A pre-packaged insolvency option which would allow the debtors and creditors to work for an informal plan has been proposed by Indian and once the freeze on the filings is lifted as the nation braces for a spike in bankruptcies, the plan would be submitted for approval. Comments have been invited by the Ministry of Corporate Affairs from the General Public which if accepted, would become a part of the Insolvency and Bankruptcy Code, 2016 according to the statement which was made. An option has been suggested by the Sub-committee which recommended to quickly amend the code, preferably by an ordinance, to implement the code.
As the proposal suggests, the aim is to aid the existing insolvency framework and to cut the time and the cost of the process of resolution. A pre-packaged insolvency would allow the creditor and the debtor to work on a resolution informally without the involvement of a tribunal or a court, while there is no specific definition. If the parties agree, the plan can be presented to the adjudicating authority for their approval. The plan can be applied even before a default as it is a combination of the formal and the informal insolvency. In the past, experts have battled for the time taken to complete the process of insolvency resolution and the process of citing a high caseload at tribunals.
The proposal for such comes when the filing of the fresh filings of the bankruptcy remains suspended during the pandemic protect firms as the firms are facing distress due to the COVID-19. A detailed scheme is to be recommended by the sub-committee for its implementation, among other things suggested by the sub-committee of the Insolvency Law Committee which was set up in June 2020. A skeletal provision may be made by the IBC Code enabling a pre-pack, while the informal part could be guided by a self- regulation, best practices, guidelines, or left for market practice etc. For any stress, pre- and post-default and for all the corporate debtors, pre-pack must be made available. This may be commenced by allowing for defaults starting from Rs. 1 lakh to Rs. 1 Crore and for the Covid-19 defaults. This can be followed for defaults above Rs. 1 Crore, and then defaults from a Corporate Debtor (a company which has defaulted from debt) which may be from Rs. 1 to Rs. 1 lakh and this shall initiate a pre-pack with the consent of a simple majority of the unrelated shareholders and creditors. This period of moratorium shall be available, whether by the approval of the resolution plan or otherwise, from the date of the pre-pack commencement till the closure of the process.
During the pre-pack process, the corporate debtor shall remain under the possession and the control of the present management and promoters. In respect of the resolution applicants for the submission of the plan of resolution, there shall be no dilution of the provisions of the Section 29-A which defines the eligibility of the applicant of resolution. Except when the committee of creditors decide to liquidate the corporate debtor with a voting share of 75%, the pre-pack shall not end up with liquidation. The benefit of the regulatory which is available to the process of insolvency shall be available to the pre-pack. For the market participants, pre-pack should allow 90 days for them to submit their resolution plan to the adjudicating authority which will have the duration of 30 days to approve the plan.
The following are the key features of the Pre-Packed Insolvency Resolution Process issued by the Ministry of Corporate Affairs under the Insolvency and Bankruptcy Code, 2016 on January 08, 2016.
To assist the stakeholders in the conduct of the process, the pre-pack usually requires the services of an insolvency practitioner. The extent of the authority of the practitioner differs across various jurisdictions.
A consensual process is envisaged by a pre-pack – a prior approval by or a prior understanding among the stakeholders about a course of action to address stress of a Corporate Debtor, before eliciting the formal part of the process. The confidentiality of the process is ensured up to a point and reduces the disputes and litigation.
The plan of action here could be a CD sale of business or a reorganisation plan of action to resolve the stress of the CD. Depending on the context and the purpose, this requires varying levels of marketing.
The approval or understanding could be limited to impaired creditors, secured creditors or to all the creditors. This conclusion is arrived at after the declaration of relevant details to the stakeholders.
The CD remains under the possession of the debtor usually, during the process (current management and promoters). Disruption of business is minimised due to this.
Moratorium is usually enjoyed by the formal part of the process.
The first right or the exclusive right to submit a reorganization plan or to buy the business of the CD is with the current promoters and the management.
The Indian economy has been affected adversely by the COVID-19 pandemic and the subsequent national lockdown which has further caused financial hardships to several businesses across the nation, especially to those who were already under distress. The president has promulgated an Ordinance of the Code of the Insolvency and Bankruptcy, in the wake of the present situation and to prevent the proceedings of the mass insolvency. The application under Insolvency and Bankruptcy Code Section 7, 9 or 10 of the code can be filed for a period of 6 months (if extended up to 1 year) for default occurring after 25 March. It is an expedient time to revisit the process of IBC and the pending reforms, while the reform had been receiving mixed response from various stakeholders. Some alternative to the conventional corporate insolvency resolution process (CIRP) could be explored by the reforms for the resolution of distress rather than the absolute suspension of the initiation of the proceeding of IBC. It could terminate causing a huge loss for a number of stakeholders because of the depletion of assets, if not.
