Packing up

Times are drastically harder. For 15 years the average default rate in Europe was 3.2%; that is likely to hit double digits this year, according to Standard & Poor's. It used to be that when companies were on the brink of disaster, stakeholders would work out private (out-of-court) restructurings on a case-by-case basis. That is now less of an option; the big bad wolf is well and truly at the door.

Everywhere you look, numbers back up the fears. Standard & Poor's expects the double-digit default rate to mean up to EUR25bn of debt default this year alone; while Alchemy's Jon Moulton estimated 200 covenant breaches were on the cards among UK portfolio companies for Q4 2008.

There are simply too many covenant breaches for banks to allocate adequate resources for each to go through a private restructuring. This is a point widely accepted among GPs, insolvency practitioners, company directors and senior bankers. The expectations are also unanimously gloomy on sourcing buyers for the growing list of firms primed to enter administration.

Certain sectors are more prone to doom than others. "In the rest of 2009, I would expect that any b2c sector could have a very difficult trading period as consumer confidence is still declining as unemployment increases, the sterling weakens and general day-to-day living costs are on the increase. Personal discretionary spend is being slashed, which will impact retail, leisure, travel, and automotive sectors and it will take a little while yet before confidence in the housing sector starts to improve," predicts Liz Bingham, who sees a great deal of the recent restructure action as a partner and head of restructuring in Ernst & Young's transaction services.

Fancy a quickie?

There are a handful of options for struggling companies; unfortunately many have negative connotations. The nicknames alone reveal this: A pre-pack administration, for example, is commonly referred to as a 'stitch-up' or a 'quickie bankruptcy'. This raises questions about whether or not the pre-pack scepticism is warranted. Pre-packs are also often confused with enforcements of security.

Because a buyer is lined up prior to appointing an administrator, pre-pack cynics question the deal transparency. In addition to questions about sales to connected third parties, they are also criticised for allowing failing companies the same stale set of directors while jettisoning debt and preventing new investment.

"The negative reputation probably arises from the fact that stakeholders may not feel appropriately consulted, or they may be resentful if a deal is struck with parties connected to the old business," explains Bingham. "The reality, however, is that an administrator must justify their actions and be able to demonstrate that the optimum result was achieved. When we do a pre-pack administration, it must withstand scrutiny from all possible parties so even a sale to a connected party should not matter. Used properly, the pre-pack administration is a strong tool to have in the armory of restructuring professionals."

Analyse this

Regulatory bodies have taken notice of the increase in pre-packs, as well as the negative feedback surrounding the high-profile cases, and have taken action: On 1 January 2009 the UK Joint Insolvency Committee issued SIP 16, a set of updated pre-pack guidelines which re-enforce the need to scrutinise the way pre-packs are administered (see box). Despite its newness, there are already cynics about SIP 16, with one professional telling your author 'it is only a guideline' and another calling it 'a band-aid'.

The European High Yield Association's (EHYA) Insolvency Reform Committee is also on the case. It is concerned about pre-packs, likening them to liquidation procedures, wherein a once-robust company is effectively dissolved and you are left with nothing more than a shell. From their perspective, pre-packs can be driven by a single group of creditors whose short-term focus on immediate market valuations can compromise the stakes of longer-term investors, including subordinated creditors. This, the EHYA argues, does not take into account future business potential. "The real question is how you determine value in the market as it is now," points out Stephen Mostyn-Williams, a co-founder of the EHYA.

The EHYA has put forth a reform proposal that will expand rescue frameworks in insolvency law. Aimed at financial creditors, the EHYA seeks to build a framework where a company can apply for a court stay of enforcement, enabling companies to continue to trade during a restructure. The goal of the new proposal is not to eliminate existing insolvency laws, but rather to add a protective procedure for companies that have a chance of a rescue, before they enter a company voluntary arrangement (CVA).

Beyond pre-packs, both Bingham and Mostyn-Williams emphasise that even the term 'administration' is subject to assumptions and a tainted reputation in the restructuring world. Administration can be used as a rescue tool and is not necessarily a precursor to liquidation. While the majority of cases result in liquidation, a minority are turned around. "Administration has largely proven to be a failure as a method of keeping companies alive," comments Mostyn-Williams. "Most administrations go on into liquidation."

No matter what the outcome of the recent discussion around UK insolvency law, there is no more pertinent time to spell out or even increase the options for troubled companies. Speed seems to be of the essence.

Statement of Insolvency Practice 16 (SIP 16)

Pre-pack is an arrangement where the sale of all, or part of, a company's business or assets is negotiated with a purchaser prior to the appointment of an administrator, with a sale done shortly thereafter.

Reiterates Insolvency Act 1986: "The administrator must perform his functions in the interest of the creditors as a whole."

Requires full disclosure by administrator to the unsecured creditors (detailed explanation and full justification) demonstrating that the administrator acted with regard for their interests. This must include: the source of the administrator's initial introduction; valuations obtained; details of directors or former directors of the company involved in management or ownership of new purchaser; any options or buy-back arrangements attached to contract of sale; whether a director has given a guarantee to a prior financier for amounts due from the company and if the financier is financing new business.

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