Prashansa Singh[i]
The Insolvency and Bankruptcy Code, 2016 ("IBC") was, and still is, one of the most fundamental legislations of its time, as it fulfilled the need of a uniform structure for insolvency matters. IBC’s implementation has shown positive results overall as India’s rank jumped to 108 from 136 in 2018 and to 52 in 2019 in the ‘Resolving Insolvency’ bracket of the Ease of Doing Business Index of the World Bank. However, it has been observed that CIRP proceedings have resulted in more liquidations than successful resolutions. The IBC provides for insolvency resolution after the creditors (financial or operational) apply for the same under Section 7 or 9 or if the Corporate Debtor himself applies under Section 10 of the Code. This stops the Code from providing a framework where the resolution of insolvency is done before the default occurs, i.e. the debtors and creditors, as of now, do not have a provision to discuss and decide on a resolution plan before a default occurs, or before an application is filed before the NCLT. The IBC does not give recognition to the concept of out-of-court resolution of debt.
Pre-packaged insolvency, or Pre-Pack, is an emerging concept which can be used to tackle this problem. India, as of now, has suspended the initiation of IBC for a period of six months extendable up to one year for any default that occurs from 24 March, 2020 onwards during the nationwide lockdown. The rationale behind this was to give companies a breathing space to deal with the economic blow of COVID-19 on their businesses. Payment defaults were expected to increase greatly, and the suspension was done to save companies from facing liquidation for factors beyond their control. Moreover, even if debtors were admitted into IBC proceedings, there would be more liquidations than resolutions right now, as third-party bidders are hesitant to bid for distressed assets due to the uncertainty around the pandemic.
A pre-pack provides for the restructuring plan to be submitted along with the application for bankruptcy. All the creditors are informed about the said plan before filing an insolvency application, which the parties negotiate. Subsequently, a conclusion is reached through a vote.
There is no prevalent market norm in India for out-of-court debtor restructuring as of now. The Bankruptcy Law Reforms Committee had deliberated on incorporating pre-packs in the IBC. However, no formal recognition has been given to the concept as of yet. The advantages of a pre-pack when it comes to the duration or the cost or minimum hindrance to the debtor’s business make it a good alternative for companies struggling due to the COVID-19 pandemic. An out-of-court resolution gives parties the freedom to arrive at a plan suited to everyone’s interests.
There are several advantages to incorporating pre-packaged insolvency into the Indian insolvency framework. However, the limitations must also be kept in mind while forming a framework for pre-packs in India.
Advantages
Speedy & Cheaper Resolution: Pre-packs serve as a cheaper and less time-consuming alternative to the standard CIRP, as all the necessities of a CIRP are fulfilled beforehand, such as negotiation, voting, and settling on a resolution plan. It reduces the legal cost involved in a formal procedure, while also reducing the cost of hiring a resolution professional.
Certainty: Pre-pack helps parties have greater certainty regarding the repayment of debts, which is not the case in an ordinary CIRP, where the share of each creditor depends upon the circumstances prevailing and the plan chosen. Moreover, the promoter and management of debtor will have more incentives to cooperate as a pre-pack will let them negotiate directly with investors and stakeholders to formulate a plan which maximizes the assets of debtor while taking into account the interest of the stakeholders.
Continuity of business: In pre-packs, the business of the corporate debtor is continued. The restructuring plan can be negotiated and agreed upon without interrupting the business of the debtor, thus preventing disruption that may result from the sudden removal and replacement of management. In most industries, a break in the company’s process will inevitably have a detrimental effect on the business. However, carrying out business during insolvency may not be an option if no funding is available, or if it is not possible to comply with regulatory requirements. Pre-packs facilitate a quick and relatively smooth transfer of a business, allowing the business to continue uninterrupted.
4. Value protection: News of insolvency or financial difficulty can lead to a reduction in the value of a business, as people lose confidence in the business. Pre-pack resolution is confidential in nature and that helps in preserving the value of the business of the Corporate Debtor. The risk of value-reduction can be avoided by completing a Pre-pack before the news of insolvency enters the marketplace.
