The Workings of the Pre-Pack Insolvency Process a Primer
The Workings of the Pre-Pack Insolvency Process a Primer
While the evolution of the insolvency and bankruptcy laws in the country coupled with the black swan event sweeping the globe has led to the imminent implementation of the pre-pack process, there are quite a few lacunae which would have to be addressed before this whole additional option under the Code could become fully functional and effective
The introduction of a pre-packaged insolvency/bankruptcy regime is expected to be an organic development arising out of the impact and evolution of the Insolvency and Bankruptcy Code, 2016 ("IBC, 2016" or "the Code"). The market has been advocating and anticipating a resolution framework which is a hybrid of the court supervised insolvency framework and out-of-court restructuring schemes to facilitate resolutions that are happening today in the shadow or on account of the Code. In recognition of the need, the Government started exploring the feasibility of implementing a 'pre-packaged' insolvency mechanism, to aid the existing insolvency framework and cut cost and time of the resolution process.
Pre-pack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings. It seems to be a preferred hybrid framework, as it empowers stakeholders to resolve the stress of a CD as going concern, with the minimum assistance of the authority related mechanism. It starts with an informal understanding, engages the stakeholders in between, and ends with a judicial blessing of the outcome, though the nuances differ across jurisdictions. The insolvency laws around the world provide a variety of pre-pack mechanisms, in addition to regular resolution process.
In the 'Report of the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process'(ILC-PIRP), it has been stated that pre-pack ought to adhere to broad principles and contours of the Code. It envisaged a pre-pack framework that provides a level playing field and does not disturb the balance of power too much to preserve the credit discipline that has been achieved with implementation of the Code in the last three years. It broadly identified 3 principles which any pre-pack ought to abide by; which are as follows:
(i) the basic structure of the Code should be retained;
(ii) there should be no compromise of rights of any party; and
(iii) the framework should have adequate checks and balances to prevent any abuse.
It identified three features, namely, creditor in control, moratorium during resolution and binding nature of an approved resolution plan, which could be considered as part of basic structure of the Code.
WHAT IS A PRE-PACK?
A pre-pack is a restructuring plan which is agreed to by the debtor and its creditors prior to the insolvency filing, and then sanctioned by the court on an expedited basis. The United Nations Commission on International Trade Law (UNCITRAL) uses the term 'expedited reorganization proceedings' for pre-packs, as these proceedings follow the procedure of reorganization, but on an expedited basis, combining voluntary restructuring negotiations, where a plan is negotiated and agreed to by the majority of affected creditors, with reorganization proceedings commenced under the insolvency law to obtain court confirmation of the plan in order to bind dissenting creditors.
In a pre-pack, a troubled company and its creditors negotiate the terms of an insolvency resolution plan prior to the commencement of the formal insolvency process, which allows formal process to be implemented at maximum speed. The most prevalent form of pre-pack process envisages a resolution plan, which is negotiated and finalized between the creditors and the debtor before the commencement of statutory proceedings, and is sanctioned under the statute.
It is expected that pre-packs in India would be an optimal semi-formal combination of the CIRP process, the informal settlement options and the typical pre-pack regimes prevalent across the globe.
OBJECTIVES AND LEGAL FRAMEWORK OF PRE-PACK:
The ILC-PIRP in its Report has explicitly stated that since pre-pack is envisaged as another option within the Code, it should pursue the same objectives as the Code does.
The pre-pack process would look to ensure:
i. Rehabilitation of the Corporate Debtor;
ii. Maximize the value of the assets;
iii. Prioritize the distribution rights of the creditors and stakeholders;
iv. To provide a forum for voicing the interests of affected parties.
It is usually seen that laws relating to financial markets, regulation of corporate entities, etcetera are mostly incomplete and empiric but they are made complete with the evolution of requisite subordinate legislation in sync with the changes and dynamics of the market, economy and its needs. In keeping with this best practice, the ILC-PIRP in its Report has stated that the Code may make a skeletal provision enabling pre-pack, and prescribing the contours of subordinate legislation also to ensure flexibility and adaptability of the same.
WHO CAN INITIATE PRE-PACKS?
The ILC-PIRP in its Report has stated that after detailed deliberations, the Sub-Committee is of the view that the option to avail pre-pack process ought to be made available to all the corporate debtors without any bar regarding the minimum threshold of default and without precluding COVID-19 defaults, as is done in the CIRP process currently. But the implementation of the pre-pack process for all is expected to be done in phases.
The corporate debtor and its promoters understand the finer workings of the company, the stress which it is experiencing and also have plausible aces up its sleeve for resolution and thus corporate debtors, akin to their contemporaries across the world, ought to be given the opportunity to initiate the pre-pack process voluntarily after obtaining the consent of the requisite stakeholders. The ILC-PIRP recommends consent of simple majority of shareholders of the corporate debtor and a simple majority of unrelated FCs for initiation of pre-pack.
WHEN CAN PRE-PACKS BE INITIATED?
