Why critics of Phoenixing or Pre-pack liquidation are wrong

Pre pack liquidation or phoenixing has been much debated in the last year. A pre pack liquidation is the process by which the assets of a failing company to be sold to a new business (often owned by the directors of the old company). The new business then begins to trade in place of the old without the burden of historic debts. The old company is generally closed (or liquidated) leaving unsecured creditors with little or no return.

It is those representing unsecured creditors who have been most vocal in their criticism of this insolvency process. They argue that the pre pack process is being used to leave creditors high and dry with no hope of recovering what they are owed.

It is also suggested that there is not enough transparency in the process of the sale of assets within a pre pack. During the process, assets are valued and sold without any opportunity for unsecured creditors to intervene. As such, the best price for assets may not be realised and creditors are again left carrying the can. To put it bluntly, pre packs are simply being used to avoid paying unsecured creditors.

I believe that it we look a bit closer we can see that this is simply not true. The main reason for this is that it is not the pre pack that causes a company to fail. The only time that pre pack liquidation is considered is where a company is insolvent. In this situation by definition there is not enough money to go around. As such, the likelihood is that the business will be closed, any assets realised and ultimately many unsecured creditors will receive little or no payment.

It is true to say that the primary idea behind the pre pack process is to ensure the survival of a viable business thus preserving jobs and future trading opportunities. This is not the only aim, the process was also designed with the increased protection of unsecured creditors in mind. A pre pack focuses on achieving the maximum sale value of a failing company's assets which maximises the potential dividend distribution to creditors.

Given the situation that the business is facing insolvency the question is:

Can the pre pack process really deliver a better outcome for creditors than might otherwise be the case in a simple liquidation or company administration?

The answer I believe is that pre packs are the best way of extracting value from distressed businesses.

The reason for this is that the old business' assets are generally valued as a going concern and therefore are seen as far more valuable than they would be in a traditional fire sale during a liquidation. For example in a "people business" where assets would evaporate in a formal insolvency, they remain together in a pre pack and can be sold as a valuable whole. Phoenixing minimises the period of disruption to the business and enhances the value of the assets. In almost every case, if the company was simply liquidated or put into administration, the value of the enterprise is damaged beyond repair, ultimately reducing the amount available for unsecured creditors.

It is important to highlight that insolvency practitioners are bound to extract the highest value for creditors from the pre pack process. Statement of Insolvency Practice 16 (SIP 16) outlines the insolvency practitioner's duty to take steps to ensure that the pre pack sale of company assets can be justified and is the right action in the circumstances. A recent insolvency service report indicates that only 3% of cases the conduct of the IP did not meet this guidance.

It is my belief that far from disadvantaging unsecured creditors, pre packs maximise any value left in a business which is doomed to failure. The process generates maximum value in the old business assets. Equally importantly and perhaps overlooked is the fact that even if the distribution to creditors is little or nothing, the pre pack process generates an ongoing business, preserving employment and a future trading partner. Ultimately, companies are worth more alive than dead.