A detail study of Pre-Packs: A New Regime of Insolvency in India- By Adv. Akash Srivastava

Pre-Packs: A New Regime of Insolvency in India

Introduction

The Insolvency & Bankruptcy Code, 2016 (hereinafter referred to as Code) was enacted to provide timely and efficient resolution to the ever-growing stress assets in India. The main essence of the present code is a speedy procedure and its time-bound process. Therefore, the Code provides for strict timelines for completion of CIRP: if a corporate debtor is not resolved within this time-frame, it would have to be compulsorily liquidated.[1] However, by way of judicial interpretation, certain periods, including the time taken during legal proceedings, have been excluded from the mandatory timelines prescribed under the Code.[2] As a result in most of the cases, the time limit prescribed by the code for completion CIRP is exceeded. For example, as per the data available till December 2019, it took, on average, 394 days to successfully resolve 190 cases, which far exceeds the timeline of 330 days currently provided under the Code.[3] It is pertinent to note that delay in resolution can cause serious detriment to the on-going concern of the corporate debtor impacting the realizing value of the assets. The need of the hour is the speedy and effective resolution which can be achieved by pre-pack.

What is Pre-Pack?

In a pre-pack, “a troubled company and its creditors conclude an agreement in advance of statutory administration procedures” which “allows statutory procedures to be implemented at maximum speed.”[4] In other words, pre-pack means a corporate rescue of the business of corporate debtor i.e. its trade and enterprise value. Therefore, the purpose of pre-pack is to strike down a balance between safeguarding the interest of the creditor(s) and maintaining the business and assets of the corporate debtor by facilitating a swift transition of such assets and business.

Initiation of Pre-Pack

The essence of the pre-pack is that the terms of restructuring/ resolution plans are formulated before the insolvency commencement. Pre-pack can be initialted in two ways (i)  A pre-pack is undertaken by a corporate debtor before the occurrence of an event of default of a creditor then it would be the corporate debtor who would be in a position to purpose the commencement of the pre-pack. (ii) A pre-pack is undertaken when the corporate debtor had defaulted or triggered the potential event of default or even when the creditor is aware of the distress of the corporate debtor then the creditor may seek its debt restructured as pre-pack.

Whether the process is creditor driven or debtor driven is an important factor for determining the pre-pack. In an event the corporate debtor seeks to initiate the pre-pack, it would have to ensure that the necessary shareholders’ resolutions and board resolutions have been passed. For a creditor to initiate a pre-pack, the crucial factor is the inter se understanding of all the creditors of the debtor company.

Why pre-pack is needed in India?

The Code has a positive impact on the promoters of the corporate debtors in terms of repayment, liquidation is a grave threat to Corporate Insolvency Resolution Process (CIRP). If the CIRP fails that would lead to liquidation which not good for our economy’s health it might be seen as the best option in the short-run but will have a deep devastating effect for the corporates in the long-run. This problem will further escalate when it is a micro, small, and medium enterprise (MSME) at the receiving end due to lack of resolution applicants interest in the assets of MSMEs and viable resolution plans most of these MSMEs which is the backbone of Indian economy are forced to such corporate deaths. Time and costs, even after big companies and ongoing concerns undergoing CIRP, a huge factor creates an aversion towards CIRP.

The necessity of the pre-pack is that, there is a possibility that before the pre-pack stage the corporate debtor may enter into management buyout for the transferring of the assets to another entity. However, such buyout would not have the approval of Court or Adjudicating Authority and it should be open to challenge by the creditors if it subject to such transactions that are prohibited under the Code to safeguard the interests of the creditors.

The risk of the aforementioned situation would not arise if the pre-pack is approved by the Adjudicating Authority. By proposing mandatory approval of Adjudicating Authority for the execution of the pre-pack, another advantage which fears the creditors, investors, and other stakeholders would be about the safeguarding the rights against the corporate debtor in the recovery process in other forums as the pre-pack transaction would be final and binding on all the creditors of the corporate debtor.

