A Bankruptcy Lawyer’s Blog

Pre Pack Administrations – Opportunity For Fraud?

A business failure is a terrible thing. For those unfortunate enough to experience this any avenue for rescue must be welcome. There are some procedures in the UK and USA that provide protection from creditors and allow a business to trade out of difficulty. There are others that allow a business to be transferred debt free without any authorisation by the courts and are therefore open to abuse by the fraudster.

Around fifteen years ago my friend started his own business growing fish in the west coast of Scotland. The early years of an aquaculture venture can be more fraught with problems than in most other industries. It takes years for the stock to grow to such a size that it is ready for sale. During this time he had to deal with livestock and the extremes of the Scottish climate. This meant that he faced one major problem after another. He had difficulties in obtaining the young fish to grow on, attacks by predators wanting to eat his crop, solving design problems with his equipment, problems with security and trouble with harvesting the final product. Solving each of these problems in turn cost a great deal of money, which because he had no income from the slow growing stock forced him to borrow from various sources including the bank, from his family and from the government.

He managed to find solutions to all his problems and eventually had a robust core business. However, now his debts were so high that the business was no longer viable. He sought advice and ended up having a receiver appointed to deal with his business. He then bought back his business assets and continued his business debt free. This was well over a decade ago, and was always an area of the insolvency process that raised criticism with its commentators. In this case the court had to approve the process and a fair price was paid for the assets allowing the creditors to get some of their money back at least.

However, the Enterprise Act 2002 introduced an even faster process known as “administration” that was easier and cheaper to implement. Unlike the process used by my friend, it did not need judicial approval to ensure any deal being done was fair. The process is now called a “pre-pack” and allows a new company to arise using the assets of another. The new company might be owned by the old directors or shareholders. In practice they arrange with an insolvency practitioner to sell the assets of the business before being appointed. Then, on appointment the sale of the business is a “done deal”. The administrator does not need to consult anyone or market the business externally before the sale.

The insolvency arena will always be a rich picking ground for the fraud investigator. In many cases it is simply because that is the time when the inner workings of a company are laid bare for external scrutiny. However, in the case of the pre-pack process there may be a fine line between it being the best rescue package for a failing business and a potential fraud investigation involving fraudulent trading and removing the full value of business assets from the hands of the creditors.

Mark Jenner is a forensic accountant specialising in fraud problems. He assists companies and other organisations to prevent and detect fraud and to recover stolen assets. He is a Fellow of the Institute of Chartered Accountants, a Certified Fraud Examiner and holds a Masters Degree in Fraud Management. His web site can be found at http://www.mark-jenner.com