Following the pre-pack administration purchase of Coast by Karen Millen this week, Drapers investigates the pros and cons of the process and what, if anything, can be done to make the process more transparent.
Pre-pack administration, a popular but controversial procedure for rescuing floundering retailers, hit the headlines with a bang this summer. The process, whereby struggling companies arrange a sale of all or part of the business before appointing administrators, was a crucial lifeline for embattled department store House of Fraser. Faced with significant pressure on revenue, margins and cashflow, the retailer was fighting for survival at the start of August after Chinese group C Banner called off plans to invest up to £70m in the department store chain.
Unable to find the additional £40m required to keep the business afloat, HoF entered administration in the morning of 10 August, before being bought by Mike Ashley’s Sports Direct for £90m minutes later.
Although good news for HoF and its employees, non-preferential unsecured creditors – including suppliers and landlords – were owed £484m when it went into administration. By law, administrator EY was required only to make made provision of £600,000 to pay them. New owner Ashley has faced calls to pay suppliers in full, but has no legal obligation to do so.
The process isn’t ethical and it isn’t moral
High street supplier
Drapers was inundated with calls from distressed suppliers left with outstanding debts who were growing increasingly concerned about the knock-on effect on their own businesses following the deal. Although Sports Direct is understood to have agreed new terms with suppliers it wants to continue working with, it has also said it will not “pay a penny” of debts incurred before HoF collapsed.
Already battling tough market conditions, HoF suppliers have since warned of job losses, profit shortfalls and even the risk of closure. And this is not the first time suppliers have been left counting their losses following a pre-pack administration. Several Jones Bootmaker suppliers said they were left “out of pocket” by its pre-pack administration in April last year. Unsecured creditors to fellow failed footwear retailer Shoon lost a combined £1.6m following its pre-pack last December.
The collapse of HoF, a mainstay of the high street, has led to fresh calls from suppliers for more protection and a fairer playing field.
“Pre-pack administrations have been a problem long before House of Fraser,” argues the owner of one high street supplier, who asks not to be named. “The process isn’t ethical and it isn’t moral. We need more transparency in the process and also around the health of a business before it becomes insolvent. The law needs to be changed. In other countries, when a business becomes insolvent, there is a meeting of creditors and everybody is involved in the process to save that company.”
You shouldn’t be able to walk away completely from a previous company’s debt
Retail restructuring expert
One retail restructuring expert agrees: “There should be some kind of requirement of the new owner, that if money is due to various suppliers and you are planning continuity of supply, you shouldn’t be able to walk away completely from a previous company’s debt. It strikes me as bizarre that a brand can be owed tens of thousands, or even millions, by a retailer one day and nothing from that same retailer the very next day – and that the supplier often carries on working with the retailer. Larger suppliers may be paid to retain continuity, but smaller ones don’t have that power.”
He adds that any recompense suppliers do receive under the existing system is often a case of too little, too late.
“Suppliers often only get a couple of pence in the pound and even then, they aren’t going to see that money for some time, by which case it will immaterial – they’ll have either got through it or shut down.”
Insolvency practitioners, however, argue that, despite the concerns, pre-pack administrations are often the best route forward for all parties, including creditors.
“The advantage of a pre-pack administration is that it keeps a business operating in a similar manner, which is normally good news for staff who will retain their jobs and for many of the key suppliers who support the business and whose relationships remain important to the business,” says Matthew Martin, partner and head of corporate and fashion and luxury brands at law firm Penningtons Manches.
The business is sold in a short space of time and that often means you don’t lose the goodwill attached to that brand
Matthew Martin, Penningtons Manches
“The business is sold in a short space of time, which generally means you don’t lose the goodwill attached to that brand – which is so key in the fashion industry, where reputation and brand are so important. The cons that are often linked to pre-packs are that they have a reputation for a process where the business is not properly marketed to maximise the return and therefore what is available to creditors, and that in most cases the same people who ran the business into an insolvent situation have the opportunity to start running it again, having shed some of the liabilities.”
Too little, too late
By the time a business reaches a pre-pack administration, much of the damage has already been done, argues Stephen Grant, managing partner of law firm Wilkins Kennedy.
“By the time you get to an administration, a business doesn’t have the cashflow necessary to continue trading,” he says. “You don’t have that luxury. Creditors don’t like pre-packs because they are presented to them as a fait accompli, but insolvency practitioners have to make the best of a bad situation.”
Peter Saville, managing director of business turnaround consultancy Alix Partners, agrees: “The advantage of a pre-pack is that it allows the business to maintain a level of continuity and carry on trading. For consumers, there isn’t much difference and pre-packs are often used in retail companies where there a very big contractual issues [with lots of suppliers] and you don’t want to disrupt those contracts.”
You have to balance having to move quickly with marketing the business properly to ensure the best deal for creditors
Julie Palmer, Begbies Traynor
Saville argues that one of the biggest criticisms of pre-pack administrations is that employees, landlords and suppliers can feel ambushed by a sale: “A pre-pack can look like it has come out of the blue. For consumers, it doesn’t really matter – the product is there tomorrow, as it was yesterday. But for those with a vested interest, such as employees or creditors, it can be a case of did they know about or should they have known about it.
He continues: “Obviously the board knows [about a potential pre-pack], and some senior staff members, but in a pre-pack some stores are kept and some are closed. You often don’t know until the end of the process what the purchaser wants to keep, so telling employees would be disruptive.
“A lot of pre-packs are also accelerated because of the withdrawal of credit. You might speak to a board and if you’ve got a period of three months, say, to sell a business, you can get the maximum value for it. But if that story gets out into the market, and trade insurers start pulling cover and there’s a run on working capital, instead of three months you might have just six weeks.”