Framework of Pre-Packs in India

The working of pre-packs in India would be different from the rest of jurisdictions (UK & US) as it would need broader in its usage to utilize the various tools to revive corporate debtor and to rectify the ongoing financial stress. In the Indian context, change in management, sale of assets of the corporate debtor to another company, interim financing and refinancing, assignment of debt of the corporate debtor to asset reconstruction companies and turnaround funds are a few tools that a corporate debtor and creditors possess while undertaking the corporate rescue of such corporate debtor. These tools are also available to a bidder (resolution applicant) once a debtor company is subject to CIRP. It would be interesting to blend the aspects of the IBC with such corporate rescue tools, prior to the corporate debtor undergoing CIRP itself.[5]

The three effective frameworks of pre-packs are:

• Pre-packaged Insolvency Resolution Process (PPIRP)[6]
• Pre-arranged Insolvency Resolution Process (PAIRP)[7]
• Pre-arranged Sale (PAS)

The procedure of the above-mentioned frameworks of pre-packs are explained below:

Aspects of Pre-packs in India

A. Value of the corporate debtor

The main object of the Code is the resolution of the corporate debtor and subsequently the responsibility of the Insolvency Professional/ resolution professional that the corporate debtor functions as an ongoing concern during CIRP. Whereas COC plays an important role as the approval of 66% of members of COC is necessary to undertake any activities which affect the corporate debtor as well as COC. Therefore any decision of IP for sale of either a part or whole of assets of the corporate debtor under pre-pack would be permitted to be executed only after the corporate debtor has filed an insolvency petition with approval of the COC.

The disadvantage in the above circumstances is that when a company is under CIRP the value of the assets eventually depreciates after the insolvency proceedings are concluded and the resolution plan for the sale of assets or business of the corporate debtor is approved COC then by the Adjudicating Authority. It is the creditor who would ultimately bear the loss due to the devalued sale of the assets. The Code provides the calculation of the liquidation value of the corporate debtor. The liquidation value of a corporate debtor is defined under the IBC as the ‘estimated realizable value of the assets of the corporate debtor if the corporate debtor were to be liquidated on the insolvency commencement date.’[8]

As Code permits the COC members to have access to the liquidation value of the corporate debtor undergoing CIRP. Further, instead of the liquidation value, the resolution applicants are provided with the ‘fair value’ which is, ‘the estimated realizable value of the assets of the corporate debtor, if they were to be exchanged on the insolvency commencement date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had acted knowledgeably, prudently and without compulsion’.[9] This would help to ensure that the value of the corporate debtor does not depreciate and the damage to the brand value may have occurred due to the commencement of the CIRP. Furthermore that the price discovery in terms of pre-pack, the ‘fair value’ as mentioned in the Code may help IP, creditor, the prospective investor a choice to evaluate the actual value of the corporate debtor. Thus the existing law will not have to be amended for a new formula to calculate the enterprise value of the corporate debtor under pre-pack.

 B. Creditor Control

Creditors play a very important role in any corporate rescue mechanism. Most jurisdictions around the globe follow the creditor control approach in insolvency-related laws India also follows the abovesaid approach. It has been reiterated by the Supreme Court of India in its landmark judgment in the case of Innoventive Industries v. ICICI Bank Ltd. [2017] ibclaw.in 02 SC, [10] that the promoters of a debtor company under CIRP have no powers to take any decisions on behalf of the debtor company, or for management of the debtor company.[11]

The Interim Resolution Professional (IRP) is responsible to ensure that the interest of all the stakeholders are protected, and not of a certain class of creditors. This ensures that the resolution plan is not prejudicial to any section or class of creditor of the corporate debtor.

