Pre-pack insolvency business transfer

A “pre-pack” arrangement is an agreement for sale of business and/or assets that is used in conjunction with external insolvency administration to restructure a business without some of the uncertainties of outcome associated with trying to restructure through traditional voluntary administration. If the owners of small business are properly set up, they could be in a position to use this approach to keep their business, which is quicker, cheaper and less invasive that relying solely on external insolvency administration.

1. What is pre-pack insolvency

Pre-pack insolvency involves the pre-arranged sale of the business and/or assets of a company to another entity prior to, or immediately after, the appointment of an external insolvency practitioner. The insolvency practitioner is appointed and reviews the terms of the sale to determine if they are satisfactory to the stakeholders and, if they are, then ratify the sale.

If the sale has not been completed by the time of the appointment, and the insolvency practitioner is of the opinion that the terms of the sale are not appropriate, they can choose not to proceed with the contract for sale. In circumstances that the sale was completed before appointment, a liquidator would be appointed and they could notionally seek to recover the assets from the purchaser, on the basis that it is an uncommercial transaction, and would then conduct their own sale of the assets.

The pre-pack would just be a “sale” if it didn’t also include an insolvency regime to deal with (and shut down) the company operating the business. This can be done either by putting the company into liquidation or by putting up a deed of company arrangement (DoCA). Which form of insolvency administration is chosen and what type of DoCA may be proposed will depend on each case and should be determined after obtaining proper advice.

Under a pre-pack insolvency, the assets can be sold to a third party. However, they can also be used by small businesses to transfer the business and assets to a new company controlled by the current owners, subject to the amount paid for those assets.

2. The benefits

The benefits associated with a pre-pack insolvency, which is extensively used overseas, in comparison to small business using the traditional voluntary administration and a DoCA to restructure, include the following:

· avoiding disruption to the business of a voluntary administrator operating the business, which could last between one and six months

· avoiding the stigma of trading as a company under external administration, which requires that all official communications with the company’s name must include “(Administrators Appointed)” and then if a deed of company arrangement is entered into, replaced with “(Subject to Deed of Company Arrangement”)

· avoiding the costs and disruption of a voluntary administrator operating the business leading up to a sale

If the business/assets are being sold to a third party, using a pre-pack arrangement, it can avoid the reduction in price that usually occurs on a “fire sale” of assets in insolvency.

It is important to understand that if the assets are being sold to a third party, the amount paid for the assets belong to the company and not to the owners. The directors may be personally liable for the sale price if it is not properly accounted for in the company’s records.

3. The issues

Whilst using a pre-pack has the benefits referred to above, they are not for every situation. The directors should consider the following issues when deciding whether this is the right tool to restructure:

· this approach will still lead to a formal insolvency where the transaction may be scrutinised and may be set aside as an uncommercial transaction or as an illegal phoenix arrangement (see paragraph 4 below)

· formal insolvency could also expose the directors to liability for insolvent trading claims and other liabilities

· it may still be necessary for the directors to propose a DoCA to protect against liability for insolvent trading

· the cost associated with paying “fair value” and having sufficient working capital may make the exercise commercially unviable (see paragraph 5 below).

The amount required for the owner to propose a DoCA would be less if the owners’ investment is protected as a secured loan registered on the PPSR. Use this link to learn more about owners protecting their investment.

4. Phoenixing

A significant issue with the concept of pre-pack insolvencies in Australia has been the removal of a valuable assets from the company, so that the realisation of that asset is not available to pay the amount owed to the creditors.

Removal of the business to a new entity has been associated with illegal phoenix activity in Australia, where a new company is incorporated to run the existing business without an amount paid to the company for that asset.

In addition to existing duties owed by directors to the company to act in good faith and to consider the creditors when approaching insolvency, there are new laws known as “creditor-defeating dispositions” that has been introduced to deal with this issue. In that situation:

· a liquidator can seek to set aside the transaction; and

· ASIC can make an order directing that the third party delivers the asset back to the company or pays “fair value” — not abiding by that order can lead to substantial fines

Accordingly, the most significant issue is the valuation of the assets and the price paid by the purchaser. It is best practice to get a formal valuation of the asset and to agree the price for the asset at or about that sum.

5. Owner as secured creditor

The issue raised above as to the commercial viability of an owner using this method, in terms of the cost associated with paying “fair value” and having sufficient working capital, will be dramatically altered if the owner is a secured creditor of the company, with a registration on the PPSR.

If the owner has invested funds into the company that have not be repaid and those funds have been protected as a secured loan, the owner will be entitled to be paid their debt before other creditors (other than the bank).

If the debt that is owed to the owner is at least about the same amount as the valuation, or a significant part of that, the actual amount of money that needs to change hands may approach zero in exchange for the owner forgiving the debt owed by the company. That is because, if the purchasing company were to pay the sale price for the business/assets, it would be paid to the owner as the secured creditor.

A DoCA may still be proposed in circumstances that the owner is a secured creditor, albeit usually with a substantially smaller deed fund. This may be done to avoid any chance of the company being wound up and the liquidator bringing an action for insolvent trading.

Use this link to learn more about the benefits of owners protecting their investment as a secured loan registered on the PPSR.

In order to utilise such an approach, small-business owners must seek advice to ensure that they can take this approach without exposing themselves to any liability.