House of Fraser’s sale to Sports Direct has brought pre-pack sales back into the spotlight. The process associated with the pre-pack is often criticised, but is also often misunderstood. Why was the sale of House of Fraser managed this way, how does it work and why is it so controversial?
A house of cards
House of Fraser entered administration on 10 August 2018. We are yet to see the report by the administrators and therefore the reasons behind the administration and sale are unclear at the moment. When they do publish their report, it will almost certainly reveal the reason why the sale to Sports Direct was considered to be the best that could be achieved in the circumstances.
The creditors, in particular the landlords, had rejected the restructuring deal into a CVA and the prospects of investment in the existing business had fallen away. Therefore, there was little option but to try and salvage as much as possible through administration.
Controlling the trading of a multi-location business like House of Fraser during administration is very difficult and potentially enormously costly. The administrator will need strong local management in place, plus they will need to pursue a juggling act of managing the interests of creditors – many of whom may have proprietary claims over goods they have supplied. There will be questions as to whether the lenders will continue to support the business during a trading administration, particularly when there is a risk of extending their exposure rather than making a recovery.
What is a pre-pack administration?
The answer is to try and find a purchaser for the business and assets who is prepared to move quickly. The terms of the sale are agreed before the formal appointment of the administrator takes place and the sale contract is signed immediately upon appointment. This allows a seamless transfer to the purchaser as a “pre-pack”, in other words, where the sale terms have been packaged up in advance of the formal appointment.
The term “pre-pack” and the process is often misunderstood. There seems to be a view that this is a special procedure created by a change in the law. In fact pre-packaged sales have been with us for as long as businesses have sought protection under the insolvency legislation.
The administration procedure was introduced in the 1986 Insolvency Act, but up until 2002 an administrator could only be appointed by formal application to court. The process tended to be expensive and time consuming and its use in the main was limited to larger companies. The Insolvency Act 2000 (enacted in 2002) introduced the out of court administration process which allowed an administrator to be appointed, usually by the directors, simply by filing certain documents. It is quick, simple and cheap and so opened up the procedure to a much wider range of companies.
This provided the opportunity to extract value through an early sale of the business, rather than being forced to sell assets on a break up basis, in many more companies than had been possible previously. So, actually, a pre-pack can be more favourable to the closure of a business, which would almost certainly have led to job losses.
Why is a pre-pack controversial?
The problem with a pre-pack is the first most creditors get to hear about it is when they get notice that their customer has entered administration. They get little or no input into the deal and often have to write off their debt completely with only the secured creditors seeing a return from the funds realised from the sale. The final nail in the coffin is that in many instances the sale is to a new company set up by the existing management. It is unsurprising then that the process is often seen as a stitch up! Actually the process is heavily regulated and there are clear guidelines a proposed administrator must adhere to.
A detailed explanation about the background and the reasons for the sale must be provided to the creditors, including details of independent valuations obtained and the reason why the sale agreed was considered to be in the best interests of the creditors. The proposed administrator is also expected to consult with key creditors to obtain at least their tacit approval to the deal.
In smaller companies it is often the case that the existing management is the only party which can see any value in the business. The administrator’s role is to achieve the best possible value from the assets. If it is clear the only way to do that is by selling to the existing management then they are duty bound to do so.
However the controversy will not go away. Sir Vince Cable is currently backing an enquiry into pre-packs, however, the suggestion that a parliamentary committee should be consulted on pre-pack sales of large companies is completely impractical. Historically, the Government has been reluctant to interfere with the commercial judgement of administrators (as indeed have the Courts) particularly when there are often so many jobs at stake.
The pre-pack pool, a group of independent business men set up to review and comment upon pre-pack sales, has been of limited use and has done little to mollify the concerns. With such a high profile name being sold via a pre-pack there is bound to be further scrutiny of the process.