A problem that may arise in India is where inter se creditor right is concerned. Where the dissenting creditors in terms of pre-pack would fail pre-pack on democratic decision making and enforcement of majority vote. Therefore it will be a crucial consideration for the legislation for contemplating pre-packs to set out provision under the Code to inter se treatment of creditors in terms of decision making under pre-pack. The event of the principle of majority democratic vote is incorporated as a part of the pre-pack regime, whether the dissenting creditor would continue to have the right to seek initiation of CIRP under the Code, de hors the pre-pack terms would be a key consideration for legislators.

 Role of Connected/ related parties in pre-pack

The involvement of connected parties in the present legislative framework is partly different from the scope and implementation of a pre-packs in India.

Where CIRP is initiated against a debtor company which is party to an inter-company loan transaction, the lender company (which is the related party) will not have the right of representation, participation or voting in the COC.[12]

The Code was specifically amended by The Insolvency and Bankruptcy Code (Amendment) Act, 2018 (Amendment Act)[13] to inter alia address the issue of connected party involvement in CIRP of a corporate debtor. The Amendment Act under section 29A has effectively barred the existing management of the corporate debtor from taking any steps which would permit them to regain control over the assets of the debtor company.[14] The Amendment Act culminated due to cases of CIRP being undermined by the existing promoter group.[15]

That once CIRP has initiated the existing management of corporate debtor is suspended and all the powers vest on IRP. Under the said amendment the resolution plans should not contemplate the purpose of resolution process in which the existing management may return to manage the corporate debtor. The management of the company during the implementation of the resolution plan should be vested with entities that are required to be completely unconnected from the existing management of the debtor company.[16]

There may be differing views regarding connected party pre-packs some of us support the view that the existing management has served the corporate debtor and would know the better plans to revive the distressed company but on other hand, some are of the view that where the distress is not caused by the promoter or managerial causes but due to financial and business risk than in that case replacing the existing management would be counterproductive.

In India, there is a creditor centric approach in which the management vest in court-appointed IP with a link of insolvency to the displacement of the management. However, where the existing management has control over the corporate debtor is also strong as when a corporate debtor files a voluntary insolvency then there is an added advantage to the corporate debtor to reorganise its business efficiently. This is because of the extra protection of the court to the creditor on non-payment by the corporate debtor of its dues. Thus both approaches are benefitted to the corporate debtor regardless of who has the control.

However, the Indian legislature has taken a strong stance against the connected parties after insertion of section 29A of the Code, therefore, connected party involvement in the resolution of the corporate debtor, one may assume that connected party pre-packs may not be favoured if pre-packs are formalised in India by the regulators, if not altogether prohibited along the lines of the present section 29A of the Code.

Advantages of Pre-packs

If a pre-pack is introduced, it can maximize value by “combining the efficiency, speed, cost, and flexibility of workouts with the binding effect and structure of formal insolvency proceedings”[17] since it will involve out of court negotiations of resolution plans, but the approved resolution plan will receive the sanction of the Adjudicating Authority under the Code. There is evidence in some jurisdictions that due speed and reduction of formal proceeding procedure in pre-packs have resulted in good recoveries of some class of creditors. The features of pre-packs that particularly serve to enhance values include:

• Speed: A pre-pack process is typically less time-consuming and cheaper than formal proceedings, as the resolution is negotiated and agreed before initiating the statutory resolution framework.[18] The speedy disposal of a pre-packaged case decreases the total cost involved in the process,[19] which is often key to saving small businesses that cannot withstand the costs of prolonged insolvency[20] and helps in maximizing the value of the corporate debtor.
• Confidentiality: This element of confidentiality prevents destruction of value that takes place on the proclamation of insolvency and is arguably one of the key advantages of pre-packs over formal proceedings, as it can contribute to preserving the going-concern value of the company.
• Sanction of appropriate authority under the statue: The other forms of restructuring do not posses sanctions from appropriate authority but pre-packs work within the fold of statutory schemes, which makes the outcome binding on all the stakeholders. This certainly increases the investor’s confidence and prevents the threat of non-compliance.
• Reduction of cost & time in litigation : The pre-pack process has recognition across the globe and the need for a pre-pack process in India is necessary to revive the debt ridden corporates. The Government has acknowledged that it may help in “reducing litigation cost and delays” and may “decongest the overburdened Court/ NCLTs.”[21]0

