House of Fraser (HOF) has been in the headlines for months. It started with reports of widening losses and being dragged down by soaring costs and a drop in consumer sales, but official comment from the 169-year old retailer remained positive. Then there were rumours of CVAs and negotiations with landlords leading to further controversy. Finally, last Friday (10 August 2018), a stock market announcement delivered the news that Mike Ashley’s Sports Direct had brought House of Fraser out of administration for £90 million, just hours after the store had announced its collapse. The deal was struck through a pre-pack administration process. A pre-pack is a popular mechanism to sell a financially distressed business quickly but it has been the cause of some debate over the years. Is it a good way to keep a brand, a business, and usually its staff intact, or is it fundamentally unfair on the suppliers and unsecured creditors left behind?
A pre-pack describes the process through which a company is put into administration and part of, or all of, its business or assets (or both) are immediately sold by the administrator under a sale that was arranged before the administrator was appointed. For example, Sports Direct said in a statement that the group has acquired “all of the UK stores of HOF, the HOF brand and all of the stock in the business”.
There are some downsides to this type of restructuring strategy, for example it can take unsecured creditors – like suppliers – by surprise. They usually have no opportunity to protect their interests by considering and voting on the pre-pack proposal. On the other hand, secured creditors, such as a bank, will be involved and consulted in advance because they have to consent to the release of their security (where secured assets are to be included in the sale). HOF has both wholesale suppliers, which get paid after their goods are delivered, and concession holders that are paid after items have been bought by customers. HOF suppliers and concessionaires, being unsecured, have suffered substantial losses for payments (collectively they are owed an estimated £70 million for goods) but it has been reported that Mike Ashely will not be “bailing out suppliers”. A letter reportedly seen by The Times and sent by the CFO of Sports Direct, said it will “honour payments for stock sold from the time of the acquisition”.
This seems harsh on the face of it because the pre-pack process will have been negotiated and agreed and put in place without their knowing. Criticism is often centred around the creditors having no say in the process before it has happened and no vote on the sale of the distressed business, while others will question whether the best price has been obtained.
Unsecured creditors do have ways to challenge pre-pack deals. Creditors have a statutory right to bring an action against an administrator to challenge the administrator’s conduct or for misfeasance. Creditors should also be aware of the requirements of SIP 16 (see below) and should check to see whether these have been followed.
Another criticism levelled at pre-packs is that the Insolvency Act 1986 does not expressly provide for pre-pack situations, instead, they tend to be executed in the context of commercial judgement. Therefore, the administrator can sell assets of the company before his proposals have been agreed by creditors and without court approval. Although this sounds uncontrolled, there is regulation, in the form of Statement of Insolvency Practice 16 (SIP 16), which makes the latter less of a concern. These are professional guidelines that relate specifically to pre-packs, which aim to make the process more transparent, including providing creditors with information about the marketing of the business and the alternatives considered before a pre-pack is executed. For example, Mike Ashley beat off competing offers from Philip Day (the owner of the Edinburgh Woollen Mill Group) and turnaround specialists Alteri Investors.
The regulations also set out the standards which the administrators need to adhere to and includes information that the administrator needs to disclose to creditors within seven days of completing the pre-pack sale. Although SIP 16 is not legally binding, failure to comply could lead to the administrator facing regulatory or disciplinary action.
There are a number of benefits to a pre-pack restructuring strategy, for example, it can result in the quick and relatively smooth transfer of a business to a new owner. The transaction speed is usually essential in the context of a distressed business, which is brand and reputation dependent such as House of Fraser and other fashion retailers. It will minimise the erosion of the value of the business caused by the fact of the seller’s insolvency, helps to retain goodwill in the business and the brand, and acts to reduce the administration costs, which in turn result in an improved return for the creditors. Pre-packs can also work to minimise the erosion of confidence amongst suppliers, customers and employees that is inevitably a result of insolvency proceedings. The strategy can also save more jobs than an administration procedure: HOF has 59 stores and over 16,000 staff and since Sports Direct’s acquisition, Mike Ashley revealed he plans to keep 80% of the HOF stores open for business. This is significantly more than the number of stores set for closure before Sports Direct stepped in, which would have led to the loss of around 6,000 jobs.
There is a relatively recent development in the use of ‘Pre-Pack Pool’, which provides a mechanism for obtaining an independent review and opinion on a pre-pack. There are calls for this to be developed further into a mandatory independent approval process.
Overall, sometimes there is simply no alternative to a pre-pack, especially where there is no funding available to make it possible for the administrator to continue trading the business until it is sold at a later date or otherwise restructured. The worse option would be liquidation and the immediate cessation of the company’s business. HOF went through various negotiations for cash injections pre-administration, with Mike Ashely approached for a cash injection and C. Banner, an international retailer, agreeing and then cancelling a planned round of fundraising.
Full details of the plans for the future of HOF are yet unknown. Speculation includes rebranding some stores into Sports Direct and others into the more upmarket Flannels, and Mike Ashley has stated his ambition to transform HOF into the ‘Harrods of the High Street’. The latter concept is already facing some scepticism from the luxury brands operating concessions unless significant reinvestment to transform the store experience is forthcoming. HOF is sure to continue to hit headlines but it will be interesting to see how the pre-pack business rescue is executed.