An economic law is mostly empirical. It is constantly evolving as a result of experimentation. Although to continue experimentation in economic matters is a grave liability, but refusal of such right to experiment carries significant implications for the country. Thus, in May 2016, the Insolvency and Bankruptcy Code (“IBC”) was enacted with the aim to “consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of value of assets of such persons.” Essentially the Code has been successful in bringing down the timeline of resolutions by establishing a new insolvency system, thus saving stressed-out businesses, which indeed promotes competitiveness and growth in the marketplace, as well as entrepreneurship and credit supply in the economy. However the formal approach of settlement such as, Corporate Insolvency Resolution Process (“CIRP”), mentioned under IBC necessitates both time and resources to complete, taking into account both direct and indirect costs. The Reserve Bank has prescribed certain out of court debt restructuring mechanisms but they lack the legal sanctity that the IBC mechanism enjoys, and on a realistic basis, it becomes difficult to carry out such debt restructuring.
Taking into consideration the evolution of the ecosystem, stabilization of the processes, and the growing jurisprudence, it can be said that the market has been calling for and expecting a settlement system that is a combination between court-supervised insolvency and out-of-court turnaround schemes. In this regard, Pre-pack has arisen as a novel corporate rescue tool that combines the benefits of both informal (out-of-court) and formal (judicial) insolvency proceedings.
What is a Pre-package Scheme?
Pre-package Scheme is a form of corporate rescue in which the Corporate Debtor and its creditors reach an arrangement to resolve the debt of the troubled Corporate Debtor prior to filing an insolvency claim with the Adjudicating Authority. It could be understood as a hybrid process of proceedings which empowers the stakeholders to overcome the stress of a CD as a going concern with the least amount of state assistance.
An agreement for the resolution of the debt of a company is reached through an understanding between secured creditors and investors before the filing of an application under Sections 7, 9 and 10 of IBC. Following the conclusion of the negotiations, it would only need to be accepted by the committee of creditors (“CoC”) and, later, by the NCLT. Thus, the mechanism saves both the debtor and the creditors’ time by excluding them from all lawsuits and other legal formalities, such as inviting prospective settlement applicants under Section 25(2) (h) of the IBC.
Therefore, it is regarded as a fast, cost-effective, and effective method of resolving tension, far before value deteriorates, with the fewest market disturbances, and without attracting the stigma associated with the structured insolvency procedure. It is referred to as a “expedited reorganization proceeding” by the United Nations Commission on International Trade Law (“UNCITRAL”).
Pros of adopting pre-pack insolvency
Pre-package scheme combines the combines “the best of both worlds” takes into account the advantages of both formal and informal trials and its availability in accordance with CIRP broadens stakeholders’ choices and increases their interest in the process. This, along with the fact that pre-package is more casual, cost-effective, which takes less time to complete, enables businesses to go through insolvency processes more smoothly.
With the appointment of the interim resolution professional the image of the corporate debtors in the market is affected, and as a result, the market value of the corporation's assets falls because new buyers are unwilling to risk their funds. Thus, when the company will be liquidated, it will not receive the full value of the assets. However, with pre-packs, as after negotiations it only needs to be approved by the CoC and then by the NCLT, the market has quite less time to react. Unlike the CIRP approach, where there is an Insolvency Professional-in-possession with a creditor-in-control, a hybrid approach of debtor-in-possession with a creditor-in-control would be used in Pre-Pack, which means that the Corporate Debtor will maintain possession of the management.
Until invoking the structured aspect of the procedure, pre-pack envisions a consensual process, i.e. prior consensus among by an agreement by stakeholders on the course of action to resolve CD tension. While the stakeholders, voting creditors are aware of the negotiating plan, the information can be efficiently kept off the general market. This preserves the process's confidentiality up to a point and reduces disputes and litigation. The courts already have minimal infrastructural capability and can only fulfill their duties under those limits. Because of its casual and consensual existence, a pre-pack has the ability to minimize lawsuits. It is not necessary for the court to be present during the informal proceedings and requires minimum role of courts during formal process. Hence, it reduces litigation cost and delays and helps to decongest the overburdened courts.
Cons of adopting pre-pack insolvency
A structured deal between the parties is more likely to be broken by someone and there are no substantial repercussions and there is no legislative justification. Furthermore, creditors who disagree may dominate a negotiation and cause a delay in reaching an agreement. This could jeopardize one of the primary advantages of pre-packs.
Because of the essence of pre-packs, there is a lack of transparency prior to the selling as the parties work to secure the future of the company without jeopardizing the confidence of creditors, consumers, and workers. This secrecy makes unsecured creditors feel disenfranchised, particularly if the purchaser is linked to the insolvent business. As it is mostly confidential, there is not enough incentive to carry out extensive marketing that would be in the interests of all creditors, especially unsecured creditors. In these situations, the value owed to unsecured creditors may be captured by connected parties, while the current management regains ownership without having to bear the liability of repaying a large portion of the older debt. As the directors/promoters/management are involved in the resolution, there is a high chance that the debtor’s related party creditors might end up getting all the assets.