 Disadvantages of Pre-packs

•  The capture of Value by other stakeholders: There is a concern since the process is typically confidential, and receives only the approval of secured creditor, there is a high possibility that extensive marking of for the submission of resolution plan would not be done as a result this would hamper the all the creditors especially unsecured creditor. Therefore, the value due to unsecured creditors may be captured by other stakeholders. The constant fear is that the value will be captured in cases where pre-pack results in the sale to the parties which are conneted and related to the corporate debtor. In these cases, the value due to the unsecured creditor may be captured by the connected parties, and the existing management will have the control to repay the old debts of the unsecured creditors. Since the pre-pack deal is negotiated and drafted while the existing management of the company remains on board. Further, while an insolvency professional ultimately concludes a pre-pack arrangement, concerns have been raised that, in practice, valuations and marketing exercises are undertaken by the insolvency practitioner merely as check-boxing exercises.[22]
• Bad Business: In cases where connected parties purchase the business of the corporate debtor through a pre-pack sale, there is a concern that the lack of transparency results in the perpetuation of ‘bad businesses’ without allowing for a genuine restructuring or exit of the corporate debtor.
• Frauds and doctored balance sheets: In some cases, there are concerns that pre-packs are used by connected parties where the business is only technically insolvent and originally not insolvent, to benefit from the re-engineering of the balance sheet, especially to undercut their business rivals.[23] Critics also argue that in some cases a pre-pack is a “sham… to ditch debt”, which could result in ‘phoenixing’ of companies “whereby 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.”[24] This will hamper the interest of unsecured creditor and employees of the corporate debtor and it would become a legalised tool for fraud and mismanagement.
• Increase in undervalued and preferential transactions: This can go against the fundamental principles of insolvency law, which is to maximize the value of assets of the corporate debtor. There will be a situation where under the pre-pack arrangement the assets of the corporate debtor is sold to a third party or related party at an undervalued price while will giving preference to such related party which is not permissible under the Code.

Conclusion

“Speed is of the essence for the working of the bankruptcy code”[25], the Supreme Court has observed that “one of the important objectives of the Code is to bring the insolvency law in India under a single unified umbrella with the object of speeding up of the insolvency process”.[26] The framework of the pre-pack being proposed to enable the swift resolution under the Code. However, the framework cannot be implemented without amending the Code and the rules amd regulations prescribed under it. Once the framework is implemented then it would reduce the burden on Adjudicating Authority under the Code resolving the financial distress of the company in a timely and cost-effective manner. However, more responsibity will be on the Insolvency Professionals for balancing the interest of stakeholders and ensuring that no undue advantages are given to the secured creditors and the promoters by misusing the framework such as PPIRP, PAIRP, PAS.

Further, mandatory approval from the Adjudicating Authority would reduce the fear from the stakeholders regarding as the resolution plan will be binding to all. It would also reduce the problem of preferential transactions under section 43 of the Code. The concept of pre-packs promotes the objective of the Code which is to maximise the value of the assets of the corporate debtor and safeguarding the interest of all the stakeholders.

Hence it is expected that the legislature will strike the perfect balance between the existing law and pre-pack framework. The transistion would not be a cakewalk but the certainly with few amendments would lead to the smooth implementation of the pre-pack regime in the Code.

Reference: 

[1] Insolvency and Bankruptcy Code, 2016, Section 33(1). Section 12 of the Code had originally required CIRP to be concluded within 270 days from the date of commencement. Subsequently, in light of judicial precedents that excluded the time taken for litigation from this time-line, Section 12 was amended, vide Insolvency and Bankruptcy Code (Amendment) Act, 2019, to expressly provide that corporate insolvency resolution process ought to be completed within 330 days, including “the time taken in legal proceedings”.

