Insolvency Regime Changes – A Step Forward

There’s nothing like issuing a major Government announcement on the Sunday of an August bank holiday weekend to get good media coverage is there? But as it’s raining and I have nothing much else to do, I have read the announcement and here is a summary:

The announcement is entitled “Insolvency and Corporate Governance – Government Response” (see https://www.gov.uk/government/consultations/insolvency-and-corporate-governance ). It is the Government’s response to past public consultations on how to tackle some of the perceived problems when companies get into difficulties or go bust. Such examples as House of Fraser (see my past blog posts on that subject where I called for reform of pre-pack administrations), Carillion, BHS, et al.

It aims to tackle issues around company director actions when a company gets into difficulties but one of the main proposals is very significant. That is that the Government intends to introduce a “Moratorium” scheme where a company can hold off its creditors for up to three months while it seeks to develop a restructuring proposal. Although a Moratorium will be a court process and will be supervised by a “Monitor” who is likely to be an insolvency practitioner, the directors of the company will remain in control albeit with some limitations.

Representatives of secure creditors (e.g. bank lenders) did not seem to like this idea at all based on their responses to the consultations, but it’s not quite as generous as first appears. Apart from the “monitoring” requirement to protect the interests of creditors, the initial period of a Moratorium will only be 28 days and can only be extended to 3 months if justified, and the company must be able to meet the normal insolvency rule that current obligations must be capable of being met as they become due during the Moratorium. But it is surely a step in the right direction in that it will provide more chance of those businesses that are not pure basket cases of being rescued to the advantage of trade creditors, pensioners and shareholders. That’s as opposed to the present situation where a pre-pack administration can instantly dump everyone except the secured creditors with massive damage to everyone else.

But directors of companies will need to act more in advance to ensure that a Moratorium is of help. To encourage them to do so the Government hopes to improve shareholder stewardship by identifying means to help the actions of institutional shareholders and others to escalate their concerns about the management of a company by its directors.

In addition the Government wishes to improve board directors effectiveness and training including raising awareness of their legal duties when making key decisions, and developing a code of practice for board evaluations. Comment: it is certainly the case that in smaller public companies the directors often seem to be unaware of their legal obligations and this sometimes extends to larger companies. I have argued in the past that all public company directors should have some minimal education in company law and their other responsibilities when acting as a director.

One issue examined was the payment of dividends by companies when companies were apparently in a weak condition such as having substantial pension liabilities or were paying dividends shortly before they went bust. Whether a company can pay dividends is governed by the calculation of whether it has “distributable reserves”, but that is a calculation that only the company and its auditors might be able to do. It’s not obvious from the published accounts. The Government is to work with interested parties on a possible alternative mechanism.

There were also concerns expressed that some companies are now paying dividends only as “interim dividends” which can escape approval by shareholders at Annual General Meetings. The Government has asked the Investment Association to report on the prevalence of the practice and they will take further steps to ensure that shareholders have an annual say on dividends if the practice is widespread and investor pressure proves insufficient.

In summary, I welcome all of these proposals as a step forward in rectifying some of the defects in the existing insolvency regime. The slight concern is that companies will be reluctant to enter a “Moratorium” due to the adverse publicity it might generate and the costs involved so we will have to see whether that turns out to be the case or not. But almost any restructuring solution is better than a formal administration or liquidation.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Mulberry Profit Warning – Better Late Than Never

On Saturday (18/8/2018) I wrote about the damage to suppliers from the pre-pack administration at House of Fraser. One of the companies mentioned was Mulberry Group Plc (MUL) and I queried why they had not issued an RNS announcement indicating the likely impact on their profits. I suggested it could be £2.4 million.

This morning Mulberry issued a profit warning that spelled out the likely figure. There will be a provision of £3 million of “exceptional costs” related to the 21 “concessions” that they operated in House of Fraser stores. That arises from “a review of debtor balances, fixed assets and potential costs that may result from restructuring”.

