CONUNDRUM OF PRE-PACK INSOLVENCY IN INDIA: PART 1

Source : Leiden Law Blog

This article has been authored by Himanshu Chandel, a third-year law student at Campus Law Centre, Delhi.

Introduction:

The Insolvency and Bankruptcy Code (“the Code”) which is widely regarded as one of the most important structural reforms in recent times has lived up to the expectations and aims for which it was enacted and it would be a fair analysis that the critics to this big ticketed reform have more or less been proved wrong. The Code in its nascent stage had to go through rough patches and the evolution process invited hurdles that could have made the code follow in the shoes of its predecessor legislations such as the Sick Industrial Companies Act, mechanisms such as Corporate debt restructuring and other ancillary initiatives which failed miserably but the Code managed to get past such hurdles and has provided India a well-established insolvency framework. It would be fair to say that the balance between creditor-debtor relationship has been established and a robust jurisprudence has developed under code through effective judicial pronouncements since its inception. Both empirical and anecdotal evidence suggests that the time is ripe to have thought out discussions on marrying the statutory process for resolution of corporate insolvency under the Code, and the schemes of out-of-court debt restructuring mechanisms. Barring the effect of the ongoing Covid-19 crisis which will certainly increase the pressure on Tribunals and jeopardize the proceeds from the Code’s implementation, working to implement out of court settlements under the code remains imperative and the pandemic has further incited the debate.

A pre packaged or a pre-arranged insolvency resolution process is one hybrid process, that can marry the advantages of an informal workout—which are characterized as speedy, economic, and flexible processes—with the statutory protection that is accorded to formal proceedings. It is one where the resolution plan is formulated and finalised prior to the commencement of formal proceedings. The pre pack allows “a troubled company and its creditors conclude an agreement before the commencement of statutory administration procedures” which “allows statutory procedures to be implemented at maximum speed”[1]

Pre pack could be initiated in two forms, (i) if a company is not in default but there is a suspected stress then a corporate debtor can undertake a pre-pack before the occurrence of an event of default of a creditor. If the default has not been triggered or threatened to be triggered it could be then initiated by the debtor himself or in the event that there is an eminent threat of default. (ii) If the corporate debtor defaults on a underlying payment due to a creditor or when the creditor is aware of the distress of the corporate debtor, in that case a creditor may seek to restructure its debt through a pre pack insolvency mechanism. In case the debtor endeavors a process through pre pack, the situation would require a board resolution to be passed and in case of a creditor of a debtor company pursuing to initiate the pre pack, a broad understanding of the all creditors of the debtor company becomes vital. Fundamentally what a pre pack does is preserve the value of the enterprise and strike the balance between the interest of all stakeholders. A delay in resolution can cause serious detriment to the on-going concern of the corporate debtor impacting the realizing value of the assets. The need of the hour is the speedy and effective resolution which can be achieved by pre-pack.

The Bankruptcy Law Reforms Committee which prepared the first draft of the Code had deliberated on the introduction of pre-packs as part of the Code. However, the Committee felt that further consultation with stakeholders and a separate set of rules governing pre-packs were required before pre-packs could be introduced.

The purpose of pre-pack is to strike down a balance between safeguarding the interest of the creditor(s) and maintaining the business and assets of the corporate debtor by facilitating a swift transition of such assets and business. One of the causes for the failure of out of court restructuring mechanisms in India was the presence of a fragmented legal regime for insolvency resolution. A comprehensive and effective insolvency law is one of the pre-requisites for the success of informal workouts[2]

The practice of pre-packs was first introduced in the US, following the enactment of the Bankruptcy Reform Act of 1978 which expressly allowed for pre-packs. In fact, pre-packaged proceedings have been considered more effective than both, the formal reorganisation proceedings under Chapter 11 of the US Bankruptcy Code and pure out-of-court restructurings. In a pre-pack, “a troubled company and its creditors conclude an agreement in advance of statutory administration procedures” which “allows statutory procedures to be implemented at maximum speed.”[3]

The US Bankruptcy code prescribes three different types of pre-packs i.e pre-packaged bankruptcy proceedings, pre-arranged bankruptcy proceedings and pre-plan sales. India can certainly incorporate its own set of independent frameworks for pre-packs through these mechanisms taking into account the unique features of the IBC and the aspects of Indian context.

Procedure:

In a Pre-packaged insolvency resolution process (“PPIRP”), a corporate debtor, or a financial creditor to whom a specified percentage of the total outstanding debts of the debtor are owed, may initiate the process by appointing an independent insolvency professional (“IP”). The insolvency professional should conduct the pre- packaged insolvency resolution process keeping in mind the objectives of the Code and with a view to maximize the value of assets of the corporate debtor. To ensure transparency and accountability, an insolvency professional would be held liable ex post, if there is any proof of misconduct on her part.

