IT company insolvencies rose 25 per cent in July, according to figures from Experian. Of course, any perfectly good company can be pushed under by causes beyond its control, but often the ultimate problem may be mismanagement of one kind or another. Some then resurrect themselves rapidly, in a remarkably similar form - so-called phoenix companies. Then, of course, there are the zombie businesses - those that carry on for long periods, just one step away from bankruptcy.
Eddie Pacey, managing director of EP Credit Management and Consultancy, says phoenixes still occur, although due to changes in the insolvency rules many now do so through pre-pack administration, where the original owners may buy specified assets, often at a knockdown price, and carry on as before.
“Ten or 20 years ago, the IT sector was blighted by far too many phoenixes, and my memory banks are full of names and instances,” adds Pacey. “The trend declined when firms could no longer go from £0 to £10m revenue in less than two years. Also, some - not all - distributors got tough with those failing repeatedly.”
Pacey says fewer insolvency practitioners will handle such liquidations these days. They did, however, once provide bread-and-butter income, encouraging some to become specialist “ambulance chasers”.
A 2009 paper by the government’s Business and Enterprise Select Committee investigation into the insolvency regime explains that the Enterprise Act 2002 made it easier for companies to enter administration, and in fact it adds that the number of pre-packs has increased since then.
“There is controversy over the balance between the benefits and the drawbacks of pre-packs, including their susceptibility to abuse,” the committee wrote. “[But] we accept the logic that more value will be recovered from the sale of a company's business and assets where it continues to trade than where it is broken up. Research by academics such as Dr Sandra Frisby of the University of Nottingham indicates that secured creditors do particularly well, recovering an average of 42 per cent of debts as part of a pre-pack, compared to 28 per cent in a business sale.”
Also, according to the committee, jobs can be saved. Existing management may buy back the business and trade clear of their original debts. However, unsecured creditors - such as the majority of resellers when a supplier goes under - can be even worse off, recovering just one per cent of their debts on average, versus the three per cent they might get in a standard business sale. Competitors that meet their financial obligations can also be at a disadvantage.
Pacey notes that sometimes a business faces sudden, enormous pressures, such as losing a major client or being victimised by fraud. In such situations, pre-packs or phoenixes can remain a legitimate way of giving a company another chance at life and growth.
“One could argue that directors should be in control, but I have come across some where I actually recommended they move to liquidation and a fresh start. The point I made, however, was they should not be the same business as before and evidence control,” he says.
“I never had time for directors who contribute little by way of investment, are woeful at managing their businesses, and who view the phoenix as a convenient way to wipe out liabilities and start again, perhaps repeating the error a year or two later.”
Pacey describes a heated argument with one director, who at a creditors meeting “had the cheek” to suggest that since most of the creditors would be insured, it hardly mattered what he did.
“I pointed out this was not dissimilar to breaking into a house, stealing valuables and other assets, and excusing it given household insurance cover. He knew nothing of [the] cover or the extent [of it],” he says. “Thankfully, he got the message and moved on to selling vegetables or something. Administration pre-packs are not dissimilar and the same process, alas, applies here.”
If the acquirer is not connected to the previous owners of the company, and manages the new incarnation well, saving jobs as well as giving the original supplier a chance to make profit and offset bad debts, the practice can indeed be acceptable, Pacey reiterates.
Sometimes, the original owners have become directors of the acquiring company because they may have been in discussions with the ultimate buyer of the business before the move to administration - so assumptions cannot be made.
Meanwhile, Mike Weir, SNP spokesman on regulatory reform and MP for Angus, has called for a new inquiry into the insolvency regime, claiming that many creditors are suffering.
• Have you been affected by pre-pack or phoenix activity? Contact [email protected] or call 020 7316 9513.
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