For the avoidance of doubt, I have never owned the shares, nor bought their products. They do sell some nice handbags at £1,000 plus though. Both the products and the share price are too rich for me. At a prospective p/e of over 50 even before this morning’s profit warning, they must have some loyal followers.

The share price has fallen by 17% this morning at the time of writing. I hope shareholders in Mulberry will complain to the Insolvency Service (part of the BEIS Department – the responsible Minister is Kelly Tolhurst M.P.). The insolvency regime needs major reform.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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House of Fraser – The Real Damage from the Pre-Pack and to Mulberry

I have covered the abuse of pre-pack administrations and the case of House of Fraser in two previous blog articles. But now that the initial administrators report has been published the real damage is very clear.

House of Fraser had total debts of £884 million of which trade suppliers were owed £484 million. The latter means goods supplied to the company, and sitting in the stores being sold to customers which will not be paid for by either the administrator or the new owners. The suppliers included big names such as Mulberry, Giorgio Armani, Gucci and Prada plus no doubt a large number of smaller suppliers as is common in the “rag trade”. Some of the latter might well go bust as a result.

Let’s look at luxury products supplier Mulberry which is a UK listed company (TIDM MUL). They are owed £2.4 million when last year their net profits were £6.2 million so the potential hit to their profits is very substantial as the administrator is very unlikely to pay them. What might offset those losses?

They might have “reserved title” on the goods supplied if they wrote their contracts correctly although such claims are typically resisted by administrators. They might also have insured the risk of not being paid by their customers in which case the cost will fall on the insurers. They may also do some kind of compromise deal with new owner Mike Ashley whereby he pays a figure to ensure continuity of supply. But Mulberry have made no public announcement of the likely impact on profits which is surely required sooner or later from a public company. Perhaps they are still trying to figure out the impact or are simply “in denial” about the cost.

Retail concession operators within the House of Fraser stores are also in a difficult position. Stock in the stores is theirs and has been removed in some cases. But past sales will have been put through the House of Fraser till system. The cash may be in a trust account, or it may not.

Retail customers of House of Fraser have also been affected, particularly those who ordered products from the company’s web site. These should have been delivered from warehouse operator XPO Logistics who are owed £30 million and stopped processing orders soon after the administration. Whether the customers will get refunds or will have to claim against their credit card suppliers is not currently clear.

The House of Fraser web site is currently unusable so they will be missing a lot of potential orders. The site simply says “We’re currently working hard to make some improvements to the website” which is a misleading euphemism for “systems needing to be totally rebuilt with a new supply chain”.

You can see from the above that although a pre-pack administration appears a simple way for a business to continue while jobs are protected, in reality it is far from simple and enormously damaging to a wide range of people and companies. The bankers and lenders to the company are first in line for any payout as “secured” creditors but typically all other creditors get nothing in such cases. It seems unlikely that it will be any different here.

In conclusion, you can see from the above, and the impact on the pension fund of the company covered in a previous article, that pre-pack administrations are only simple solutions for insolvency practitioners and bankers. For everyone else they are a nightmare. The disruption they cause creates much wider impacts and justifies looking for a better solution to the problems of companies that are losing money and running out of cash.

THE INSOLVENCY REGIME NEEDS REFORM. THERE ARE BETTER SOLUTIONS TO THE HANDLING OF INSOLVENT BUSINESSES.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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House of Fraser Pre-Pack – More Details Disclosed

The Financial Times disclosed more details of the pre-pack administration of House of Fraser this morning which I previously commented on here: https://roliscon.blog/2018/08/12/house-of-fraser-pre-pack-is-it-such-a-great-deal/

The FT makes it clear that there was at least one other serious bidder for the company who was willing to purchase the business as a “going concern”. That bidder was Philip Day. How much he was willing to pay is not totally clear, but EY, the administrators are quoted as saying “For the avoidance of doubt, this was the only available offer to save the business, and in comparison to the alternatives represented by far the best recovery for the creditors of House of Fraser”.

