working. It is unfair for old owners to cherry-pick the best bits of their business and restart without consulting trade creditors. And it is unfair to allow owners to place orders while planning administration.
Suppliers have two interests in an insolvency — recovering sums due and retaining the ongoing business as a customer. But they can protect their interest only if they are kept informed.
A first change should be to prevent the person advising on a pre-pack becoming the administrator. As soon as an adviser is appointed, unsecured creditors ought to be ringfenced. And before selling assets to connected parties, a serious effort must be made to find other buyers, if only to test the price. The insolvency rules need reforming before the recession ends.