Jones Bootmaker: restructuring through pre-packs
Premium footwear retailer Jones Bootmaker has weathered more than one pre-pack administration. Private equity firm Endless bought 72 Jones Bootmaker stores in a pre-pack in March 2017. Although 840 jobs were saved, Endless jettisoned 25 underperforming stores and six concessions, resulting in 262 job losses.
The business later closed a further nine stores following a review by its new owner. However, continued tough trading meant that by February 2018 the retailer was rescued through another pre-pack. Fellow footwear chain Pavers bought 42 Jones Bootmaker stores, its website and the brand, safeguarding 389 jobs. The head office and five stores were not included.
Suppliers, however, argue that they are unfairly kept in the dark.
“Someone needs to look at what happened [at House of Fraser] to see if suppliers were misled in any way,” says one. “It is totally unfair. Suppliers were being told one thing – that everything was fine and the business was getting more investment – while [senior management] were holding secret talks with Ashley about a rescue deal. It is not acceptable.”
Creditors left out of pocket believe pre-pack administrations do not achieve the best possible deal for a distressed company.
However, Julie Palmer, partner and retail insolvency expert at professional services firm Begbies Traynor, argues that moving quickly can secure a better price: “One of the challenges facing insolvency directors is their duty to creditors to get the maximum amount from the [pre-pack] process on their behalf.
The advantage of a pre-pack is that it allows the business to maintain a level of continuity and carry on trading
Peter Saville, Alix Partners
“An extended marketing campaign for the business can create competitive tension. But the longer you sit there, the longer the value of the business is crashing.
“The administrator is also stepping into the shoes of the management team and they don’t have any more of a bottomless pit of money than they did. You have to balance having to move quickly with marketing the business properly to ensure the best deal for creditors.”
Phoenix from ashes
But is there more that could be done to improve the transparency of pre-pack administrations and address creditors’ concerns?
The government is already assessing the impact of measures introduced in 2015 to improve the transparency of pre-pack deals involving connected parties. Sometimes known as “phoenix companies”, in these deals an insolvent business is sold back to existing management.
One of the measures introduced in 2015 was voluntary service the Pre Pack Pool – an independent group of experienced business people who are able to review the viability of a proposed pre-pack. However, just one in 10 eligible cases were referred to the Pool last year, which the body argued was because of its lack of regulatory bite.
Retailers can be caught out by the speed of the decline
Alan Hudson, head of UK and Ireland restructuring at EY
Former business secretary and Liberal Democrat leader Vince Cable, whose 2014 review of pre-packs led to the introduction of the new measures, has called for all pre-pack administrations to be reported to a parliamentary select committee to assess whether there are any conflicts of interest.
“When it comes to improving pre-packs, what people tend to suggest is that there should be a more formal process for getting a deal approved by an independent body,” Penningtons Manches’ Martin says: “You could extend the marketing period or perhaps outsource the sale process to a party totally independent of the administrator that sanctions it.”
Wilkins Kennedy’s Grant agrees: “Communication is often the key issue – could you perhaps offer the business to creditors, or could an insolvent business be advertised more widely? In reality in the case of House of Fraser, the average supplier wasn’t in a position to take on the business.”
Up for scrutiny
Alan Hudson, head of UK and Ireland restructuring at EY, stresses that pre-packs are already surrounded by rigorous scrutiny. However, he adds that struggling retailers themselves could sometimes be quicker at recognising when the writing is on the wall.
“The challenges comes when a supplier is trading with a company and clearly the board of that company should have recognised what was going to happen. The tension can come if a board should have known sooner and whether they should have carried on taking supply.
A good supplier with a keen credit control should be able to recognise the early warning signs and consider turning off their supply
Julie Palmer, Begbies Traynor
“You can talk to boards who have recognised the challenges and tried to navigate them, or equally have conversations with businesses who say, ‘We can’t make the payroll’ – in which case there’s not a lot of time to fix that. The dynamics of retail can play into this, because there are a lot of big costs, like large payrolls, going out the door. Retailers can be caught out by the speed of the decline.”
There is also an onus on suppliers themselves, argues Begbies Traynor’s Palmer: “A good supplier with a keen credit control should be able to recognise the early warning signs and consider turning off their supply.”
What’s the alternative?
In the US, struggling businesses can apply for chapter 11 bankruptcy protection. After a petition has been filed, an automatic stay comes into effect that stops creditors collecting pre-existing debts, and any litigation. The business filing for bankruptcy has the
first chance to propose a reorganisation plan detailing how it will repay creditors and survive. Creditors have the option of filing their own reorganisation plan.
Among the fashion companies to have used chapter 11 are True Religion, Charlotte Olympia and Nasty Gal.
However, some House of Fraser suppliers left out of pocket argue that the did recognise – and act on – early warning signs but have still been hit.
“We followed the signs and cancelled our autumn and winter orders but were due payment for a previous order on 11 August – the day after House of Fraser went into administration,” says one supplier. “We’d pulled out completely and were just waiting for our final payment. We did everything we possibly could but we’ve still been stung.”
All too often, pre-pack administrations are an unhappy compromise. As insolvency practitioners stress, by the time a business becomes insolvent the paths forward are limited. Both cash and time are in short supply.
A pre-pack administration can at least give suppliers the promise of future business – even if that is a slim recompense for those left owed thousands. However, is it equally important that the process is as transparent as possible, the government needs to act to ensure a fairer system for all parties.