The first part of that statement conflicts directly with the other information obtained by the FT. My conclusion is simply that the administrators preferred one bidder rather than another, probably at the behest of the secured lenders (i.e. the banks). There can be a number of reasons for doing so but in essence it’s very typical of what happens with pre-packs where the rush to complete the deal prejudices obtaining the best outcome other than for the secured creditors. So stuff the pensioners, stuff the trade creditors who have supplied goods they won’t now be paid for, stuff the property owners and stuff everyone else so long as the banks get paid.

The administrators can always claim in such circumstances that other offers were not available because very few bidders are likely to make an offer without some information about the business they may be buying and they may need time to put in place the funding required. At least some minimal due diligence is essential. But the administrator can delay or hold back information to thwart other bidders than their favourite candidate. So they can claim that there was only one firm offer on the table when the business was placed into administration.

This is a corruption of the administration process when there should be open marketing and time allowed for reasonable offers to be made so as to obtain the best solution for all stakeholders.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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House of Fraser Pre-Pack – Is It Such a Great Deal?

The acquisition of House of Fraser by Sports Direct is a typical “pre-pack” administration. In administration one minute, sold the next. The national media promptly welcomed it as the rescue of everyone’s favourite department store, the protection of 17,000 jobs and just what is needed to help save Britain’s High Streets.

Mike Ashley of Sports Direct trumpeted this as a great deal. All the stores and stock were purchased for £90 million when gross assets were £946 million and the company made a profit last year of £14.7 million – more on the financial numbers below. He plans to turn House of Fraser into the “Harrods of the High Street”.

But is it such a great deal? I have written many times in the past about the iniquities of pre-pack administrations. How creditors and shareholders are dumped, and pension schemes likewise. The administrators save themselves the hassle of winding up the business or looking for a buyer of the business as a “going concern” while collecting large fees for little work. I think the insolvency regime should be reformed.

The figure of £946 million of gross assets given by Sports Direct is from the last published accounts of the parent company House of Fraser (UK & Ireland) Ltd for the year ending January 2017, which is the last set of accounts filed at Companies House. The truth is that the company had net assets of £111 million with trade creditors of £365 million and long-term borrowings of £284 million. Debts including short terms borrowings probably grew substantially since then. Although Mr Ashley is paying the administrators £90 million for the assets, it would appear that both the trade creditors and the lenders will be very substantially out of pocket.

That’s not to mention the property companies who are the store landlords who face a default on their leases. Mr Ashley is unlikely to want to keep half the stores, so many of the jobs will be lost and he will no doubt want to renegotiate the leases on other stores downwards. So any property companies you may have invested may be damaged.

The company will have got shot of its defined pension schemes (approximately 10,000 members) which will be taken on by the Pension Protection Fund. That’s a public body that is funded by a levy on all pension schemes, so basically someone else will be paying if there is any shortfall. Although the pension scheme may be in surplus at this time, in such circumstances pensioners usually face a substantial cut in their future income as there will be no more contributions from the company.

Now House of Fraser might have been a retailing basket case with excessive debt, but surely a more equitable solution was possible? Indeed the Mail on Sunday today called it a “Fix” because there was an alternative offer on the table from retail billionaire Philip Day who allegedly offered £100 million for the company including taking on the pension obligations. The Mail suggested that the bankers and bondholders forced acceptance of the Ashley proposal in their interests. This is not unusual in pre-packs.

Sir Vince Cable suggested an investigation by the BEIS Department is required followed by reform of the pre-pack system. I agree with him. There are better solutions to how to deal with companies that run out of cash or become insolvent due to excessive debt which could protect the interests of trade creditors, employees and pensioners.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Conviviality Fire Sale

Conviviality (CVR) has now gone into administration, and the ordinary shares are probably worthless (they were suspended some days ago and are likely to remain so). The administrators have already sold the major parts of the business in “pre-pack” administration deals. That’s where arrangements are made to dispose of assets in advance of the appointment of administrators by the prospective administrators before they have in fact been appointed. Is that legal you may ask? Yes it is because of a past legal case however perverse the result might be.

