This article has been authored by Thrisha Rai, a second year student at Jindal Global Law School, Jindal Global University.
The enforcement of the Insolvency and Bankruptcy Code, 2016 (“IBC”) saw the onset of a new insolvency regime in India. The Code attempts to address the issues of insolvency and bankruptcy as a domestic question. Although it has greatly cut down the timeline for recovery and resolution of a company, a process under the IBC utilizes time and money. Generally, insolvency proceedings are propelled by two kinds of approaches: Formal and Informal. The formal approach entails a resolution process under a particular statute like the IBC and approaching a judicial/ quasi-judicial forum for its enforcement whereas, an informal approach could be a mutual resolution being decided between the creditors and debtors like those prescribed by the RBI, without the usage of any statutory provisions. The main drawback of the informal way of restructuring and resolving is its lack of legal recognition compared to the IBC and therefore its enforcement could become difficult. The slow progress of Corporate Insolvency Resolution Process (“CIRP”) under the IBC has been one of the key concerns of the creditors.
What exactly is a Pre-Pack?
The Government of India has been exploring and contemplating the introduction of Pre-packaged insolvency which could promote a faster resolution process of stressed assets. A pre-pack could be understood as a hybrid process of proceedings that initiates a discussion between the interested parties. An agreement for the resolution of the debt of a company is reached through an understanding between secured creditors and investors instead of public biddingprocess and then approaching the court for enforcing it. The United Nations Commission on International Trade Law (“UNCITRAL”) describes it as an ‘expedited reorganization proceeding’. The most widely accepted form of pre-pack process comprises a resolution plan which is negotiated between the creditors and the debtor before the proceedings start and is then sanctioned under a relevant statute.
One of the major differences between Pre-Pack and CIRP is the level of party autonomy. Pre-Packs grant a greater autonomy with minimal court intervention. The other contrast is that the Pre-Pack mitigates the harsh implications of insolvency on the debt-ridden company like the dismissal of the board of directors that usually happens in a CIRP.
Benefits of adopting a Pre-Pack Insolvency
As discussed, mainstream insolvency process is usually carried out when the debtor company is already burdened and is unable to carry on its regular business due to lack of funds. A major breakthrough in terms of continuing business is propelled by pre-packs as it facilitates the detection of debt restructuring at the primitive stages. Hence, by an early detection even a company undergoing insolvency, through pre-packs can continue its functioning.
The other benefit that pre-packs bestow on the corporate debtor is confidentiality with respect to the informal proceedings. While the stakeholders, voting creditors are aware of the negotiating plan, the information can be efficiently kept off the general market. There have been countless cases where companies undergoing CIRP have lost market support and goodwill. Therefore, pre-packs could be a relief to the companies that are afraid of losing market support and pending IBC petitions against them and help in value protection. The reduced costs in a pre-pack is another reason that makes it an attractive resolution option. It is less time consuming because the resolution is negotiated before invoking a statutory provision.
Drawbacks of a Pre-pack
A structured deal between the parties has a higher possibility of being defaulted by anyone as there is a lack of serious consequences as there is no statutory basis. Moreover, creditors who are in disagreement could over power a negotiation and delay a consensus. This could threaten one of the key benefits of a pre-pack.
One of the key concerns about the pre-packs is the possibility of ‘phoenixing’. This is generally used by companies that are actually not insolvent but just are technically insolvent and are led to a point of winding up and then they are restructured with the help of a pre-pack, with similar people managing the company.
Pre-packs want the regulatory and statutory exemptions a company enjoys under the CIRP process, unless it is approved by the court. This is the reason that the JET Airways’ out of court settlement did not work as they failed to get exemptions. As Etihad which was willing to invest had one condition that was it did not wish to make an offer under the SEBI (Acquisition of Shares and Takeover) Regulations which could have been possible had the process been initiated under the Code. The lenders waited for months trying to find a way outside the IBC by inviting bids for investments, but only Etihad placed a bid, which was extremely conditional and hence it did not materialize. Not getting a buyer meant that the company could not continue as a going concern and all hopes of revival had been lost, therefore liquidation was the only solution left.
Insolvency in the Indian Context
There are some gaps in Indian insolvency provisions that need to be bridged. There is a huge value destruction that companies face while entering the insolvency process under the IBC. This is primarily due to the fact that many companies are pushed into liquidation, whereas they should be restructured and revived. This fear leads a company to delay insolvency proceedings which further devaluates the company.
The law engages the committee of creditors to be comprised of a majority of financial creditors thereby, entrusting the future of the corporate debtor with the committee of creditors. There is also a huge disadvantage to operational creditors as they lack representation or voice in the Committee of Creditors. The other provision that we need to consider while examining the Indian insolvency landscape is the corporate restructuring under the Companies Act 2013. Contrary to the Section 14 of IBC, wherein a moratorium can be declared on individual recovery action against the corporate debtor’s assets, the Act does not stipulate a statutory moratorium. Which makes debt restructuring through the Act more challenging compared to the Code.
Pre-Packs in India- The Sub Committee Report
The Sub Committee Report on the Pre-packaged resolution process issued by the Government proposes to adopt the pre-pack within the IBC framework, rather than drafting a separate legislation for it. Therefore, the report establishes that every pre-pack arrangement negotiated between the creditors should also further the objectives of the IBC, that includes Rehabilitation, Asset Maximization and water fall mechanism mentioned for liquidation under Section 54 of the IBC, while determining the priority of creditors.
The report has suggested some regulations with respect to the implementation of pre-packs. It recommended that the corporate debtor should be able to initiate the pre-pack agreements. As, in essence they are the ones who have a genuine interest in reorganization of the assets. It also mentions that to safe guard to prevent the use of this restructuring tool, a simple majority of shareholders should be attained before a pre-pack process can be initiated by the corporate debtor. The correct time to initiate the pre-packs was when the debtor makes a default of any amount in the range of Rs. 1 Lakh to 1 Crore. The report also states that once this system is working efficiently, it will also consider allowing pre-packs to be initiated for pre-default stress. The Sub Committee has decided to make Section 14 of the IBC applicable to pre-packs as well. Therefore, to avoid any kind misuse, the moratorium of 90 days from the pre-pack commencement date and an additional 30 days will be granted for the adjudicating authority to approve the plan. Lastly, the report also states that if a company fails to negotiate a pre-pack and opines that the liquidation is the only recourse, the Committee of Creditors can go ahead with the same but will require a higher threshold of votes.
While the IBC is still a work in progress, and the insolvency professionals are still inculcating the necessary expertise that is required to effectively deal with insolvency proceedings, adopting a pre-pack agreement in place of initiating a Corporate Insolvency Resolution Process could streamline the process while providing relief to the creditors being impacted by the government’s orders or a suspension of insolvency proceedings for various reasons. The sub- committee report makes one thing absolutely clear about their intentions that is the supremacy of the IBC which is proved by their desire to retain the crux of the IBC which is the control by the creditor, moratorium imposition and a resolution plan. India can actively take lessons from around the world about the implementation of pre-packs to avoid any malpractice and avoid any manipulations in their financial statements. Thus, Pre-packs is a much-awaited measure which is a hope for every creditor on the brink of a financial loss especially in a covid-hit economy.