LONDON (Reuters) - As British companies go bust at their fastest rate in nearly 20 years, a fast-track insolvency system that preserves brands and some jobs at the expense of creditors is becoming controversial.
In buoyant times the pre-packaged administration, or “pre-pack,” was an attraction of the country for overseas entrepreneurs. Now critics say it may accelerate company collapses and is exacerbating the pain for small businesses.
With 4.7 million small businesses in the United Kingdom which according to the Federation of Small Businesses provide more than 58 percent of jobs to about 13.5 million people, the impact could be significant.
How pre-packs work is illustrated by the case of Whittard of Chelsea, a purveyor of fine coffees and teas that went bust last year. Contrary to expectations the stores — with jolly teapot window displays and tourist-luring family crests — stayed in business.
The brand name was preserved, as were the jobs of around 1,000 Whittard’s employees. But many lenders saw their loans written off as immediately after it went into administration, Whittard’s was sold to a private equity firm.
While most staff and even managers held on, many of the small and medium-sized businesses involved were left with unpaid debts. Their value was never fully disclosed, though a source close to the case said they included around 15 million pounds ($22 million) of secured debt plus millions more in unsecured debt.
“With a pre-pack, all too frequently it is the case that for the sake of one company staying open, another has to close,” said a spokeswoman for the Association of British Insurers.
Unlike “Chapter 11” bankruptcy protection in the United States, administrators in Britain cannot raise additional funding but must move swiftly to rescue or sell a company.
In the U.S., raising additional funds — or “debtor-in- possession financing” — can allow a company time to restructure its debt, and also offers existing creditors an incentive not to give up on the company.
But “pre-packs” allow a company going bust to be sold privately ahead of formal insolvency. The system is now used for more than half the British companies that fold each year.
The system gives rapid clarity, but groups representing creditors say the increased use of pre-packs can make it too easy for owners to walk away from their debts and then retake control of the company and resurrect it, phoenix-like.
An example of the painful consequences for smaller business comes from Peter Luff, a member of parliament for mid-Worcestershire in central England.
He said one of his constituents ran a small hauliers’ firm and lost 54,000 pounds when a printing firm he supplied went into pre-pack administration. For the businessman, it was like seeing his retirement fund suddenly go up in smoke.
Many creditors — especially vulnerable ones like suppliers and customers — complain about the secrecy and suddenness of the process, which often leaves the previous management in charge but conveniently free of debt.
Member of Parliament Luff, who is chair of the British parliament’s Business and Enterprise Committee, says there is growing anecdotal evidence that pre-packs need to be re-examined, especially given their impact on small businesses.
Luff’s committee is conducting an inquiry into insolvency laws, including pre-packs, and will report later this month.
“There is never smoke without some fire,” he told an evidence session of his committee last week. “My political experience is that when issues climb up the agenda, they usually do so for a reason, not by accident.”
One case which has been raised in the committee’s inquiry is that of Scottish fashion retail chain, USC, which also folded late last year.
USC was part of private equity partnership West Coast Capital. Its buyer when it went into pre-pack administration was Dundonald Holdings, another West Coast Capital Group company.
Dundonald bought the majority of the chain’s stores and retained many staff, but the debts were left behind with the carcass of the old business.
“The impact on a lot of small businesses in a recession can be very serious,” Luff said.
Officials at the British government-backed Insolvency Service stand by the pre-pack, saying they have studied countries such as Australia and New Zealand to refine the law and continue to monitor international comparisons.
Stephen Speed, the service’s Director, cites World Bank data ranking countries for their “ease of doing business,” which puts Britain among the best places to start up, and close down a business.
“Insolvency law is complex, and it has taken such a long time for us to get it to where it is,” Speed told Reuters.
“It strikes a careful balance between creditor and debtor — and our view is that before you start to unpick it you need to have very good grounds, very strong evidence for doing that.”
Speed agrees cases such as the USC example don’t look good. But he is keen to stress that pre-packs save jobs and preserve the value of a business.
He cites research by one of the country’s leading academics on insolvency laws, Dr Sandra Frisby, whose data show that in more than 90 percent of pre-pack administrations, the entire workforce is retained.
He also says old-style schemes such as receivership, or systems in other countries, offer little more.
“The problem I have with the debate about pre-packs is that people have focused on the fact that the people who lose from pre-packs are small businesses, suppliers, customers and vulnerable people,” he said.
“I don’t disagree with that — but I’m afraid that is what happens anyway. I don’t like it, but it is not an evil that is unique to pre-packs.”
Nick O’Reilly, president of R3, a trade body which specializes in insolvency and business recovery, agrees.
“It’s because the company is failing, or has failed, that creditors lose money — not because the business was pre-packed and sold on. In fact, a pre-pack is often the only option available to save a business and jobs and avoid liquidation.”
Writing by Kate Kelland; Additional reporting by Matt Falloon; Editing by Sara Ledwith