It’s interesting to look at the deals done by the Conviviality administrators:

  1. Retail chains Bargain Booze and Wine Rack have been sold to Bestway for £7 million.
  2. The wholesale division comprising the former businesses of Mathew Clark and Bibendum has been sold to C&C (owners of Magners Cider) for £1, although it seems the new owners have taken on some of the debts owed.

Matthew Clark was bought by C&C for £200 million three years ago and Bibendum was bought for £60 million in 2016. You can see why I call this a “fire sale” when the administrator seems to have lined up buyers in just a few days and disposed of these businesses at a value that seems to be a great bargain for the buyers.

One of the problems with administrations is that often the administrators have an objective to sell the business absolutely as soon as possible. This is to protect their own financial interests it frequently appears to me as much as it is to protect the jobs of employees and maintain a business as a “going concern”. Administrators can only get paid out of the cash that is present in the business or can be collected. That’s why nobody wanted to take on the administration of Carillion and it went straight into liquidation.

Administrators have an obligation to market a business for sale but can that be done adequately and the best price obtained when the deal has clearly been done in just a few days? That obviously does not allow any time for the normal due diligence on a substantial deal so the buyers won’t have paid anywhere near the normal market price for the assets.

In summary, the buyers of the assets get a great deal, the jobs get preserved (at least to some extent), the bankers to the company often get their loans back and the administrators get well paid while minimising their risks. But the previous owners of the business (the ordinary shareholders) get left with nothing. Is that equitable?

In effect the current legal structure, and particularly the pre-pack arrangements, enable the rapid dismantling of a business when it might have been recoverable if the company had been able to have more time to refinance the business and stave off its creditors for just a few weeks.

This is why I argue that the current UK insolvency regime needs reform. It destroys companies in short order when ordinary shareholders have often invested in the company to grow the business in the past. In the case of Conviviality it only listed on AIM in 2013 and did subsequent placings to finance its expansion.

The reason for the invention of “administration” in the insolvency regime was to enable a more measured wind-up, disposal or restructuring of a business rather than a liquidation. But insolvency practitioners (i.e. administrators) seem to have changed it into a short-cut to wind-up. Reform is surely needed.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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VE and Pre-Packs

There was an interesting report in today’s FT on the case of Ve Interactive, a UK company once allegedly worth more than $1 billion (at least they had several hundred employees) which went into administration after making heavy losses. It is alleged that CEO and founder David Brown mismanaged the company and he has subsequently be made bankrupt.

The business was taken over by a consortium of investors (including Douglas Borrowman and Mark Pearson) some of whom became directors before it went into administration. It was subsequently sold quickly to those directors via a pre-pack (for £2 million).

But the administration (by Smith & Williamson) has been challenged in court and they have been removed by the court. Mr Brown and two former members of the consortium mounted the challenge based on the claim that the administrators were “completely blind” to the conflict of interest in selling the business to the directors. They also claim the sales process was mishandled and bidders only had one day to make an offer. They say there was no chance of a meaningful bid being made because of insufficient information being provided to potential buyers. Ve Interactive is now trading as “VE” and is owned by Ve Global UK Ltd.

At least that’s the gist of the story so far as one can understand such complex events.

In essence this is a typical example of a pre-pack administration which I have commented on many times in the past. A business is sold in extreme haste, often to related parties as in this case. The process happens so quickly that there is no chance of adequate marketing of the business to get a fair price. The administrators can ignore anyone but their chosen buyer and deter them by restricting information and giving them little time to raise finance or adequately consider the matter.

In summary, pre-packs are ethically dubious, legally corrupt and should be outlawed as soon as possible. As I said only recently in an article about events at Carillion: “Regrettably in the UK, insolvency law seems to have been devised mainly in the interests of insolvency practitioners and bankers. It is time for a complete reform of the law and practices in this area.”

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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