Broad contours of the proposed structure of pre-packs scheme in India

Dr SK Gupta and Jay Kothari

The Union Government has been considering the introduction of pre-packs in India since 2019. In light of the current scenario, it has become extremely vital to introduce statutorily recognised schemes of pre-packaged insolvency. While there are a number of concerns surrounding the efficacy of pre-packs in India, the benefits offered by pre-packs cannot be ignored. The objective of the government in introducing these pre-packaged insolvency schemes is to provide more options to the lenders and corporate debtors for resolution of bad debts.

These schemes are specifically directed to reduce costs and the time taken for insolvency resolution of debtors, while at the same time reducing the judicial burden on adjudicating authorities under the Insolvency and Bankruptcy Code, 2016. It is reported that the government is planning to introduce these schemes right after the termination of the moratorium on proceedings imposed by virtue of Section 10A of the Insolvency and Bankruptcy Code, 2016.

While the details of these schemes are still being worked out, the proposal is expected to allow stressed companies to prepare reorganisation plans with the approval of at least 2/3rd of its creditors. The said resolution plan is then to be placed before the NCLT for approval.

Two schemes are being envisaged to work on this mechanism. One scheme seeks private discussions between promoters and financial creditors, while the other one involves bringing in a third-party to ensure appropriate market-based price discovery. However, the plans for introducing pre-pack are still in their infancy and while they are developing quickly, there is still some time before we can see the implementation of these schemes in the Indian Insolvency ecosystem.

Purpose of introducing pre-pack mechanism

The purpose of introducing pre-pack is to strike a balance between safeguarding the interests of creditors on one hand and maintaining the business and assets of the debtor company on the other hand. It provides quick and efficient means for effectuating the sale of a business without considerable costs. For a business, pre-pack are a highly viable option, particularly in cases where the company does not have access to sufficient funding to enable it to continue trading. IBC has several objectives, of which the first order objective is resolution. The second order objective is maximisation of value of assets of the firm and the third objective is promoting entrepreneurship, availability of credit and balancing the interests. This order of objectives is sacrosanct.

Liquidation of companies is neither the objective of the Code nor a desirable result. However, by December 2019, a total of 562 applications for CIRP were admitted, out of which resolution plans were approved in only 30 cases and only 14 cases were settled, while a whopping 132 cases went into liquidation. This seems to suggest that the IBC is promoting corporate deaths rather than rehabilitation and resolution. The problem comes around in an even more disturbing manner when it comes to the micro, small and medium enterprises (MSMEs), which are mostly at the receiving end due to a lack of investor interest in their assets during the CIRP. It is interesting to note that the NCLT, in Lokhandwala Kataria Construction Limited v. Nisus Finance and Investment Managers, allowed a settlement by entering into consent terms by the parties after the insolvency proceedings under section 7 of the Code had been admitted. The Apex Court, while observing that the Tribunal does not have such a power, invoked its discretionary power under Article 142 to put a quietus to the matter.

Perceived benefits from pre-pack

A pre-pack can maximise enterprise value by “combining the efficiency, speed, cost, and flexibility of workouts with the binding effect and structure of formal insolvency proceedings”. In fact, pre-pack in certain jurisdictions have led to improved recovery rates. One of the major benefits of pre-packs is the surety of outcome. The resolution plan is already negotiated and finalized, giving confidence to the creditors. Another advantage is that pre-pack can facilitate going concern sale of business at ‘fair value’ and not just ‘liquidation value’.

Pre-packs being an out-of-the-court settlement process, it significantly reduces the time involved in resolution of a stressed debtor. The CIRP becomes smoother with an already decided plan and creditors on board. The current framework prescribes about 330 days for insolvency resolution after admission of a petition, which is usually delayed due to several rounds of litigation.

Under CIRP, the parties approach NCLT once before initiating the process and once for approval of resolution plan. However, in case of pre-pack, the parties’ approach NCLT only after agreeing to a resolution plan, in order to seek its approval and secure its enforceability. Pre- packs also provide a substantial protection to brand name. The company in distress can avoid negative publicity drawn out of bankruptcy process and the chances of non-responsive creditors can also be negated to a great extent. Ultimately, it also reduces the burden on the adjudicating authority, providing access and certainty to potential resolution applicants.