The ultimate authority with the Court: For a pre-packed plan to be binding, it requires the approval of the Adjudicating Authority. Hence, only that resolution plan will be approved and will be binding which has all the essential features of the resolution plan given under the Code. If implemented in India, the pre-pack schemes will reduce the already burdened NCLT’s tasks as already there will be a resolution plan, and since the plan would already be endorsed by the creditors, it will effectively bypass various requirements and interventions by the NCLT at different stages under the usual IBC process and would help unburden the already over-burdened NCLTs.
Disadvantages
Despite the benefits of pre-packs, there are disadvantages to it as well, which are stated as follows:
The disadvantage to unsecured creditors: A big disadvantage of a pre-pack is that it only binds those who have explicitly consented to it. Also, due to the confidentiality of the process, only the secured creditors’ approval is taken. The unsecured creditors are made aware of the transaction only after it has occurred. It means that the unsecured creditors will not have any say in the distribution of shares. This would leave their rights to be decided by stakeholders who do have a say, and they may try to exploit this opportunity to give the unsecured creditors less than what they may have gotten through CIRP.
Increase in fraud or undervalued transactions: Pre-pack insolvency may lead to an increase in preferential or manipulated transactions, which would defeat the fundamental objective of any insolvency law i.e. to maximise assets of the corporate debtor. In a pre-pack, the debtor controls the business of the company for a large part of the negotiations and hence the resolution professional would not exercise much control over the process of arriving to a resolution plan. This would result in fraud or preference transactions being much harder to unearth, which may adversely impact smaller financial creditors and operational creditors.
No advantage of moratorium: Since a pre-pack does not fall under Sections 7, 9, or 10, it will not be able to claim moratorium. This would make the company vulnerable as the creditors can enforce their rights, while the corporate debtor goes for a pre-pack resolution. It would open opportunity for claims by creditors who do not consent to the resolution plan.
Process-related litigation: The lack of transparency or an open bidding process might give rise to a lot of litigation regarding its process. Already there is a tendency of stakeholders to start litigations around the IBC procedure. The proposed schemes can be challenged at any stage and hence, there would be big scope of increasing litigation in case of pre-packaged insolvency, which is not guided by any statute. Extra litigation surrounding a debtor’s resolution would slow down the resolution process, defeating IBC’s purpose of time-bound solutions.
Certain other caveats must also be noted. A pre-pack will not be effective in every case as it presupposes threshold-level cooperation between the debtor and creditors, which may be absent in some cases. Similarly, pre-packs are likely to fail in cases where there are a large number of geographically dispersed creditors with different interests, making it difficult to bring them together. Thus, while pre-packs should definitely be permitted, considering them a replacement to CIRPs will probably backfire. Ultimately, the creditors should have the biggest say in a pre-pack or a CIRP being best suited for a particular debtor.
Conclusion
In the present scenario, pre-pack insolvency is yet to be explored in the Indian marketplace. Pre-packs would undoubtedly ease the process of debt resolution, especially in a time where almost all businesses are affected by the Covid-19 pandemic. Going through with a pre-pack would save several struggling companies facing liquidation. However, it would come with its own challenges. The potential implementation of pre-packs would be walking a tight-rope, for it may be opposed. However, the stakeholders should have the option to choose between a pre-pack and the standard CIRP, an option which is yet to be available before them. Further, mandatory approval from the NCLT of the resolution plan will reduce fear of stakeholders and creditors, regarding their interests as they would feel more at ease with the binding nature of the contract after the NCLT backs it. The concept of pre-pack will assist the IBC in achieving its objective, i.e. to maximize the asset value of the corporate debtor and safeguard the interest of all stakeholders involved. The Covid-19 induced economic crisis is an opportunity that needs to be taken to introduce pre-packs into the insolvency resolution mechanism in India. The regulatory framework for pre-packs needs to be designed carefully, as it cannot be considered a replacement for CIRP given in the IBC.
[i] Prashansa Singh is a 3rd-year student at Dr. Ram Manohar Lohiya National Law University, Lucknow. She is interested in Insolvency laws, Competition law, and Banking laws. For any discussion or feedback regarding her submission, she can be reached through e-mail, at 99prashansa@gmail.com. Preferred Citation: Prashansa Singh, Pre-Packaged Insolvency During Covid-19 And Beyond? Arbitration & Corporate Law Review, Published on 6th August 2020.