Home Indian Insolvency Laws Is pre-pack paradigm the future of Indian Insolvency Laws

Indian Insolvency Laws

Is pre-pack paradigm the future of Indian Insolvency Laws

July 28, 2022

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This article is written by Hardik N. Sawant a student of a “Certificate Course in Insolvency and Bankruptcy Code pursuing the United States – Certified Public Accounting (US-CPA). This article has been edited by Ojuswi (Associate, Lawsikho).

This article has been published by Sneha Mahawar.

Table of Contents

Background

The IBC, 2016 has been instrumental in inculcating the discipline with which the promoters and the boards run the day-to-day affairs of the corporate debtor, emphasizing good corporate governance practices, making them answerable to the authorities for the financial decisions they take in the best interest of the stakeholders. The prime objective of the Code is to ensure the resolution of the corporate debtor with liquidation only as a matter of last resort and that under no circumstances the law is to be referred to as a recovery mechanism.

After considering the vast experience gained through the highs and lows of the Implementation and Execution of the Law since the inception of the Insolvency and Bankruptcy Code, 2016 (IBC/ The “Code”), the Insolvency Law Committee decided to put in place a Sub-committee of itself to study the Prospects of the Pre-Packaged Insolvency Resolution Process (PPIRP) as one of the Feasible options for speedier Resolutions of the Stress faced by the Defaulting Corporate Debtors.

The Sub-Committee which was constituted on 24^th April 2020, under the Chairmanship of Dr. M.S. Sahoo, the Chairperson of the Insolvency and Bankruptcy Board (IBBI) vide the Circular of the Ministry of Corporate Affairs (MCA) finally submitted its Report on 31^st October 2020 consisting of Recommendations for going ahead with the Pre-packaged Insolvency Resolution Process in the Indian Context, while also learning from the similar Practices followed by the International Community.

The Recommendations of the Sub-committee were duly recognized and the Ordinance was floated in the Parliament on 4^th April 2021 by the Hon’ble Union Minister of Finance and Corporate Affairs Mrs. Nirmala Sitharaman making amendments to the Insolvency Code, which was converted into IBC (Amendment) Act, 2021 w.e.f. On the same date introduced PPIRP for Corporate Persons classified as Micro, Small, and Medium Enterprises to the Indian Market. Sections 54A through 54P, in Chapter III-A of Part 2 of the Code envisage the Pre-packaged Insolvency Resolution Process. This article will dive deep into the details of how the Country shall navigate through the newly prescribed Law and only time will tell how India shall move ahead with the same, gaining experience through the Process in due time.

The purposeful relevance of the PPIRP mechanism

The Covid19 pandemic-induced difficulties exposed a lot of Corporates, financial markets, and Economies around the world to Financial Realities and the Ability to Survival in the Testing Times of the Developed and Developing World likewise. This also brought many of the companies in the MSME Sector, which is held as the Backbone of the Economy, to the edge, impacting their Financials, ability to create jobs, and stand firm through the Storm. The Government did provide the necessary Relief to them by suspending filings under the Code for one year starting 25^th March 2020.

These Small and Medium enterprises have been Critical to the Indian Economy as they contribute a considerable chunk to the Gross Domestic Product (GDP) and also provide Employment Opportunities to the population. Therefore, understanding and addressing the concerns of the MSMEs were necessary for their survival and to help them strive through the resolution of their stress, due to their unique nature of businesses.

Hence, it was proposed to provide an efficient alternative insolvency resolution mechanism for the MSMEs under the Code, ensuring quicker, cost-effective, and value-maximizing outcomes for all the stakeholders, in a manner that is least disruptive to the continuity of their businesses.

Why is Pre-pack insolvency needed in India

The Code has a Positive Impact on both, the Promoters of the Corporate Debtor (CD) in terms of the Repayment and if possible, retaining the control as well as the Financial or Operational Creditors to whom the Debt is owed. The Possibility of a Liquidation is always a grave threat to the CD; as it may seem to be a better option in the short run, but may have devastating effects on the economy as a whole in the long run. This danger might further escalate when it comes to Micro, Small, and Medium Enterprises as there is often a lack of interest in the Assets of the Companies in the MSME sector and also unfavourable Resolution Plans. They might not have the skills, expertise, money, and manpower to handle the Lengthy process of the Corporate Insolvency Resolution Process (CIRP) to be able to present the viability to continue as the Going Concern and prove their Mettle in the Market.

One of the Importance of the Pre-pack is that- there may be a situation where before the Pre-pack Resolution stage, the Corporate Debtor may enter into the Management Buyout which would, in turn, result in Transferring the assets to another entity. However, such transactions may not have the approval of the Courts or Regulators such as the Competition Commission of India, the SEBI, or the RBI for that matter. These cases may face an open challenge by the Creditors claiming their Rights on the Assets of the Company irrespective of the fact that much time shall be lost and the Value of Assets of the CD would deplete through every single day of delay in the Process.

