Normally it is illegal to trade while insolvent but pre-pack administrations allow directors to spend weeks plotting their insolvency and then buy the best bits of their company and resume business. The new rules were brought in to help rescue companies but they risk causing the collapse of suppliers who go unpaid while the directors carry on trading.

Pre-packaged administrations involve the directors bringing in an insolvency advisor who negotiates with secured creditors – usually banks – to wind up the business with the adviser as administrator who then simultaneously sells the best assets to a new company with the same directors. That provides funds to repay the banks but the first the unsecured creditors learn of the insolvency is after the deal is completed, leaving them with unpaid debts. No attempt is made to sell the business to third-parties that might offer more.

The business re-emerges debt-free under the same name in the same premises with the same managers and directors but freed from its debts, the loss-making parts of the business – unprofitable shops in a chain, for instance – and without any onerous contracts or leases.

In theory pre-packs ensure some part of the business and some jobs are retained, but in practice dozens of suppliers can be left with unpaid invoices and have to lay-off their own workforce or even go into administration themselves. The company could have been placing high orders with these suppliers to build up stock during the time they were plotting their pre-pack.

Often the suppliers not only have to face financial loss but to decide whether to continue supplying the new business – very likely on new, inferior, terms. Some big-name companies and entrepreneurs have exploited the pre-pack route this year to shed their debts and remain in business.

Pre-packs have accounted for about a quarter of all administrations this year with connected parties emerging as the new owners in more that four-fifths of cases.  Many were management buy-outs purchased too expensively with too much debt that have been caught by the recession and credit crunch: pre-packs allow management to continue with a smaller but profitable business that has no borrowing.

The Insolvency Service needs urgently to review the use of pre-packs. Alongside unsecured creditors, the main losers are credit insurance companies that pick up the bills: their trade body, the Association of British Insurers, is calling for a ban on the insolvency adviser becoming the administrator, wants debts incurred after the adviser is appointed ringfenced, and is demanding that unsold stock is quickly returned to suppliers.

These deals lack transparency and ethics.  Unsecured creditors should be as involved in any discussions as the banks that will be paid in full. All pre-packs should be investigated by an authority such as the Insolvency Service. There should be evidence the directors bought at a fair price. And those investigations should ask whether the directors were trading illegally while they plotted their insolvency. As the administrators are part of the deal, they cannot be relied on to blow the whistle.

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