[2] Committee of Creditors of Essar Steel India Limited Through Authorised Signatory v Satish Kumar Gupta & Ors [2019] ibclaw.in 07 SC , Civil Appeal Nos. 8766-67 of 2019. Decision date – 15 November 2019; ArcelorMittal India Pvt. Ltd. v. Satish Kumar Gupta [2018] ibclaw.in 31 SC; Quinn Logistics v. Mack Soft Tech, [2018] ibclaw.in 09 NCLAT.

[3] Insolvency and Bankruptcy Board of India, Insolvency and Bankruptcy News (The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, Vol. 13, 2019) 18

[4] See Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd edn, Cambridge University Press 2009) 453; V. Vilaplana, ‘A Prepack Bankruptcy Primer’ (1998) 44 The Practical Lawyer 33

[5] See Insolvency Procedures — Investigating the pre-pack paradigm in India by Sanjana Rao

[6] Designing a Framework for Pre-Packaged Insolvency Resolution in India Some Ideas for Reform https://vidhilegalpolicy.in/wp-content/uploads/2020/02/Report-on-Pre-Packaged-Insolvency-Resolution.pdf

[7] Supra

[8] Insolvency and Bankruptcy Board of India (Insolvency Resolution of Corporate Persons) Regulations, 2016, regulation 2(k).

[9] Insolvency and Bankruptcy Board of India (Insolvency Resolution of Corporate Persons) Regulations, 2016, regulation 2(hb).

[10] Innoventive Industries v. ICICI Bank Ltd. [2017] ibclaw.in 02 SC

[11] In the above judgment, the apex court further clarified that the existing management of the debtor company does not possess the power to file an appeal against orders of the court pertaining to the debtor or to appear on behalf of the company in its proceedings as representatives of the debtor company.

[12] Insolvency & Bankruptcy Code, 2016 (IBC), section 21(2)

[13] The Amendment Act was passed by both houses of Parliament on 19 January 2018.

[14] IBC, section 29A.

[15] In Edelweiss Asset Reconstruction Co. Ltd. v. Synergies Dooray Automative Ltd. & Ors. CA (AT) Nos. 169 to 173-2017, by divesting assets of the debtor company to an associate company, the associate company of the debtor company was able to participate in the CoC as a majority creditor. The resolution plan which was ultimately formulated envisaged a 98 per cent haircut for the lenders of the debtor company.

[16] ^supra

[17] Jose M. Garrido, Out-of-Court Debt Restructuring (World Bank Study 2012), para 101

[18] Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd edn, Cambridge University Press 2009) 456

[19] Rodrigo Olivares-Caminal et al, Debt Restructuring, (1st edn, Oxford University Press 2011), para 3.129

[20]  S. Frisby, ‘A Preliminary Analysis of Pre-Packaged Administrations (Report to the Association of Business Recovery Professionals)’ (2007) R3 – The Association of Business Recovery Professionals https://www.iiiglobal.org/sites/default/files/sandrafrisbyprelim.pdf

[21] Ministry of Corporate Affairs, Government of India, Monthly Newsletter (Vol. 13Z, November 2018); the Ministry of Corporate Affairs has also sought public comments on, inter alia, pre-packaged insolvency resolution process under the Code. See MCA Notice dated 16 April 2019

[22] Teresa Graham, ‘Graham Review into Pre-pack Administration: Report to The Rt Hon Vince Cable MP’ (2014), paras 7.64, 7.65, 7.78-7.81 http://data.parliament.uk/DepositedPapers/Files/DEP2014-0860/Graham_review_into_pre-pack_administration_-_June_2014.pdf

[23] Teresa Graham, ‘Graham Review into Pre-pack Administration: Report to The Rt Hon Vince Cable MP’ (2014), para 7.46

[24] Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd edn, Cambridge University Press 2009) 74

[25] Ministry of Finance, The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design (2015) Executive Summary

[26]Innoventive Industries Ltd. v ICICI Bank and Ors, [2017] ibclaw.in 02 SC

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