They thought it would be the right time to revitalize the debate over the introduction of the pre-packaged insolvency (pre-packs) after taking note of the existing situation and to codify the prepacks into the scheme of the IBC. The discussion of the subject of pre-packs is not new for India although the nation might not have still recognized pre-packs in its legal framework. The introduction of the pre-packs as part of the code has also been deliberated by the Committee of the Bankruptcy Law Reforms. The concepts of pre-packs have still not been given any formal recognition, till date.
What Are Pre-Packs?
Pre-packs is a mechanism which is used for encouraging the stakeholders in the process of restructuring to mutually negotiate the terms of restructuring, which is generally preceding to the commencement of the proceedings of insolvency. It is expected that the court gives a formal recognition to the said plan, while the parties can agree for a mutually cognizant plan of resolution. It is necessarily not an absolute out of court settlement between the parties which are involved, contrary to the popular perception, and for the final implementation of the pre-packs, the interference of the tribunals/ courts would be required. Therefore, along with a mutual settlement of the terms of the restructuring between the creditors and the debtors it can be said that it will be a hybrid process which also involves court settlement. To ensure that no prejudice is caused due to the terms of the restructuring to any stakeholders, the court’s oversight is also necessary to ensure that the restructuring is arrived at and that everyone is fairly treated.
The major implementation of the pre-packs remains the same, coming out as a popular method of a corporate rescue, while the practical aspect of the pre-packs differs across these jurisdictions.
Pre-Packs Proposition in India
The standard duration which would be taken for the completion of the process of resolution in India crosses the timelines stipulated under the IBC Code, 2016. For this reason, the central government has been contemplating introducing the pre-packs as an alternative to assist significantly in reducing these timelines. It will also be a welcome relief for those adjudicating authorities who are already overburdened with a significant number of pending cases of such number, apart from reducing the timelines. Thus, the pre-pack would also help in de-clogging the whole overburdened NCLT ecosystem and not only in promoting the cost and time efficiency by cutting the fewer filings and the litigation cost.
Considering the fact that banks are under pressure already and are facing pressure, in the wake of the COVID-19 pandemic, the present blanket ban of the fresh proceedings of the insolvency under the Section 7,9, 10 of the code might not be a good step as it might lead to a way of the creation of unscrupulous borrowers and would increase more stressed debt levels at the banks consequently. For the government to introduce pre-packs formally with a proper mechanism in place, given the above background. This introduction can achieve a dual objective of mitigating the impact of COVID-19 on financially distressed businesses and promoting debt enforcement restructuring. Further, to both the debtors and the creditors, this process might be agreeable.
Implementation and future of pre-packs
The introduction of pre-packs in India would essentially mean that it would require some serious contemplation and due diligence as there exists no legal frameworks and prior regulatory experience with respect to pre-packs. For the big corporations, introduction of such a mechanism might be a risky option if it is not implemented well without prior knowledge of its effects. Therefore, a phase-wise introduction of the pre-packs can be considered by India. The mechanism can be further expanded to other sectors, upon getting a successful and favourable outcome in the first phase, based on the regular analysis of the process. It is suggested that in the first phase, the pre-packs are introduced in the Micro, Small, and Medium Enterprises (MSME’s) sector given the fact that pre-packs would be a new reform that comes with its own sets of risks and challenges and given the fact that they have a smaller number of financial creditors.
In June last year, a pre-pack framework with the basic structure of the Insolvency and Bankruptcy Code (IBC), by the sub-committee of the Insolvency Law Committee (ILC) which was constituted by the government and the report was submitted in October.
Benefits of A Pre-Pack
Pre-packs have the advantage of being a more informal process and having the possibility of closure in a shorter period of time compared to a regular corporate insolvency resolution process (CIRP) under the IBC.
Pre-pack provides the stakeholders with flexibility in working out of a consensual, but efficient, strategy for the maximisation of the effective resolution and value since the process prior to the commencement of the formal proceeding is informal which may be difficult under the formal procedure of insolvency.
Because a substantial part of the proceedings is undertaken before the beginning of the formal proceedings by the court, the whole process takes considerably less time. This assists the company as keeping a stressed company running for a longer period is not only difficult but it also increases the resolution cost.
