Pre-Packs in Indian Insolvency Regime – A Much-Needed Paradigm shift

Vishesh Jain and K.Amoghavarsha

Introduction

On 5^th June 2020, the Government of India promulgated an ordinance for the Insolvency and Bankruptcy Code, 2016 as a closing move to what was a series of steps to protect Corporate Debtors from initiation of insolvency proceedings in these unprecedented times. It has inserted Section 10A which has effectively suspended Sections 7,8 and 10 for a period of one year. It is appreciable that the government has considered the plight of Micro, Small and Medium Enterprises (‘MSME’) and has taken steps to protect their interests. However, the suspension of the aforesaid sections makes one think of the extraordinary amount of insolvency proceedings which the NCLT would be dealing with after the six month lapse as well as rapid loss of asset value and consequentially, an unending burden for many stakeholders. There is a possibility that such circumstances may cause a robust insolvency regime to crumble. Therefore, to solve this, Pre-Packaging schemes ought to be introduced in our insolvency regime. In this short piece, we intend to discuss how the ‘Pre-Packs’ scheme can prove to be a game-changer in these tough times.

Pre-Packaging scheme and its advantage

Pre-Packaged or a pre-arranged insolvency process [Pre-Packs] is a method of asset resolution wherein the resolution plan is deliberated and decided before any formal proceedings have begun against the corporate debtor. This mechanism comes with a host of benefits as it allows an out-of-court method of resolution which makes it time and money-efficient, it also helps the corporate debtor maximize the value of his/her assets. Maximisation of assets is a very vital aspect for both creditors and debtors. Although  in traditional insolvency proceeding the appointment of Interim Resolution Professional is a time consuming process which affects the goodwill of debtors as well as the value of their assets. Pre-packs Scheme of restructuring usually takes place in a private setup where parties (debtor and creditor) negotiate to reach a settlement where the value of the assets can be maximized and the business can be revived. This settlement then has to get approval by the tribunal, which takes less time and protects the corporate debtor from corporate infamy. Pre-Packs in the long run will positively affect the ease of doing business, improving the Indian economy as a whole.

Pre-Packs as a response to COVID-19

The IBC ordinance has left the situation of the creditors quite ambiguous as the suspension of Sections 7 and 8 have left them with no mode of redressal under the Code for the present time. This move has had a direct impact on the very spirit of the Code. Pre-Packs, if implemented, can preserve the interests of the creditors as well as safeguard the object of the Code.

It is imperative to mention that the already burdened tribunals would be tremendously burdened after the suspension of IBC is lifted. Therefore, A pre-packaged scheme would reduce the burden substantially as it requires fewer filings and fewer court visits than a usual Corporate Insolvency Resolution Process (“CIRP). Pre-Packs are time and effort saving even on the legislative front as they do not need to be regulated as much as other mechanisms, even in countries where it has become prevalent like the UK or the USA. Presence of a statutory framework is not necessary for Pre-Packs, rather it is the flexibility of this scheme which helps the debtor as well as the creditor.  They also cause little or no disruption to the business of the debtor which makes it a lucrative option for companies facing losses due to the pandemic as they can still get through the resolution process at a cheaper and faster rate which makes it a relatively logical choice in such times.

After a cost-benefit analysis, it is reasonable to say that Pre-Packs are a great mechanism to tackle the COVID-19 situation and they also have the potential to revolutionise Indian insolvency regime permanently.

Hurdles in the Implementation of Pre-Packs

Cooperation among Creditors

Pre-Packs to work more efficiently pre-supposes cooperation among different classes of creditors and debtors. Unlike the CIRP, the promoters will continue to be in control of the business during the pre-pack discussion and if they fail to provide necessary information related to the scheme and valuation of the assets to the creditors, the pre-packs scheme would be hapless and would serve no purpose to the creditors particularly operational creditors. As this arrangement usually works with the consultation of the management of the corporate debtor, it gives reverence to the interest of debtors and secured creditors before operational creditors. Consequently, Pre-packs are likely to fail or create more litigation out of a process where the number of creditors is dispersed and has disparate interests. Therefore, the creditors should be left alone with the decision of choosing a pre-pack or CIRP for a particular corporate debtor.

