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On 23 December 2011, architect YRM went into administration. It sold its core contracts to RMJM, in a 鈥減re-pack鈥� sale. As part of that deal, some of YRM鈥檚 management team moved to RMJM. YRM鈥檚 other employees were left without jobs.

YRM鈥檚 management - and the concept of the pre-pack sale itself - faced criticism in the aftermath of the deal. But what is a pre-pack? Does it have any benefits? And how can you protect your business against the risk that a business partner becomes insolvent and takes that route?

What is a pre-pack?

A 鈥減re-pack鈥� sale is a way of selling an insolvent firm鈥檚 business or assets. Typically, the proposed administrator of the company negotiates the sale before the company goes into administration and completes the deal almost immediately after his appointment.

A pre-pack sale is often used where a firm has insufficient cash to allow it to trade in administration, or where the business could not easily survive formal insolvency.
The circumstances of a pre-pack deal can mean a company鈥檚 existing management team, who know the business inside out, are often best placed to complete a deal. However, if they do, it can seem like a means for the management to retain control of the firm while walking away from most of the debts.

Who benefits from a pre-pack?

Pre-packs can be the best way of realising value for creditors from an insolvent firm.

A sale of a business as a going concern will typically achieve a higher price than a sale of assets on a break-up basis. A pre-pack can sometimes be the only prospect of realising going concern value for a business. A pre-pack sale can also reduce the costs of the administration itself, as the administrator does not have to incur costs in trading the business in administration.

Preserving the business can also preserve employment. The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) provide that in many cases, the employees of a business transfer automatically from the insolvent firm to its new owner. In YRM鈥檚 case, it seems that only specific contracts transferred, rather than YRM鈥檚 business as such. Accordingly, TUPE did not apply and employees did not transfer.

How can you protect your business from the risks?

For a business, the best way to protect yourself against the effect of trading partners鈥� insolvency is to be proactive. By understanding your legal and commercial position, you stand the best chance of minimising any potential losses.

It is important to police a company鈥檚 compliance with its payment obligations. It may be worth exercising any right to suspend supplies for non-payment, for example, in order to limit exposure to the customer.

It follows that it is important to understand the terms of the contracts with the insolvent company. It is important to know the circumstances in which a contract can be terminated for insolvency. If a contract is terminable on (or before) the administration of the company and that right to terminate is exercised, the new owner of the business will have to make a new contract with the supplier. A key supplier might well raise its prices or otherwise change its terms so that, overall, it claws back some of the losses it faces in the old company鈥檚 insolvency.

Will the government act?

Cases where a pre-pack sale has led to criticism from stakeholders in the business have caused the Insolvency Service to bring in a new code of conduct, under which creditors must receive detailed information to justify the decision to do a pre-pack sale and the price of the deal. The government had considered bringing in legislation to amend the pre-pack process but has shelved these plans. Instead it may tighten the code of conduct further.

In the meantime, there are likely to be many more such transactions, meaning that business must remain vigilant to protect their interests in case of the insolvency of a firm they trade with.

David Rawson is head of PLC Restructuring and Insolvency at Practical Law Company