IBC Laws Blog

An Analysis of Pre-packaged Insolvency Resolution Process – By Ms. Priyam Sharma

Considering the emerging need and varied benefits of Prepack many corporate entities are resorting to Prepack to resolve Insolvency. Apart from the motivation that the control of the CD will be with the debtor, it provides a cost-effective amicable solution. In India, the current framework is for MSMEs and there is a need for legislation to expand the same to Companies and Limited Liability Partnerships with the incorporation of the basic structure of the design proposed by the Sub Committee on prepack with safeguards to ensure that there is time bound, quick and effective resolution of debts.

An Analysis of Pre-packaged Insolvency Resolution Process

– By Ms. Priyam Sharma,
Final year law student at University of Mumbai Law Academy (BBA LLB Hons)

The Insolvency and Bankruptcy Code, 2016 (herein referred to as IBC) provides for the resolution of debts of a corporate person either by way of Corporate Insolvency Resolution Process (CIRP) or by way of liquidation (usually when CIRP is not successful) or by Voluntary liquidation. It is pertinent to state that IBC is an economical law. An economic law is essentially empiric i.e., it evolves continuously through experimentation.[1] A Corporate Person on committing default (Corporate Debtor) has essentially three ways out to get itself out of debt:

  • CIRP/Liquidation/Voluntary Liquidation.
  • Companies Act: Section 230- Scheme of Arrangement for restructuring of business.
  • RBI’s Prudential Framework.

On a bare perusal of the above three options, options under IBC and Companies Act involve court interference and immense control in the hands of the Resolution Professional (RP) or Liquidator in terms of managing the assets and the day-to-day operations of a company whereas RBI’s Prudential framework has limited applicability i.e., it is applicable only to banks and NBFC’s permitted by the RBI.

When the Corporate Debtor (CD) or financial/operational creditor trigger CIRP, the RP is empowered under section(u/s) 17,20 and 25 of the Code to protect and preserve the assets of the CD as well as manage the operations of the CD as a going concern. Further, section 14 stipulates that during the operation of the moratorium period, the essential goods or services which are critical to manage the business as a going concern are not subject to the moratorium period i.e., the same cannot be suspended or interrupted.

Under Liquidation, Section 35 of the code highlights the duties of the RP to take measures to protect and preserve the assets of the CD, take control and custody of the assets as well as manage the business of the CD. The distribution of the assets liquidated must be in accordance with the order of priority stipulated under section 53.

What is Pre-Pack?

A Pre-packaged insolvency (Prepack) is a financial plan where the restructuring is pre-posed and agreed in advance with creditors and other stakeholders before a CD declares its insolvency. Hence, prepack is nothing but a quasi-formal procedure where the resolution plan is finalised before the actual initiation of the proceedings under the Code.  The entire framework of the Prepack revolves around the CD having control of its entity i.e control to manage its affairs, assets and discuss the possible modes of Resolution through restructuring with the creditors.  The motivation for a debt burdened stressed out CD in Prepack is to figure out an agreeable way for its own corporate revival and save itself from its death. For the creditors, prepack would offer a faster route and a finality of a feasible resolution plan as an outcome of the self-interests of every party.  It is pertinent to state that even though u/s 12 of the Code, the maximum time limit for completion of the proceedings is 330 days, often at various instances, the process does not end within the stipulated period, and at the expiry of the period of 180 days from commencement of CIRP, with no resolution plan in hand or a resolution plan which has no feasibility for implementation results to liquidation. The outcome of this uncertainty is that the payment of the debt to the Creditors is delayed to another process of liquidation, with other costs and an enlarged time limit and procedures to recover debt.

It is thus necessary to provide for a prepack framework for Companies and Limited Liability Partnerships and enlarge the scope of the current framework which currently focuses on debt resolution for Micro Medium Small Enterprises.

The argument whether a CD would draw out an acceptable plan balancing the interest of all the stakeholders, and the chances of acceptance of the plan put forth by the CD to the creditors displays that an intermediary i.e a RP will be required to supervise and coordinate between the CD and the creditors.

Benefits of Pre-pack:

Cost Effectiveness:

  • The CD continues with the existing management during pre-pack, it avoids the cost of disruption of their work since it does not shift management to the RP and then to successful RA and continues to retain employees, suppliers, customers, and investors.
  • It also saves the cost of RP to the extent he does not have to run the business of the CD as a going concern.
  • The process remains away from limelight till the commencement of the formal process, it minimizes indirect costs in terms of stigma and loss of reputation and goodwill to the business. Since, the proceedings are usually outside the court, the costs are considerably reduced.

Speedy resolution process: 

  • It is difficult to keep a company alive in a stressful state. If stress is not resolved quickly, the value degrades eventually till nothing is salvageable, making resolution difficult.
  • Pre-pack enables a faster resolution, preserves the value of the stressed assets thereby increasing the possibility of resolution.

Value Maximisation:

  • Any distressed asset has a life cycle and the longer it stays in a state of stress, the greater depletion it suffers.
  • Pre-pack preserves value by cutting down these elements of the formal process. Early initiation and closure of the process as compared to the formal process, is useful in terms of maximising the value of assets in a timely manner.