The Pre-packaged system is the Answer for shortening the Timelines even further while at the same time being able to maintain the Legal Sanctity of the Process through the timely detection of Stress or Default. Pre-packs can be thought of as a mix of Court-oriented processes under the IBC and the out-of-court Debt Restructuring involving the Lender Banks. The Process under Pre-Pack emphasizes the formation of the Resolution Plan to save the stressed assets and debts of the CD, before initiating the formal provision-bound court process through the NCLT as in the case of CIRP. In this case, A Plan would be negotiated, circulated to the Creditors, and voted upon, before the case is filed. Because of its very nature, a PPIRP has to have a very high level of support from its stakeholders, thereby ensuring the highest chances of the revival of the CD. This is the need of the hour, as, without the Promoter’s Cooperation, it would be nearly impossible to negotiate a Pre-pack. A Robust Framework of Pre-Pack would push the Debtors to settle their debts voluntarily and out of court, thereby reducing the burden of the Courts.

A typical Process of Pre-Pack in India will have the Flow as follows:

Source: Annexure to the Report of the Sub-committee of the Insolvency Law Committee

International Practices in the area of Pre-packaged insolvency

United Kingdom

It is commonly used as the Strategy for selling a Business as a Going Concern, by using the Administrator’s Power to sell the Company’s Assets without the Approval of the Creditors.
It commences with the co. resolving to appoint an Insolvency Practitioner as an Advisor, with a possibility that the same person would be appointed as an Administrator.
Once the terms of sale are agreed upon, the Insolvency Practitioner is officially appointed as an Administrator who helps in the negotiation and arrangement of the Rescue Plan for a debtor, before formal administrative proceedings.
There is a procedure here formulated by the Statement on the Insolvency Practice wherein, the Administrator has to Disclose the activities undertaken to market the Assets of the Debtor in question to be sold and a detailed narrative justification is needed as to why the pre-packaged sale was given a priority over the other methods. This information may be later used to challenge the conduct of the Administrator in charge of the process.

United States of America

The US has more of a common Bankruptcy approach towards the resolution of companies. In that, the US Bankruptcy Code provides for three forms of pre-packs, namely:

Pre-plan sales u/s 363 of the Code;
Pre-packaged Bankruptcy Proceedings u/c 11;
Pre-Arranged Bankruptcy Proceedings u/c 11.

The Pre-plan sales are somewhat similar to the one followed by the UK as mentioned above. Even in this case, their law does not put forth any specific guidelines or procedures to deal with the sales of the assets of the CD.
For the Pre-packaged procedure, the CD reaches an agreement with the terms of the plan with the key creditors and manages to gather approvals from them while also circulating a Disclosure statement to them. With the majority of the votes of the class of creditors in favour, the CD proceeds to submit a petition for ‘Chapter 11 Bankruptcy’ in the Court.
In the case of Prearranged Bankruptcy process, also known as Pre-negotiated, the CD reaches an agreement with its key Creditors, but does not circulate the plan or does not even try to gather favourable votes in this regard, as this is done after filing for Chapter 11 Proceedings formally in the Court.
In either of the cases, the plan must be reviewed and approved by every class of affected parties, including the Creditors, of course, with at least 2/3 of the amount and half of the number of them accepting the plan.
If the Required majority of the parties vote in favour of the plan, it is deemed to have passed and is binding on all the concerned parties.
The plan filed with the Chapter 11 Bankruptcy petition shall be approved by the court subject to compliance with the stipulated disclosure requirements. Once the Reorganisation plan is confirmed by the Bankruptcy Court, it stands to be binding on all parties whether or not any one party voted in favour or against or not voted at all.

Singapore

The Scheme of things in Singapore in the context of Pre-packs is noticed to have been somewhat identical to that of the Provisions of the Indian Companies Act, 2013 – Sections 230 through 240 that we have about the Schemes of Arrangement or Compromises, Mergers, and Amalgamations.
Sections 210 (3AB) (a) and (b) and 211I of the Companies Act of Singapore empower the Court with certain wide discretionary powers to satisfy itself with the fact that- had the meeting of the Creditors not taken place, the outcome of the Resolution Plan would still prove to be carried out in the best of interest of all affected parties. Then, and, only then, the court shall approve the Resolution Scheme presented to it.
These Provisions relating to the Compromise and Arrangement were shifted to a New Law brought into force in mid-2020 namely: ‘Insolvency, Resolution and Dissolution Act, 2018.’
‘Insolvency, Resolution, and Dissolution (Amendment) Bill, 2020’ proposed a new Pre-pack Scheme for the MSMEs to be able to sail through the Covid19 Pandemic period.
An automatic Moratorium would be triggered when a company gets admitted into the Scheme and there would be no requirement to convene the meeting of Creditors.
The Company thus admitted would rather be prepared to prove that if a meeting of the Creditors or the class of Creditors had been called, a majority of them would have approved the proposed scheme.

India is yet to have its own first-hand experience in the context of the Pre-packaged Insolvency Resolution Process (PPIRP) as it is a relatively new and uncharted territory that has to be followed in the years to come. Maybe that is why we don’t have material case studies to draw references from and learn from them. Some more International practices can be studied to gain an understanding of the ways to deal with Pre-packs, for eg. The Systematic 4-point approach of France categorizes the Stressed CDs according to their Financial Status.

