Pitfalls of pre-packs: How the Insolvency panel tried to address these concerns

While designing the pre-packs framework, the sub-committee of the Insolvency Law Committee had kept in mind the concerns/lacunae of the existing pre-pack systems followed globally. The sub-committee has, therefore, tried to address some of these concerns while drafting the framework for India.

We enlist some of the major concerns raised and how the sub-committee tried to address these concerns.

Lack of rigours: The main purpose of having pre-packs is quicker and cost-effective resolution with limited involvement of courts. This often means minimal legal oversight, leaving a lot of scope for manipulation by the debtor.

To address this issue, the sub-committee has chosen a middle path. “Pre-pack for India should be the most optimal semi-formal option that harnesses the benefits of all three options, avoids the associated concerns and does not dilute the gains made so far from implementation of the Insolvency and Bankruptcy Code. It should retain the flexibility of out-of-court options and typical pre-packs and should enjoy the sanctity and privileges of CIRP,” maintains the panel.

It, therefore, has retained limited roles of insolvency professional, it requires consent by simple majority of financial creditors for initiation of the process, retains requirements for two valuers, provisions of avoidance transactions, etc.

Lack of transparency: Pre-pack process envisages private negotiation between the debtor and the creditors, and this often means lack of transparency at many levels. There are concerns about interest of unsecured creditors, fear of connected party transactions, etc.

The draft framework tries to address these issues by ensuring that whatever information the corporate debtor provides like claims of creditors, drafting information memorandum, etc are verified by the resolution professional who is appointed by the financial creditors. Besides, the framework has a provision of valuation of assets by two valuers like in a CIRP process.

The pre-pack framework also provides for an adjudicating authority where stakeholders like unsecured creditors, employees, etc can voice their concern albeit not indefinitely.

Sale of assets to connected party: In some jurisdictions, pre-packs allows sale of assets or businesses. But such sales have received criticism as they are often made to connected parties, which lead to ‘phoenixing’ of companies. Phoenixing of companies means companies are successively allowed to run down to the point of winding up, only to rise phoenix-like from the ashes as a new company formed and managed by an almost identical group of persons and utilising a company name similar to that under which the former company was trading.

In order to avoid such sales, the framework envisages resolution as the main objective of the pre-pack.

“To encourage resolution, it is proposed to have approval of resolution plan by required majority of creditors, present and voting, and a decision to liquidate a CD will require a higher threshold of approval. If the CoC does not approve any resolution plan, the pre-pack should close without any consequence and an eligible stakeholder may initiate CIRP. However, where liquidation is the only option for resolution of stress, the CoC may proceed for liquidation, but with a higher threshold of voting,” maintains the drafting committee.

Also Read: New pre-pack framework allows promoters to keep control of CD; stipulates a shorter timeline

Maximising value of assets: The focus of pre-packs is mostly on private negotiation between the debtor and the creditors, which mean minimal public participation. This may come in way of maximization of asset value.

To ensure value maximization, the sub-committee recommends that the pre-pack should start with a base resolution plan. It considered two options for generation of the base resolution plan. One is to allow the promoter to have a plan ready. Second, If the promoter is not eligible for or not interested in submitting a plan, the creditors may run a private and confidential process to invite resolution plans from promoters and other investors and select the best of the plans received at the pre-pre-pack stage to serve as the base plan.