The Insolvency Service

IS 15

Written evidence submitted by ShareSoc
(UK Individual Shareholders Society Ltd)

Insolvency Service and Pre-pack Administrations

As an organisation that represents shareholders in public companies, we are very concerned about such Administrations and have previously made a strong case to the Insolvency Service for urgent reform. But since a meeting in early 2011, nothing has been done, and the Insolvency Service have not even had the courtesy to respond to a letter I sent them in November asking about the progress on this matter.

This is what we originally said when it was proposed to introduce a 3 day notice period for creditors to stop the abuses – a change which in our view would have had little impact:

1. A three day notice period is hardly sufficient to allow time for creditors to put forward

alternative proposals. In addition it totally ignores the rights of shareholders in such

companies to be consulted on the matter.

There have been numerous cases where pre-packs have been arranged primarily to

benefit former insiders in the business. Indeed the FT reports that research by the

University of Nottingham showed that in 58% of cases of prepack administration, the sale was to a connected parties – typically to the former part owners or managers. In other words these are typical "phoenix" company situations where the company escapes its former creditors one day and starts up in business anew with the same assets, the same managers, and sometimes the same owners, the next day.

It is totally wrong for an Administrator to act in advance of his appointment as

Administrator which is what happens in practice at present. Often arrangements are made with the connivance of the company’s directors or bankers which are not in the interests of creditors or shareholders. These arrangements are often made in secret with no public knowledge and then put into place in a matter of a few hours after formal appointment of the administrator.

I had personal experience of this process not long ago in the case of Torex Retail Plc. This was a company that got into financial difficulty after an alleged fraud and claims of false accounting. The directors arranged to sell the business via a Pre-Pack Administration to some private equity investors – this mainly was to the advantage of the bankers who protected their loans to the company but also obtained a stake in the on-going business. This meant that shareholders were left with nothing, and creditors were presented with a fait-accompli. Torex was in essence a sound business that could have traded out of its problems given a short period of stability and some protection from short term creditors.

Before the Administrator was officially appointed, I tried to arrange an alternative

refinancing which would have protected shareholders and other stakeholders’ interests,

but the directors ignored our approach. We then requisitioned an EGM to remove the

directors and replace them, but the Administration was pushed through that pre-empted

this move.

In essence there was no approach by the Administrators to the open market, no

consideration by them of alternative offers, and the whole deal was stitched up behind

closed doors before most people knew anything about it.

This was surely not how Administration was conceived as working when it was put in place by the original legislation. Regrettably legal precedent has been established that seems to condone this practice, and now companies left, right and centre are using it to evade their debts and create new "phoenix" businesses from the ashes of companies in financial difficulties. The directors or parent/related companies often being the beneficiaries of these arrangements.

Another example was covered by Alistair Blair in the Investors Chronicle – namely of

Axeon. This was an AIM company that was put into administration via a "pre-pack"

arrangement at the behest of its main lender who was also a shareholder (Ironshield). The company was sold to AG Holding, a new company specially set up for the purpose by

Ironshield about one hour after it entered administration. In effect, as with all pre-packs,

the whole deal had been arranged some time before. In this case it seems even more

outrageous than normal as the company’s press release said that "creditors would be

unaffected", so only the shareholders were deprived of their interest in the business.

There have no doubt been many other cases of small companies that are listed on AIM

suffering the same fate (SCS Upholstery is another one that springs to mind). This system is pernicious and the only real beneficiaries are the insolvency practitioners. It needs full scale reform, not the putting of a sticking plaster on a failed system.

2. After the very inconclusive meeting held at the Insolvency Service – which was mainly

attended by banks and insolvency practitioners who are the main beneficiaries of the

system, but few others, I made these additional comments:

It was said at the meeting that [the three days notice] would give time for

"representations" to be made to the administrator, but in my view the administrators

would simply ignore those representations. The above examples were of course public

companies where you might expect some higher level of standard, or at least more

oversight of the process. But most pre-packs are of course in unlisted and probably

smaller companies where the oversight is likely to be much less. I am simply not

convinced that a three day "hiatus" will make much difference to the abuses that have

taken place with pre-packs since they were introduced.

In essence the proposed regulations are a damp squib which will not be effective in

reforming the practice of pre-packs, which is their prime intent.

I am also not convinced that the "review process" as indicated in the regulations will

actually provide any proper oversight of pre-packs in terms of the level of abuse that is

taking place. As I said at the recent meeting, the terms are much too wishy-washy and

need to be tightened up as to exactly what is being reviewed and the objectives of those

reviews.

It was apparent from the meeting that the insolvency practitioners were also not happy

with the proposed regulation changes, although for different reasons. They were alleging

that the changes would preclude the use of pre-packs in future, but it was not clear why.

I suspect it was more a case of not wanting to have any restrictions on the use of prepacks which at present enable practitioners to act in the interests of major creditors (such as the banks who were also present at the meeting) and ignore minor creditors, or other stakeholders such as shareholders.

The pre-pack system it seems to me was devised by insolvency practitioners, for the

benefit of insolvency practitioners, in that it enables them to deal with complex and

difficult circumstances easily and quickly. Whether that is appropriate and in the i nterests of the wider financial world is altogether another matter.

Whatever the reasons for the opposition of others to the proposed changes, it does seem

to me that the Insolvency Service, and the Minister who is setting policy on this matter,

needs to totally rethink what should be done.

If no better system can be devised, that meets the concerns of insolvency practitioners, and of other interested parties such as ourselves, then pre-packs should be simply scrapped.

It is in principle totally wrong for an Administrator to act in advance of his appointment as Administrator which is what happens in practice at present. Often arrangements are made with the connivance of the company’s directors or bankers which are not in the interests of creditors or shareholders. These arrangements are often made in secret with no public knowledge and then put into place in a matter of a few hours after formal appointment of the administrator.

Neither is it in the interest of the commercial world that a company can escape its

creditors and resume business to the prejudice of its competitors. Phoenix companies

should be absolutely discouraged, and pre-packs are the obvious route to create them.

We even have the situation lately of companies going through more than one pre-pack

administration (e.g. Allied Carpets, or Moben/Dolphin).

It was mentioned at the meeting that banks might have problems with major "debt

restructurings" (where other creditors might not be involved), if pre-packs were made

more difficult. But perhaps they should be examined in more detail as to how such

restructurings can be accommodated.

In summary, I hope the Select Committee will tackle the Insolvency Service on these

issues and encourage substantial reform.

UKSA

Roger W. Lawson

Chairman

ShareSoc (UK Individual Shareholders Society Ltd)

23 January 2012

About the UK Individual shareholders Society (ShareSoc)

ShareSoc represents and supports individual investors who invest in the UK stock markets. We are a mutual association controlled by the members with "not-for-profit" articles and incorporated as a company limited by guarantee. The organisation is financed by member subscriptions, donations from supporters and by the provision of services to members. More information on ShareSoc can be obtained from our web site at www.sharesoc.org (our objects are fully defined on this page: www.sharesoc.org/objects.html ).