For initiation of pre-pack process, the ILC-PIRP has contemplated incorporating both default and stress as triggers. The Code prohibits initiation of CIRP in respect of COVID-19 defaults forever. The ILC-PIRP stated that if pre-pack is not available in respect of COVID-19 defaults, such defaults would never be resolved under the Code and that thus it may be advisable to extend pre-pack, which is a consensual process, to COVID-19 defaults as well. Provisions are also being contemplated to be introduced to ensure mala fide initiation of pre-pack process by defaulters are not gone unchecked.
With regard to the threshold for initiation of pre-pack process, the Report states that it could be done for various phases which could probably encompass the following scenarios:
(i) Default ranging from 1 lakh to 1 crore and COVID-19 defaults;
(ii) Default above 1 crore;
(iii) Default from 1 to 1 lakh; and
(iv) Pre-default stress.
The ILC-PIRP has suggested that the scenario (iv) ought to however, require consent of higher threshold (maybe 75%) of creditors than the norm for the other 3 scenarios (i.e., 25%) to avoid any potential misuse. Another possible anomaly could be the probability of CIRP and pre-pack processes running simultaneously which has sought to be resolved and nipped in the bud itself by expressly stating that no two proceedings – i.e., pre-pack and CIRP - under the Code shall run in parallel.
PROCEDURES BEFORE COMMENCEMENT OF THE PRE-PACK PROCESS:
Pre-pack envisages completion of several tasks before submission of application to the NCLT for initiation of pre-pack. These tasks include: board meeting followed by general meeting of shareholders of the CD to approve the proposal to initiate pre-pack, engagement with creditors for approval by majority of unrelated FCs to the proposal, identification of an IP to act as RP, preparation and updating of records and information, preparation of resolution plan, etc.
The ILC-PIRP has also taken into consideration the procedures which have contributed to delays in implementation of resolution plans, schemes et cetera and has suggested that it would be optimal if the law only specifies the requirements for making an application to the NCLT, but not the manner of complying with these requirements, thereby giving some much-needed flexibility to the rigid procedures which exist in the other options.
The ILC-PIRP recommends debtor-in-possession model for pre-packs. This makes the process simpler and its closure quicker, while helping the CD operate at its optimum level during the resolution. The ILC-PIRP, therefore, recommends a hybrid approach of debtor-in-possession with creditor-in control for pre-pack with clear demarcation of responsibilities of the CD, RP, and creditors.
ROLE OF RESOLUTION PROFESSIONAL:
It is envisioned that along with the consent of creditors to initiate pre-pack process, their consent to the choice of IP to act as RP could also be obtained. In a pre-pack process, unlike a CIRP, the insolvency professional does not have the responsibility of running the business of the CD as a going concern. He would not be exercising the powers of the Board of Directors nor would he be responsible for complying with all the applicable laws on behalf of the CD. But the role of the RP is envisaged to be more of a beacon to oversee the entire process. The ILC-PIRP therefore, recommends that the RP should ensure transparency and fairness of the process, safeguard the interests of stakeholders, business, and the public, and ensure compliances with the law as regards the process.
Since the RP is to be appointed in a pre-pack process with the consent of majority of unrelated FCs, the need for replacement of RP should be rare, i.e., in case of death and/or incapacity only.
PROCEDURES AFTER PACK COMMENCEMENT DATE (PCD):
It is pertinent to note that public announcement of the PCD via paper publication would be dispensed with and electronic publication of the same on the websites of the CD and IBBI alone would suffice. This is basically because, there would not be any call for claims from the creditors, rather the RP would be undertaking the crucial task of providing the details of claims, based on books of the CD and records of the IU, to each creditor and seek their confirmation / objections.
Unlike in a CIRP where the RP would be required to constitute a CoC within 30 days from commencement of insolvency process, the RP would have to constitute the CoC in a pre-pack process within 7 days from the pre-Pack Commencement Date (PCD). This is expected to be adhered to, given that the CD would be required to hand over the details of the exact list of creditors (both financial and operational) to the RP immediately upon the PCD.
The ILC-PIRP recommends that the CD shall prepare a draft Information Memorandum (IM) which shall be certified by the Chairman/Managing Director on behalf of the Board for its completeness and accuracy. The IM shall be handed over to the RP on the PCD who would have the task of ensuring that the same is in compliance with the Code before finalizing it.
To mitigate undue losses on part of any of the creditors, the Board of Directors bear the onus to supply complete and correct record of all claims, including contingent and future claims, with an indemnification that if any claim is omitted by them, they will be personally liable to make such claim good. Further, if the CD willfully provides any wrong information or omits to provide material information with respect to any claim, the same shall attract criminal liability.
The ILC-PIRP recommends that the RP shall appoint two registered valuers to determine the 'fair value' and 'liquidation value' of the CD. This will ensure to a large extent that the pre-pack is not misused by the management of the CD to write off its debts or to defraud creditors.
