Business Phoenixing - Is a Pre-Pack a practical way to avoid company failure?

With the continuing economic downturn, increasing numbers of businesses are finding it difficult to continue trading. However, very often these difficulties are not because customers have stopped buying completely. Rather, they are buying in reduced volumes and asking for lower prices.

In these circumstances many businesses could continue to trade if they did not have the burden of servicing legacy debts. Since the Enterprise Act of 1984, it has been possible to request relief from corporate creditors using a Company Voluntary Arrangement or CVA. With the agreement of creditors, a Company Voluntary Arrangement allows a portion of corporate debt to be repaid at a manageable rate over a set period of time, the remaining debt being written off. A high proportion of early failures of the arrangement has led to much criticism of the process by creditors and insolvency professionals alike. The main argument against the CVA is that the fundamental structure of the business and its management team do not change. As such, even if the burden of legacy debt is lifted, the reasons for past failures are not likely to be resolved in the future.

Given the criticism levied against a Company Voluntary Arrangement, the process of Phoenixing (also known as Pre-Pack sale in liquidation or administration) has become more widely considered as a practical way of saving a business. Phoenixing is simply where a new company is formed which then buys the assets, contracts and goodwill of the failing business for a reasonable market rate. The legacy debt is left within the old business which is then liquidated thus allowing the new Phoenix business to trade on, debt free.

From the beginning of 2009, much comment has been made about the Phoenix process in the media. Very often this has quite negative about the process because of the fact that creditors are left with unpaid debts which may in turn lead them to suffer their own financial difficulties. However, what has been largely overlooked in these published arguments is the reason for the failing company is not the Phoenix process. The reason for the failure was the company's inability to continue to trade. In these circumstances, liquidation was extremely likely if not inevitable. The creditors would have been out of pocket regardless of the Phoenix process.

Another criticism of Phoenixing is that creditors are not afforded the right to reject the new company's proposal to purchase the business assets from the failing company. To go to an open process of sale however, is recognised to often destroy the value many of the companies assets and certainly any goodwill. In addition, discussing matters with creditors before a potential sale of assets opens the possibility of the creditor taking unilateral recovery action which may well be detrimental. As such, a Pre Packaged sale will actually deliver the best possible return to creditors. Creditors are afforded increasing protection in terms of getting the best deal when the old business assets are sold. In November 2008, the Insolvency Service published strict guidelines for this area in the form of SIP (Statement of Insolvency Practice) 16 which requires insolvency practitioners to ensure that proper market value is paid for the assets and a full report of why this was beneficial to creditors must be submitted to them.

The arguments for the Phoenix process are compelling.
- The new business is not saddled with the historic debt
- There is no obligation for debt repayment
- It allows the introduction of new procedures and ways of working
- Inappropriate location or lease agreements are not retained giveing every opportunity for sucess
- Far better chance of jobs being saved compared with Liquidation

Despite the advantages this will obviously not be the correct solution for all businesses in financial trouble. However, with increasing numbers of businesses under financial pressure and at risk of failure, Phoenixing must certainly be given serious consideration.

Derek Cooper is Managing Director of Cooper Matthews Limited coopermatthews.com and a member of the Turnaround Management Association UK.

With significant experience in working with small to medium sized businesses, Cooper Matthews specialise in providing straight forward insolvency advice for businesses with financial problems.

For free expert advice on whether Phoenixing is right for your situation visit coopermatthews.com/phoenixing.html

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