Concerns with Pre-packs
Unsecured creditors often feel disenfranchised by the secrecy as the nature of the pre-packs leads to the lack of transparency. Possible concerns are also being raised on the process of the valuation and experts feel more can be done to explain the methodology of the valuation to bring comfort to all the stakeholders. Furthermore, there is no legal requirement for the insolvency practitioner to look at the future viability of the new business which is emerging from a pre-pack sale and the legal responsibility of the practitioner is to the creditor of the old business. For both the transferring suppliers and the new suppliers this may be a concern. Criticism has also been garnered by the sale of business and assets of the corporate debtor to the connected parties.
Key Recommendations of Sub-Committee
- Pre-packed process of insolvency resolution (PPIRP) framework to be within the basic structure of the code of insolvency as an additional option for a resolution that blends with both informal and formal options. It can be bought in via an ordinance quickly.
- With checks and balances to prevent any abuse, PPIRP would pursue the same objectives as the IBC.
- Starting with defaults from Rs. 1 lakh to Rs. 1 crore, the implementation of the PRIRP may be phased, and then expanded to defaults of over Rs 1 crore.
- If 75% of creditors consent, the pre-packs in case of pre-default can be considered.
- With the consent of a simple majority of (A) Unrelated FC’s (B) its shareholders the corporate debtor (CD) can initiate the pre- pack. No two proceedings – shall run in parallel- pre-pack and CRIP. There shall be a cooling off that within three years of closure of another pre- pack, that a pre-pack cannot be initiated.
- During the pre-pack process, the corporate debtor is to remain in control and possession of the current promoters and management.
- From the pre-pack commencement date till closure or termination of the process, moratorium under Section 12 is to be available, but it wont cover critical or essential services.
- With the approval of the required majority of votes CoC is to take decisions, but approval of 75% of the voting share would be required for the decision to liquidate. However, there shall be no liquidation where pre-pack was commenced for pre-default stress, for initiation of CIRP and COVID-19 defaults which is the default below the threshold for initiation.
- The promoters of the defaulting firms are prohibited by the sections 29A of the IBC from participating in the process to continue in the case of PPIRP.
- It is not necessary for resolution value to be higher than the realisable value.
- The market participants should be allowed 90 days by the pre-pack to submit the plan of resolution to the adjudicating authority, and thereafter, 30 days for the authority to approve it or reject it.
- The plan on resolution that is approved by the adjudicating authority shall be binding on everyone.
In June last year, a sub-committee was constituted by the government to prepare a detailed scheme for the implementation of prearranged process of insolvency resolution and the pre-pack. The framework must be within the basic structure of the IBC as per the report. The framework should have the discipline and rigour of the IBC and pursue similar objectives as the code does. The framework should not impair the rights of any party beyond what is provided in the code and to prevent any abuse, it should have adequate checks and balances. The same regulatory benefits should be enjoyed by the framework as are available to the CIRP. Pre- pack should be available to all the corporate debtors and for any stress, as per the panel. Capacity of the NCLT and availability of the SIRP for MSME’s should be depending on the objective of the policy, and the implementation could be phased accordingly. After the successful implementation of the pot-default resolutions, pre-pack in respect of the pre-default may be considered with the consent of a higher threshold of all the creditors. The debtors shall commence pre-pack with consent of the simple majority of unrelated financial creditors and its shareholders as per the recommendations.
From the pre-pack commencement date (PCD) till the closure or termination of the process, the mortarium under section 14 shall be available, whether by approval of the plan of resolution or otherwise. However, it shall not cover critical or essential services. This should come from the eligible and interested promoters. The CoC may arrange a base plan otherwise, it recommended, adding that two optional approaches should be offered by the pre-pack, namely, without swiss challenge but with no impairment to the operational creditors (OC), and with rights of OCs with Swiss Challenge and dissenting financial creditors (FC) subject to minimum provided under Section 30(2)(b).
The report states that given the limitation of standard CIRP “one size fits all” which is also not available in respect of the defaults of Covid-18 and defaults which are less than Rs. 1 Crore at this time when there is a need for the economy to recover fast.
It was stated by the report that the initial point could be a variant of the pre-pack which requires the least preparation and that it can be rolled out within the ecosystem which is existing. It is important that it is made accessible. The report stated that it is the right time for the pre-packs to be introduced under insolvency law in India.