Fears that pre-pack administrations involving "connected parties" deliver lower returns to creditors, and are more likely to go on to fail again, have been validated by empirical research.
Pre-packs are controversial in their own right, but those which involve the directors of the failed firm have attracted particularly fierce criticism due to the perception that it allows "bad businesses" to resume trading shorn of their debts.
Government-commissioned research into pre-packs suggests those involving connected parties tend to leave creditors worse off and are more likely to fail within 36 months.
Of the 499 pre-packs carried out in 2010 that were examined by the report, 316 – or 65 per cent – involved a connected party.
Nearly 30 per cent of connected sales failed within 36 months, the research found, compared with just 18 per cent of companies that failed where the purchaser was not a connected party.
Despite concluding that pre-packs shouldn't be banned, report author Teresa Graham said it is "easy to sympathise" with creditors who lose large sums in administration, only to see the old directors operating the new company from the same premises and "driving the same Rolls-Royce through the factory gates".
Pre-packs – and trading administrations more generally – are not known for delivering high returns to unsecured creditors but those involving connected parties performed particularly woefully on this front, the research found.
Of the 499 pre-packs studied, in the 121 cases where a distribution to unsecured creditors was made, the median payment was a paltry 4.3 pence in the pound, with the middle 50 per cent of cases spread between 1.5 pence and 12.9 pence.
But the research also found that a creditor is more likely to receive no distribution at all in connected pre-packs than unconnected ones. Distributions paying more than five pence in the pound of the unsecured creditors' debts are also less likely in connected cases.
For the counterfactual 110 trading administration cases studied, where a known dividend was made, the median was 7.0 pence.
Graham outlined a number of allegations industry onlookers made against connected-party sales during her research, the most damning of which is that the practice is a "sham simply to ditch debt".
However, Graham said that although the figures above are "interesting", they proved nothing, adding that simply being a connected-party case does not make the pre-pack "bad".
"I cannot ignore what defenders of pre-packing, including those in favour of connected pre-packs told me," Graham said. "Often the connected party may be the only party willing to make the best or only offer for the business. They may see it as their livelihood and want to ‘have another go'."
The claim by proponents of pre-packs that they preserve jobs is also probably correct, Graham said, based on the data. She also found no evidence that "serial pre-packing" – where controlling parties had been a party to a succession of pre-packs – is a regular occurrence.
Graham concluded that there should be voluntary scrutiny of pre-packs but Eddie Pacey, managing director of EP Credit Management & Consultancy, argued that her recommendations do not go far enough.
"What I find unpalatable is when too many directors are frequently retained by the acquiring firm or may be related to those acquiring. If they screwed up the business, then they should have no role in the pre-pack moving forwards and any 'role' should be restricted to six months," he said.
"There have been many attempts to clean up insolvency rules but the fact remains the UK is still a great place to fail with no real tangible penalty attached, either fiscal or reputational."
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