When is a pre pack administration unethical?

In the United Kingdom, pre-pack administration is a legal process regulated by the Insolvency Act of 1986. It is a method used to quickly and efficiently sell the assets of a struggling company to a pre-selected buyer before it is declared insolvency.

This process is intended to rescue failing businesses and is often seen as a faster and less costly alternative to traditional administration proceedings.

However, pre-pack administration has faced criticism from some quarters, who argue that it allows directors to avoid accountability for their actions and can result in a loss of value for creditors. Despite this, the process remains widely used in the UK and is considered a lawful and effective way of restructuring a company in financial difficulties.

The Insolvency Act sets out guidelines for how pre-pack administration should be conducted and provides protection for creditors, employees, and other stakeholders. The Act requires that the pre-pack administration process is transparent and that all parties involved are treated fairly and in accordance with the law

Explaining The Controversy Surrounding a Pre Pack Administration

One of the main criticisms of pre-pack administration is that it allows directors to avoid accountability for their actions, as they can sell the assets of the company to a new entity and walk away from the old one, leaving creditors and other stakeholders with little or no recourse. This has led some to argue that the pre-pack administration process is inherently unfair and should be reformed or abolished.

Another area of controversy surrounding pre-pack administration is the potential for a loss of value for creditors. Critics argue that pre-pack administration can result in the assets of a company being sold for less than their true value, as the pre-selected buyer may have an advantage in the negotiations due to their prior knowledge of the company’s financial situation.

Some stakeholders also express concerns about the lack of transparency in the pre-pack administration process, arguing that the sale of assets should be subject to more rigorous oversight and public scrutiny. Despite these controversies, pre-pack administration remains a widely used tool for saving businesses in financial difficulties, and its legality is generally accepted in countries where it is regulated by law.

Although pre-pack administration is considered a lawful means for company owners and directors to acquire assets, such as equipment, inventory, property, contracts, and employees, for their new venture, it is still a controversial insolvency procedure. The process is criticized by many who view it as a convenient escape route for savvy business individuals to erase debts and begin anew.

Some believe that pre-pack administration can be misused, leading to an unfair advantage and potentially undermining the rights of creditors and other stakeholders.

If any of the following conditions are not satisfied, the Court can rule that a pre-pack administration is improper:

• A pre-pack administration must be justified by the directors of the insolvent company and the insolvency practitioner serving as administrator, who must be able to show that all alternative options were explored before making this decision. Its legal objective, such as a higher return to creditors, must be made very clear.
• The most crucial rationale is to demonstrate that the directors obtained the greatest price for the assets during the sale discussions because the administrator is required to operate in the best interests of all creditors. In other words, the directors must be able and willing to purchase the assets for a reasonable price.
• The administrator is required to fully record every aspect of the pre-pack transaction.
• The valuers and agents of the administrator may agree to defer payment and spread it out over a period of time.
• During the period the firm was running insolvently, the directors were not permitted to engage in improper or dishonest transactions. To determine whether these accusations are justified, the administrator will launch an investigation.

Learn more about duties of a director while trading insolvent.

Is a Pre-Pack Administration Considered Unethical?

The ethics of pre-pack administration is a matter of debate and perspective. While some see it as a necessary tool for saving struggling businesses and preserving jobs, others view it as a way for directors to escape accountability for their actions and potentially harm creditors and other stakeholders.

Those who criticize pre-pack administration argue that it can result in a loss of value for creditors and is unfair, as the pre-selected buyer may have an advantage in negotiations. However, proponents argue that pre-pack administration is a lawful and effective means of restructuring a company in financial difficulties and is subject to regulations designed to protect all parties involved.

Ultimately, whether pre-pack administration is considered ethical or not depends on one’s perspective and interpretation of the relevant laws and regulations.

An example of an unethical pre-pack administration

An example of an unethical pre pack administration – by continuously borrowing against a line of credit without any means of repayment or prospects of recovery, they may be guilty of wrongful and fraudulent trading. Their attempt to use a pre-pack administration to escape paying debts while still retaining the company’s assets for a new venture could be seen as an abuse of the process.

Such behavior can result in severe consequences, including personal liability for the company’s debts and potential disqualification as a director. This type of unethical behavior undermines the trust of creditors and stakeholders and undermines the integrity of the pre-pack administration process.

An example of an ethical pre-pack administration

An example of an ethical pre-pack administration is where a company is facing liquidation due to insolvency, creditors may petition the court to wind up the business. The end result in this situation would typically be the liquidation and dissolution of the company. However, prior to this, there may still be an opportunity for some of the directors or interested parties to purchase some or all of the company’s assets.

Through a pre-pack sale, the directors can make a fair offer for the assets, which is equal to or greater than their open market value. They can also arrange to pay for the assets over a deferred period. This process can offer a more favourable outcome for all parties involved, preserving some value for the creditors and providing a second chance for the business to succeed.

An online portal can be used to refer a case to the pre pack pool for review when a business sale to a related party is anticipated. According to the updated Statement of Insolvency Practise 16 (SIP 16), insolvency practitioners are required to inform persons engaged of the pre pack pool, even though application is optional.

When a company is facing liquidation and dissolution, the sale of assets is an inevitable outcome. In this scenario, it is not considered unethical or unfair for members of the insolvent company to collectively use their personal funds to purchase some of the assets during an administration sale.

The focus in this situation should be on achieving the best possible price for the assets, which is why the opinion of the valuation agents is crucial. A well-executed pre-pack administration sale, following all the proper procedures and guidelines, can result in a beneficial outcome for all parties involved. This is why reputable insolvency firms often recommend a pre-pack administration as a viable solution for struggling companies.

Read more: What happens to employees in a pre pack administration?

Conclusion

The ethics of pre-pack administrations in the UK have been a source of controversy and debate for many years. Some people view pre-packs as a way for company directors to escape their debts and start anew, while others see it as a necessary tool for saving viable businesses and preserving jobs. In order to ensure that pre-pack administrations are conducted in an ethical and transparent manner, the UK government has implemented a number of guidelines and regulations.

These include the requirement for an independent valuation of the assets, as well as the appointment of an administrator who must act in the best interests of all stakeholders. Additionally, the sale process must be transparent and open to scrutiny, with all parties involved having the opportunity to assess the fairness of the proposed sale. Ultimately, the success of a pre-pack administration depends on the integrity and professionalism of those involved, and it is important for all stakeholders to work together to ensure that the process is carried out in a fair and ethical manner.

We have helped a number of businesses with legal pre pack administrations over the years, if you are worried about the legality of placing your company into administration simply complete the online enquiry form.