During the pre-commencement stage, the insolvency professional should invite plans from prospective resolution applicants, and undertake adequate marketing measures to ensure that the resolution plan offering the best possible consideration is submitted. After the submission of plans, the insolvency professional should call upon the Committee of Creditors (“CoC”) to approve a plan. Thereafter, the insolvency professional should file the approved resolution plan, along with other relevant documentation evidencing the procedural steps undertaken during the pre-commencement stage, with the Adjudicating Authority. This would be followed by a public announcement disclosing the details of the pre-packaged insolvency resolution process and the proposed plan, in order to provide an opportunity to any affected stakeholder to object to the proposed pre-packaged plan. However, to ensure certainty of process, the Adjudicating Authority should consider objections that are solely related to the procedure undertaken by the insolvency professional and should disregard any challenge to the commercial decisions taken by her. After hearing objections from stakeholders, if any, the Adjudicating Authority may approve the plan. In order to ensure swiftness and certainty, it is proposed that if the Adjudicating Authority fails to approve or reject a pre-pack plan within a specified period of time after the date of filing, the Adjudicating Authority should be deemed to have approved the plan.

A Pre-arranged insolvency resolution process (“PAIRP”) works on similar lines as a Pre packaged insolvency resolution process, the only difference being that there are cases where it may not be feasible for the CoC to approve a plan at the pre-commencement stage and hence the Insolvency professional files an application before the Adjudicating authority for initiation of formal proceedings under the code after which the IP concludes the claim collection process and proceed to convene a meeting with the CoC, to consider the pre-arranged resolution plan. If the CoC approves the plan, it should be placed before the Adjudicating Authority for its approval.

A third mode of process is also proposed, specifically for time sensitive cases where a quick going concern sale would be the most value maximizing option. In a Pre-arranged sale, the insolvency professional would conduct a sale of all or substantially all the assets of the corporate debtor during the pre-commencement stage without requiring the prior approval of creditors. However, prior to conducting a pre-arranged sale, the insolvency professional should determine the necessity of such a sale, in light of the financial position of the corporate debtor and other relevant factors. However, as the insolvency professional will play a central role in a pre-arranged sale and as the profession of insolvency professionals is still at its nascent stage, it is proposed that pre-arranged sales should be enabled in India only after the profession has sufficiently developed such that creditors and other stakeholders can adequately repose trust and confidence in the professional competence of insolvency professionals to conduct time-sensitive sales independently, efficiently and according to the core principles of the Code.

A Speedy Process?

The Bankruptcy Law Reforms Committee(“BLRCReport”), observed that “the most important objective in designing a legal framework for dealing with firm failure is the need for speed. Auctions, either as pre-packs or in bankruptcy, have been utilized under the Swedish bankruptcy system with success. They have been found to be a speedy, low-cost bankruptcy procedure.[4]

The main advantage is that the time is compressed as the major aspects to the process are finalised beforehand and the company therefore avoids lame duck syndrome. Typically, during a CIRP under the code, the value of the goodwill of the company keeps going down and the company runs the risk of losing key employees as well as suppliers and clients who would understandably be concerned by its financial position. The speedy disposal of a pre-packaged case decreases the total cost involved in the process, which is often key to saving small businesses that cannot withstand the costs of a prolonged insolvency, and helps in maximizing value.[5] A pre-pack will minimize the time the company will have to spend in insolvency and thus increase the chance of rescuing its business.[6]The longer the public process goes on the more the indirect costs associated with increases and therefore pre packaged process can be utilized to truncate the time company spends in resolution.

The downside to this aspect is that when we look at the rationale of why we would want to bring the pre pack in India, we talk about the speed of the same and how quick a resolution process would become but one of the major sources of delay is time taken in litigation and unfortunately the kind of pre packs one could visualize panning out in Indian context, approval of the NCLT would be required for it to be binding and the time at the stage of the NCLT going down remains less probable.

The second part of the article may be accessed here

[1]Vanessa Finch, Corporate Insolvency Law Prespectives and Principle (2nd edition, Cambridge University Press 2009).

[2]CorporateRestructuring:InternationalBestPractices(1stedn.,TheWorldBank,2005)

[3]See Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd edn, Cambridge University Press 2009)

[4] Karin Thorburn, Bankruptcy auctions: costs, debt recovery and firm survival, Journal of Financial Economics 58 (2000) 337-368

[5]RodrigoOlivares-Caminaletal,DebtRestructuring,(1stedn,OxfordUniversityPress2011),para 3.129

[6]Bo Xie, Comparative Insolvency Law: The Pre-pack Approach in Corporate Rescue 323 (Edward Elgar Publishing, 2010).