The ILC-PIRP has also proposed that the provisions applicable to the avoidance transactions could be applied to pre-packs too. However, given the stringent short timelines envisaged for the pre-pack process, the workability of the same has not been deliberated upon.
Regarding the applicability of moratorium to after PCD, it has been recommended that the same be available, however, in a bid to mitigate the possibility of its misuse some measures have also been deliberated. The measures include that the moratorium may not be automatically ordered as a matter of right of the CD but given only on a case-to-case basis, the leeway for an early termination of the moratorium in case of any misuse etc.
The ILC-PIRP strongly recommends that the applicability of Section 29A of the Code should continue in case of pre-packs too, after having deliberated upon the dilution of the provision, as the people with questionable backgrounds and those who let down their companies, employees, lenders and stakeholders do not deserve a second chance. Participation of promoters is justified not only because they are often the only ones who are interested in the business of the CD, but also because they are not always responsible for its distress. But being accorded another opportunity to run the CD ought not to materialize when there have been mala fides on part of the erstwhile management and promoters of the CD. The ILC-PIRP has clearly stated that bad business decisions are vastly different from malfeasance. The final output which is the delegated legislation
It is recommended that the pre-pack should start with a base resolution plan. The base resolution plan submitted by promoters shall form the basis for Swiss challenge, where the details of the plan are disclosed. It's been observed and noted that the Swiss challenge is a time-tested mechanism and has proven to be highly effective in value maximization and ensuring transparency of the process. This method would also keep the promoters on their toes and would not allow them to get lax and ensure that value maximization of CD happens in the best interests of all the stakeholders. The exact details of this mechanism would have to be laid down in the proposed regulations.
Since the CD and creditors have agreed beforehand to undertake pre-pack, it is expected that the process should be completed in 90 days' which is much sooner than the CIR Process. Also, moratorium, if allowed, would also come at a cost to the stakeholders and thus the ILC-PIRP has strongly stated that the timelines would have to be adhered to stringently. A timeline of 30 days after submission of the resolution plan is also suggested for the Adjudicating Authority to decide upon the same, though this might be directory in nature. This, nevertheless could increase the pressure and work load of the NCLT, thus the need for creating NCLT Benches exclusively to hear and dispose of pre-pack matters would have to be considered. However, the 90 days timeline comes across as a mandatory one as the expiry of 90 days is also one of the methods of closure of the pre-pack process.
CLOSURE OF PROCESS:
A pre-pack process may conclude by an order of the Adjudicating Authority, based on an application by the RP, under any of the following circumstances:
(a) Approval of Resolution Plan;
(b) No resolution received or approved;
(c) Expiry of Timeline – i.e., on expiry of 90 days;
(d) Termination by CoC – The CoC may close the process with 66% of creditors, present and voting if the CD does not conduct well;
(e) Liquidation - There will, however, be no liquidation where pre-pack was initiated for pre-default stress, default below the threshold for initiation of CIRP (which is 1 crore at present) or COVID-19 defaults;
To prevent CD's from frequenting this recourse and attempting to take a shield under the same repeatedly, a cooling off period of 3 years from the closure of a pre-pack process has also been deliberated.
While the evolution of the insolvency and bankruptcy laws in the country coupled with the black swan event sweeping the globe has led to the imminent implementation of the pre-pack process, there are quite a few lacunae which would have to be addressed before this whole additional option under the Code could become fully functional and effective. This process cannot possibly be unduly hastened and is usually a product of natural progression of the insolvency laws.
The interest of the operational creditors once again looks to be vanquished to a certain extent and it would be optimal if a long rope was extended to the 'cogs' of the business and ensure some egalitarian rights given to them in the pre-pack process. The provision of the 'clean slate' principle to CD's would also have to be rationed and decided judiciously as the pre-pack process should not unduly benefit promoters and the CD, especially if there have been acts of malfeasance done by them vide the CD.
Another important point to be noted is that transparency and good, clean business principles would be required and expected of the corporate debtors, as any lapse in book keeping and maintenance of records et cetera could very well spell the death knell for them, as creditors would be watching over their dues and claims like a hawk during the pre-pack process and even generally under the IBC regime. This could be a welcome move to ensure that there is more openness in business transactions.
The scenarios envisaged for 'closure' of the pre-pack process have only been broadly addressed, i.e., on approval of the resolution process, when no resolution is received/approved, on expiry of timeline, at any time within the timeline on termination by the creditors, on liquidation (as specified). The regulations/framework would have to be clearly set out as well as the criteria and ingredients for closure.
However, with a robust set of professionals and systems in place with the onset of the IBC regime, the rolling out of the pre-pack insolvency process could very well be seen as a lucrative option in lieu of the CIRP process. But the trust and goodwill built by the professionals, plus the cohesion of the creditors and the CDs in looking to adhere to the tenets of the Code would be crucial in making this option a fruitful one.
Disclaimer – The views expressed in this article are the personal views of the authors and are purely informative in nature.