Lack of Transparency

Despite the benefits of flexibility and speed, the major concern that revolves around the pre-pack scheme of insolvency is its transparency. As the pre-packs scheme of insolvency is a confidential arrangement between the debtor and creditors, it does not include open bidding for the plan. Hence, there is a potential threat of abuse of power by the debtor, as the debtor remains in possession of the business and formulates a plan with the creditor, which may exclude certain stakeholders, specifically operation creditors. However, in this the settlement so arrived at through pre-packs has to comply with requirements of a resolution plan given under Insolvency and Bankruptcy Code (IBC). The problem in this scenario arises when the resolution professional may not be capable enough to formulate a resolution plan, as the debtor remains in control of the business during the discussion. As a result, it becomes extremely difficult for the resolution professional to bring to light the undervalued and preferential transaction to the connected party if any undertaken by the corporate debtor. This poses a risk to the mechanism of wealth maximization owing to the lack of open marketing of the business. Therefore, it should be open to the creditors to challenge these transactions and resort to the remedy available in the code.

Potential Overregulation

The paramount benefit of Pre-packs is that it gives flexibility to the debtors and creditors. Countries like the UK where pre-packs are prevalent do not have any statutory framework dedicated for its governance, they govern it indirectly through regulating Insolvency Practitioners to maintain its flexibility. The Indian legislature should ideally  amend the Code or device different statutory framework on the same line as the rationale behind pre-packs is not to create a mini CIRP before the actual IBC filing. Preferably, the legislature should regulate the enabling framework for pre-packs as a process and the potential misuse of the same as discussed above. The legislature should also provide for guidelines to protect the interests of the operational creditor to make it work more efficiently. As the Operational creditor has very little say in the whole process, a reasonable time should be provided to the operational creditor for filing the claim and raising objection to the agreed settlement. Additionally, a respectable minimum percentage of recovery should be given to the operational creditors, to protect them from the exploitation of the corporate debtor.

Section 29A of the Code

One of the most stringent challenges to the implementation of pre-packs is the continuation of Section 29A of the Code. Section 29A provides for the disqualification criteria for persons who want to be a resolution applicant (under Section 5(25)). Essentially, Section 29A bars the corporate debtor and related parties, who were responsible for pushing it into insolvency, to regain control of the business. Pre-packs is a scheme where the debtor negotiates with the creditors to remain in the business and keep it as a going concern. It is understood how this roundabout manner of regaining control of the business goes against the establishment of the Code. But in a situation where a company is ingressing into insolvency due to a macroeconomic disruption and not because of its faulty management, it would be a viable option to let the corporate debtor revive its company as he is well aware of the dynamics and operational challenges. Therefore, when implementing Pre-Packs, Section 29A has to be considered and dealt with accordingly or else if it remains in action, then it would defeat the very purpose of the mechanism.

Conclusion

The IBC Ordinance is a temporary move to reduce the stress on Indian ventures, however some solid steps need to be taken to strengthen our Insolvency regime as the post pandemic period is predicted to be even tougher for companies and there is a possibility of tribunals being overburdened and creditors and debtors losing huge amounts of money if no alternate steps are put in place. The Pre-Packs mechanism, if enacted, would strengthen our Pre-IBC mechanisms and provide a new avenue for distress resolution along with CIRP. However, its shortcomings need to be ironed out for its optimal use. We must remember that even if it is introduced as a mode of resolution, it cannot act as a replacement for the standard resolution process under IBC. The avenues for distress resolution need to be expanded for India Inc. to survive post pandemic economic crisis and the introduction of Pre-Packs in it can help it do so, substantially.

The authors are currently in their third year of study of law, enrolled at the National Law University, Orissa.