Less Burden on Courts:

  • The courts are overburdened with cases and do not have the capacity to deal with cases.
  • A pre-pack has the potential to reduce litigation, due to its informal and consensual nature.
  • It does not require involvement of the court during the informal part of the process and requires a minimum role of courts during formal process.[2]
  • There is a need to have a functional out of court restructuring process, since the vast majority of cases are restructured out of bankruptcy, with the National Company Law Tribunal acting as a court of last resort if no agreement is possible.[3]

Confidentiality:

  • The structure of Prepack is a semi formal. It is structured in a way similar to out of court options such as mediation/conciliation. The biggest advantage of this is that the proposed resolution plans are not under any form of scrutiny of the public.
  • Since the need for advertisements under the code is done away with, it incentivizes the Parties to propose better terms and also protects the integrity and the goodwill of the business. It is only after a final agreement has been reached that the plan is placed before the Court for seal and the execution. 

Flexibility: 

  •  Pre-pack adopts a flexible approach in the sense that the CD’s have the control over the assets of the company but the same is subject to safeguards protecting the interests of the creditors. Furthermore, the creditors (by a certain threshold of vote) to change the management of the CD to the Resolution Professional.

Design Proposed by the Sub Committee of Prepack: Key Takeaways and Analysis

Model:

The Prepack follows a debtor in possession model i.e the management of the CD is not transferred to the RPs. However, there must be adequate safeguards to protect interests of the creditors.

Duties:

With the control and management being vested in the CDs, it is necessary to pivot a set of responsibilities and duties towards the creditors in addition to the fiduciary duties stated in the Companies Act,2013. The CD is also responsible for all compliances that the RP usually has in a CIRP. With respect to the decisions such as interim finance which require the approval of the creditors as enumerated under section 28, shall be taken by the CD with the approval of the Committee of Creditors (COC).

Checks and Balances to ensure the interests of the Creditors are protected:

The process of Prepack can be either closed/liquidated by the COC. If the CD engages in any activities which has the effect of depleting the assets or reducing the value to the detriment of creditors, the COC can by 66% voting of creditors present, close the process of Prepack. Where the conduct of the CD is such, or where there is no viable business, or for any reason, the COC may by 75% voting decide in favour of liquidation. The COC is constituted by the RP within 7 days of the pre-pack commencement date. It comprises unrelated FCs. The COC is empowered to approve or reject a plan.

Role of the RP

In CIRP, the RP plays a critical role in the resolution of insolvency, albeit that there is no shift in management in Prepack, the RP has to ensure that the dealings are fair and transparent. The RP must guide the CD in all tasks prior initiation and must assist stakeholders to approve a plan. Since the RP is an independent person with no interest other than to ensure the best interests of the Parties and assisting the CD and creditors to draft the plan The RP also has the power to file applications before the Adjudicating Authority as regards issues relating to the conduct of the process.

Costs Involved:

Interim finance under section 28 and the costs of the RP, and other incidental costs with respect to the process of Prepack are the costs involved in Prepack. 

  1. The access to interim finance should be available subject to the COC.
  2. The fees of the RP shall be reasonable and fixed by the CD, borne by the CD and ratified by the COC.

Prepack under the Insolvency and Bankruptcy Ordinance dated 4th April 2021 for MSMEs:

Section 240 A of the Code provides that the Code is applicable to micro, small and medium enterprises (MSMEs). However, considering that an MSME has limited capital, easy corporate structure, providing for resolution under the code especially by way of CIRP may not be very feasible. Apart from considering the increased default threshold of 1 lakh to 1 crore (by virtue of the notification dated 24th March 2020) and thereby eliminating MSMEs from the provisions of the code, the easy way of resolution of stressed assets is by way of prepack. 

It is necessary to state that the Government by virtue of Notification dated 9th April,2021 has set the minimum threshold default at Rs 10 lakh for prepacks for MSMEs in respect of defaults of Rs 10 Lakhs or more. 

Conclusion

Considering the emerging need and varied benefits of Prepack many corporate entities are resorting to Prepack to resolve Insolvency. Apart from the motivation that the control of the CD will be with the debtor, it provides a cost-effective amicable solution. In India, the current framework is for MSMEs and there is a need for legislation to expand the same to Companies and Limited Liability Partnerships with the incorporation of the basic structure of the design proposed by the Sub Committee on prepack with safeguards to ensure that there is time bound, quick and effective resolution of debts.

 

Reference

[1] Page 2, Report of the Sub Committee of the insolvency Law Committee on Pre-packaged Insolvency Resolution Process (herein referred to as Committee)

[2] MCA (2018), Monthly Newsletter, November, 2018

[3] Swiss Challenge, Empower IAS, 7th April 2021, accessible at  https://empowerias.com/blog/prelims-special-facts/swiss-challenge,-pre-packs-empower ias#:~:text=A%20pre%2Dpack%20has%20the,of%20courts%20during%20formal%20process.

[4] Ministry of Corporate Affairs, Report of Sub Committee of the Insolvency Law Committee on Pre-Packaged Insolvency Resolution process, 8th January,2021, accessible at https://www.ibbi.gov.in/uploads/whatsnew/34f5c5b6fb00a97dc4ab752a798d9ce3.pdf

 

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