In certain cases, there are fears that pre-packs are being used by related parties to profit from the re-engineering of the balance sheet, especially to undercut their market competitors where the business is still potentially insolvent and not practically insolvent. Pre-pack is used a “sham... to ditch debt”, which could result in “phoenixing” of companies. It means a company reaches to a point of winding up and then they are restructured with the help of a pre-pack, but with similar people managing the company
Pre-packs want the regulatory and statutory exemptions a company enjoys under the CIRP process, unless it is approved by the court. One of the recent examples of out of court settlement of Jet Airways not working as they failed to get exemptions
Challenge under IBC
Section 29A of the IBC remains one of the most visible obstacles to the introduction of the Pre-Package Scheme. It deals with disqualification criteria for persons who want to be a resolution applicant. A resolution applicant is defined under Section 5(25) as a person who submits a resolution plan to the resolution professional. The purpose of a Pre Package Scheme is where the corporate debtors attempt to bargain with the creditors prior to any court action under the IBC. Section 29A(c) of the IBC explicitly disqualifies person who
has account classified as NPA
is a promoter of a corporate debtor the account of which has been classified as NPA
is in the management of a corporate debtor the account of which has been classified as NPA
is in control of a corporate debtor the account of which has been classified as NPA.
Section 29A was initially enacted in order to prevent defaulting promoters from returning to management via the backdoor. The Supreme Court in Jaiprakash Associates Ltd. and Ors. Vs. IDBI Bank Ltd. and Ors. held strict adherence to Section 29A, but if this is done, corporate debtors would not be able to formulate a resolution plan with the creditors as this section prohibits the same.
The Sub-Committee Report
The sub-committee of the Insolvency Law Committee chaired by Dr. M.S. Sahoo, Chairman of the Insolvency and Bankruptcy Board of India, was set up on June 24, 2020 to explore the option of introducing pre-packaged insolvency resolution process.
It stated that the corporate debtor should be able to initiate the pre-pack agreements as they have genuine interest in reorganization of the assets. It also states that in order to avoid the use of this restructuring mechanism, a simple majority of shareholders must be obtained before the corporate debtor can begin a pre-pack phase. The correct time to initiate the pre-packs was when the debtor makes a default of any amount in the range of Rs. 1 Lakh to 1 Crore.
The Sub Committee has decided to apply Section 14 of the IBC to pre-packs as well. As a result, to prevent any sort of misuse, a moratorium of 90 days from the pre-pack commencement date and an additional 30 days for the adjudicating authority to approve the proposal would be imposed. At the end if no negotiation was possible by the company, it will have to resort to liquidation.
While the IBC has had a positive impact on promoters of defaulting firms in terms of repayment discipline, liquidation is a grave danger viewed on CIRP loss, and repeated instances of liquidation may not be a feasible or attractive option in terms of promoting the corporate community in the long run. This problem is exacerbated further as micro, small, and medium-sized businesses are disproportionately affected due to a lack of investor confidence in their properties throughout CIRP. Also for large businesses undertaking CIRP, time and costs are significant factors that contribute to aversion to CIRP
It is not unknown that the COVID-19 outbreak and subsequent lockdown had a negative impact on the Indian economy, causing financial distress for many companies across the region. In light of the current condition, undoubtedly there would be mass insolvency proceedings, overburdening the Adjudicating Authority under the IBC. It is imperative that such Pre-package scheme will produce only beneficial effects and would have more advantages than disadvantages. It would indeed result in a quicker implementation of resolution plans, would stimulate progress, and would keep the business operating as a going concern while retaining employees and ensuring creditors collect the funds they are owed. The ultimate gain to the Indian economy would be noticeable, as overseas companies can move operations to India to take advantage of the flexible insolvency system.
Under the current IBC regime in India, insolvency practitioners are only developing the requisite skills over time. The implementation of pre-pack insolvency in India would require a much higher degree of expertise of insolvency practitioners, as under such resolution approaches, they have a much higher degree of involvement. If achieved correctly, it would undoubtedly improve the new insolvency regime’s settlement mechanism and, ideally, validate the IBC’s objectives.
Report of the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process, https://www.ibbi.gov.in/uploads/whatsnew/34f5c5b6fb00a97dc4ab752a798d9ce3.pdf
Designing a Framework for Pre-Packaged Insolvency Resolution in India Some Ideas for Reform, VIDHI, CENTRE FOR LEGAL POLICY, https://vidhilegalpolicy.in/wp-content/uploads/2020/02/Report-on-Pre-Packaged-Insolvency-Resolution.pdf
Akriti Shikha , Pre-packs – A Speedy Resolution Process?, https://www.indialawjournal.org/pre-packs-a-speedy-resolution-process.php
Utkarsh Mishra, Pre-package Schemes: An efficient mechanism? , https://cbcl.nliu.ac.in/insolvency-law/3211/
Year III, Sixth Semester,
University of Petroleum and Energy Studies