When companies are going under, you have to be especially vigilant about not letting customers get behind on the bills. You may think that if you are too lenient and a laggard customer folds, insolvency proceedings will belatedly recover some of what you are owed. Perhaps your customer’s debt to you is secured, which leads you to believe that you will be among the first in priority for payment if the customer collapses.

In the United Kingdom, that is not necessarily true.

When a UK company collapses, it goes into administration. An administrator is appointed (usually an accountant with considerable experience handling insolvencies). The administrator uses the company’s assets to pay creditors to the extent feasible. Exactly how it is done and exactly what powers the administrator has depend upon details such as the age of any security interests against the assets.

So far, this is comparable to what you expect when a company in a nation with similar laws, such as the USA, files for bankruptcy protection. But there is a variant in the UK that can catch you by surprise and leave you with nothing.

Pre-packaged administration (pre-pack) essentially allows the best portion of a collapsing business to be sold without prior notice to its creditors before an administrator takes over.

While an administrator sifts through assets and looks for a buyer, a collapsing company continues to deteriorate. In theory, pre-pack can save jobs and keep the productive parts of a business contributing to the economy by providing a streamlined path for handling insolvency. In practice, frequently not enough is left after pre-pack for the administrator to do much for creditors. This sometimes causes a ripple effect of job losses and business collapses among vendors to the pre-packed firm—a ripple you do not want to join.

Pre-pack has become a magic wand. Owners or directors can put together a new company, line up financing, and buy the best of the collapsing business in a pre-packaged deal. There is no prior notice, nothing put on the market to let anyone else have a chance at buying it. Creditors find out after it has been done. The new company, which may be owned and run by the same people who ran the old one, is unfettered by the original firm’s unpaid creditors or customers who never got what they paid for. Creditors may never get a penny, since the administrator is left only the dregs for satisfying the old company’s liabilities.

New guidelines took effect in January 2009 (Statement of Insolvency Practice 16). These call for disclosure of 17 factors in a pre-pack sale, to show why pre-pack is justified. However, this disclosure need not be available until after (perhaps long after) the prearranged sale. The new guidelines have a loophole for exceptional circumstances that can cause some information never to be available to creditors. Although the new guidelines are supposed to cut down on pre-pack sales to related parties (owners and directors of the insolvent firm), it is not at all clear whether that will happen.

So if you are doing business in the UK, pay extra attention to your customers’ financial health. A bankrupt customer in some countries means you will wait a long time to collect a fraction of what you are owed. But if a customer in the UK goes into pre-pack administration, you may very well never collect anything.