What is the “Swiss Challenge” method

A “Swiss Challenge” is a method of Bidding wherein a base price for the assets of the Corporate Debtor is Set and published to the market and the counter-bids are invited to either Match the base price or enhance the same.
It is a method of bidding wherein the interested party initiates a proposal or the Bid. The Details of the CD and its assets and liabilities are already in the public domain. The bids are invited from the interested parties to go ahead and execute the same to bail out the company. Thereafter, the original contractor gets an opportunity to match the Best Bid received in the auction.
The Submitter of the Resolution Plan shall have an option to improve the plan in the following manner:

The Submitter which is falling behind in bringing up a competitive Resolution Plan has an option to improve the same.
Then, the Submitter of the other Resolution plan shall have an opportunity to further improve it by at least a margin or a percentage point.
The Submitters in the 1^st or 2^nd case are then again allowed to improve their plans making them even more competitive while setting aside the ineligible and the lowest bidder in the process.

This process of improvement shall continue till either of the submitters fails to use the option within the time specified for the invitation of the Resolution Plans.

Benefits of Pre-packaged Insolvency regime

The Pre-packs combine the “Best of Both Worlds” so that it causes the least possible disruption to the Business of the Debtors and their Business activities by combining the efficiency, speed, cost, and flexibility of the workouts with the binding effects and structure of formal insolvency proceedings. The benefits of the Pre-packs are as follows:

Value maximization

A distressed asset in the ever-changing world of Commerce and Business has a Life cycle, and the longer it stays in the state of Stress, the more value is lost. The Pre-packs preserve value by cutting down the elements of a formal process. Early initiation and the closure of the Process minimize the possibility of liquidation and also the destruction of the economic value of an otherwise viable business. This is a key to saving for small businesses.

Job preservation

As the Pre-pack commences at the earliest sign of distress, it facilitates the continuity of the operations of the Business without any job losses. It ensures that a company keeps going, as compared to that of the formal court-monitored process which might result in loss of both employees and customers.

Preliminary work is already done before filing the application to AA

PPIRP commences only after 66% of financial creditors approve the proposal for PRIP and approve the name of the Resolution Applicant; the CD passes a special resolution with 75% majority of the members approving the same; CD prepares the Base Resolution plan; and last but not least, the name of the Resolution Professional has been approved by the Financial and Operational Creditors alike.

Informal understanding with the creditors before applying to AA formally

The Pre-pack system allows the CD and the Creditors to come on the same page and maintain that consensus on various issues relating to PIRP and work on the Resolution Plan informally before proceeding to the Formal filing to the Adjudicating Authority i.e. the National Company Law Tribunal (NCLT).

Fast approval and reduction of the burden of the NCLT

A Pre-pack does not require the involvement of the court during the informal part of the process and also requires the minimum role of the courts even in the formal process. Hence, it reduces litigation costs and delays and helps to make the life of the courts easier.

Base Resolution Plan is a good starting point

The Management of the CD, which has inside-out knowledge of their business, is in the best position to chart the course of the Recovery from Stress. The Base Resolution Plan chalked by the same management having the inside know-how is the best place to start with.

The existing management continues to be in control of the CD

Unlike CIRP where the entire operation of the CD transfers to the Resolution Professional, who does not know the working of the company, the management of the Corporate debtor in the case of the PPIRP itself continues with the operations of the CD, except only in case of Fraud.

Freedom to the management of the CD to partner with others

The Management of the CD in Stress, while in the PPIRP, has the freedom to bring in another person or a body corporate to jointly file the Resolution Plan. The Management can also take the help of Specialists in the field of Financial Management, Marketing, Tax, and legal consultants and present a Plan in an Individual capacity considering the insights provided by the experts.

Conclusion

“Speed is of the Essence in the process of Implementing the effective Reorganisation or Bankruptcy practices” to instill & maintain the confidence of the General Public, the legal fraternity, and the members of the Business Class of the Country in the Policies put forth by the Government. One of the Important Objectives of the court is to bring different aspects of the Law under a single integrated platform to ensure a speedy, efficient, cost-effective revival of the Debtor in Stress. Here, there is an increased responsibility on the Insolvency Professionals, balancing the Interest of the Stakeholders, and also ensuring that no undue advantage is being taken by the Creditors as this law is a Creditor-in-control one. The regulated environment outlined in the form of the Insolvency and Bankruptcy Board of India shall also be watchful in preventing the Misuse of the law.

The Concept of Pre-packs promotes the very objective of the Insolvency and Bankruptcy Code, 2016, which is to maximise the value of the assets of the Corporate Debtor and safeguard the interest of all the Stakeholders. The Indian version of the Pre-pack will be a unique one that learns lessons from the other Jurisdictions and builds an India-centric variant within the basic structure of the Code while making it ready for the Future in all possible facets.

Hence, the legislature is expected to strike a perfect balance between the existing law and the pre-pack framework. The Transition might not be a Smooth one but the continuous Innovation and discoveries while practising the law will get us a Breakthrough into this Groundbreaking REFORM.

References

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