Certain jurisdictions also provide for confidentiality of details of the corporate debtor’s financial stress and the resolution plan. This element of confidentiality prevents destruction of value that takes place on the proclamation of insolvency and can contribute substantially in preserving the going-concern value of the company.

Potential issues in a pre-pack

One of the main criticisms of pre-packs is that they are fixed deals between the management and the administrator. Another disadvantage is the lack of transparency and potential bias towards secured creditors.

This places the interest of the corporate debtor and secured creditors at a higher pedestal. Thus, the process of pre-packs is often described to be opaque. Pre- packs pose a large threat in terms of preferential, undervalued, fraudulent and extortionate credit (PUFE) transactions. While the debtor and the creditors negotiate the structure of the agreement, there is a high probability of the corporate debtor entering into a PUFE transaction and reducing the ability of creditors to recover their rightful dues. Another concern is that certain directors of the corporate debtor may be motivated to retain control of the business, and pre-pack might be used towards this cause. In fact, even Section 29A loses its effectiveness when it comes to Pre-Packs.

Also read: Pre-pack resolution: A faster alternative to an insolvency proceeding

Considering the situation in such sales, most of the times the promoters of the company themselves bid and come up with a resolution plan and in such a scenario, the effectiveness of Section 29A becomes zero. The element of confidentiality is also pretty much a double-edged sword. While it helps the CD to reorganise itself without letting out much into the public domain, it also poses a challenge to the implementation of the pre-pack. Since the entire process is opaque and only seeks to receive the assent of secured lenders, it fails to provide enough encouragement to the unsecured creditors to actively participate in the process. There might also arise a situation, where the assets of the CD are transferred without making due payment to the unsecured creditors. Thus, adequate remedies and recourse must be introduced in pre – pack to protect the interest of unsecured creditors.

The lack of a moratorium is another concern with pre- pack. It may give rise to a situation where creditors can approach the courts to enforce their remedies, while the debtor is negotiating a pre-pack resolution. Such action will ultimately lead to a lesser realisable value of the debtor’s estate as well as reduced ground for negotiation in a pre-pack.

Suggestions for introducing pre-packs in India

In order to make pre- pack workable in India, the schemes will have to be structured in consonance with the CIRP procedure. Considering most of the insolvency cases don’t reach their conclusion due to lack of consensus, it would be necessary to ensure cooperation between creditors. In this regard, the following suggestions may be considered:

1. Parties must be free to appoint a resolution professional (RP) to administer the process. However, this can only be done on the occurrence of a default and not otherwise.

2. Post appointment, the RP must constitute a committee of creditors (COC), similar to the one formed during the regular CIRP under the IBC.

3. To avoid multiplicity of proceedings, an agreement creating moratorium shall be entered between the Creditors and Corporate Debtor. During this period, all creditors must be invited to submit their claims against the CD to the RP.

4. The RP may invite bids, subject to adequate marketing. He must also take adequate steps to preserve the market value of the debtor, to avoid reputational risks and loss of employment or customer confidence.

5. The RP must ensure that confidentiality of all aspects of the process is maintained.

6. A criterion of eligibility must be prescribed by IBBI, providing appropriate clarification on the eligibility/ ineligibility of certain people (promoters of the corporate debtor and other related persons), as far as making a resolution application is concerned.

7. The RP shall carry out the valuation of the assets of the debtor and shall collate the claims of creditors.

8. Once a resolution plan is negotiated between the COC and potential buyers, a public announcement of the plan must be made.

9. The resolution plan must then be put to vote before the COC and approved by at least 66% votes of the COC.

10. After approval by COC, the plan must be presented before the NCLT for approval. The NCLT must give dissenting creditors or other interested parties, an opportunity to raise objections, and a fair hearing to such objections before approval of the plan.

Conclusion

Since India has never had any expedited insolvency resolution mechanism, the introduction of pre-pack would require serious consideration coupled with due diligence. A comprehensive study of the ground level problems may be helpful in ensuring a robust scheme of pre-pack. Before pre-pack can be introduced in India, the IBC may have to go through certain amendments, laying out the role, powers and responsibilities of a resolution professional in a Pre-pack insolvency resolution process.

Dr SK Gupta is managing director, Registered Valuers Organisation of Institute of Cost Accountants of India, and Jay Kothari is a student of Graduate Insolvency Programme. This is the abridged version of an article first appeared in IPA-ICAI Journal.