Analysing Pre-Pack Resolutions under IBC

Resolution of a corporate person’s debts is possible under the Insolvency and Bankruptcy Code, 2016 (hence referred to as IBC) via the Corporate Insolvency Resolution Process (CIRP), liquidation (often when CIRP is unsuccessful), or voluntary liquidation. Remember that IBC is a financial regulation. Economics laws are inherently experimental [1], meaning they change over time. There are basically three options available to a Corporate Person (Corporate Debtor) in the event of default:

• A Company under Voluntary Arrangement with its Creditors (CIRP) or Liquidation (Liquidation).
• For corporate reorganization under Section 230 of the Companies Act.
• Prudential Regulation by the RBI.

When comparing the three options, it is clear that the options under the IBC and the Companies Act require court intervention and give the Resolution Professional (RP) or Liquidator extensive power over the company’s assets and day-to-day operations, while the RBI’s Prudential framework is only applicable to banks and NBFCs approved by the RBI.

When CIRP is triggered by either the Corporate Debtor (CD) or a financial/operational creditor, the RP is given authority under sections 17, 20, and 25 of the Code to safeguard and preserve the CD’s assets and continue running the CD’s business as if it were solvent. Furthermore, section 14 provides that the provision of goods or services necessary to maintain the company as a going concern is not subject to the moratorium period, i.e., the provision of such goods or services may not be terminated or halted during the operation of the moratorium period.

Within the context of Liquidation, Section 35 of the IB Code emphasizes the RP’s responsibilities to acquire ownership and custody of the CD’s assets and run the CD’s business, as well as to take reasonable precautions to safeguard and maintain such assets. Assets from a liquidation must be distributed in line with the priority order set out in Section 53.

When do you use the term “Pre-Pack?”

Before a CD declares bankruptcy, it may propose and agree to a financial plan known as pre-packaged insolvency (Prepack) with its creditors and other stakeholders. Therefore, pre-pack is nothing more than a semi-formal process where the resolution plan is finalized prior to the actual beginning of proceedings under the Code.

The CD’s ability to manage its affairs and assets and to debate the different modes of Resolution via restructuring with the creditors is important to the Prepacks structure as a whole. In Prepack, a company’s aim is to find a mutually beneficial strategy for reviving the company and preventing its own demise after being saddled with a large amount of debt.

A speedier path and finality of a workable resolution plan is what pre-pack would provide for the creditors as a result of the self-interests of all parties involved. It is important to note that even though the maximum time limit for completion of the proceedings is 330 days u/s 12 of the Code, in many cases the process does not end within the stipulated period, and at the end of the period of 180 days from the commencement of CIRP, with no resolution plan in hand or a resolution plan which has no feasibility for implementation, the company is forced into liquidation.

As a result of this doubt, the payment of the debt to the Creditors must be postponed until a different liquidation process is undertaken, which entails more expenses as well as a longer deadline and more complex processes for debt recovery.

Therefore, it is important to expand the present framework, which primarily addresses debt resolution for MSMEs, to include pre-pack frameworks for companies and limited liability partnerships.

An intermediary, i.e., an RP, will be needed to supervise and coordinate between the CD and the creditors in light of the debate over whether a CD would come up with an acceptable plan balancing the interests of all the stakeholders and the likelihood of acceptance of the plan put forth by the CD to the creditors.

The Value of Pre-Packaging

Efficiency in costs:

• By keeping the same management team in place during pre-pack, the CD may save money by not having to pay to reassign staff, suppliers, customers, and investors throughout the transition to the RP and subsequently the successful RA.
• It also helps save expenses for RP since he won’t have to keep the CD’s operations running.
• Due to the fact that nothing official is done before the process officially begins, the firm incurs fewer indirect expenses from things like negative publicity and a damaged reputation. There is a huge saving in court fees since the procedures themselves take place outside of the courtroom.

Quick problem-solving:

• Keeping a business afloat in an anxious condition is challenging. When tension isn’t alleviated soon, the situation deteriorates until nothing of worth can be saved.
• Pre-pack increases the likelihood of settlement since it expedites the process and protects the value of stressed assets.

Optimization of Value:

• A distressed asset has a finite lifespan, and its value will decline the longer it remains in a stressed condition.
• Pre-packaging helps maintain value by eliminating these cumbersome formalities. When compared to the formal procedure, starting and finishing the process early is helpful for maximizing the value of assets in a timely way.

Decreased Workload for the Judicial System:

There are more cases than the courts can handle.

• Due of the informal and agreeable character of a pre-pack, it may help minimize lawsuits.
• The judicial system plays no part in the informal phase and only a minor one in the formal phase.[2]
• Since the great majority of cases are restructured outside of bankruptcy, there must be a reliable alternative to having to go to court to resolve issues.
• The National Company Law Tribunal serves as a court of last resort if an agreement cannot be reached.[3]

Confidentiality:

Prepack has a rather strict structure. It follows a format somewhat dissimilar to that of alternative dispute resolution techniques like mediation and conciliation. The primary benefit of this arrangement is that the suggested resolution plans are not subject to any kind of public examination.

The elimination of the code’s advertising requirements not only encourages the Parties to offer better conditions but also safeguards the company’s reputation and legitimacy. After all, parties have come to an agreement, the plan is submitted to the Court to be sealed and put into effect.

Flexibility:

The CDs retain authority over the business’s assets under pre-pack, but this authority is tempered by restrictions designed to protect the interests of the creditors. In addition, the creditors (by a majority vote) might transfer control of the CD from its current administration to the Resolution Professional.

Conceptualization by the Prepack Subcommittee: Lessons Learned and Evaluation

Model:

A debtor-in-possession approach is used for the Prepack, which means that the RPs do not take over the administration of the CD at any point throughout the process. Nonetheless, there is a need for proper protections to be in place in order to protect the interests of the creditors.

Duties:

Since the CDs would be in charge of running things, they will have additional obligations to the company’s creditors on top of their fiduciary responsibilities under the Companies Act, 2013. In a CIRP, the CD also handles all compliances that would normally fall under the RP’s purview. Decisions, such as those involving interim financing, that is listed in Section 28 as requiring creditor approval must be made by the CD, with the permission of the Committee of Creditors (COC).

Mechanisms of Control and Check to Safeguard Creditors’ Rights:

The COC may decide to terminate the Prepack process or liquidate its assets. The COC may end the Prepack process with a vote of 66% of creditors present if the CD takes actions that deplete assets or reduce the value to the disadvantage of creditors. The CD’s actions, the lack of a profitable company, or any other factor might lead to the COC voting in favour of liquidation by a majority. Within 7 days of the pre-pack date, the RP will form the COC. Separate FCs make up this set. It is up to the COC to decide whether or not to sanction a proposal.

The RP’s Functions:

Although there is no change in management in Prepack, the RP still plays a significant role in CIRP and must guarantee that all transactions are conducted in an honest and open manner. The RP’s responsibility is to advise the CD on how to proceed with tasks before they are begun and to help get buy-in from stakeholders.

Unlike the CD or the creditors, the RP has no vested interest in the outcome of the case and may thus act impartially in drafting the plan in the best interests of all parties involved. The RP may also make requests to the Adjudicating Authority on matters pertaining to the procedure itself.

Expenses Involved:

The expenses associated with Prepack include interim financing under Section 28, RP charges, and any other expenditures directly related to the Prepack process.

1. Provided the COC is met, access to interim financing should be made available.
2. The CD shall establish the RP’s compensation at a fair rate, which the CD shall pay in full, and which the COC shall approve.

Prepack under the Insolvency and Bankruptcy Ordinance for Micro, Small, and Medium-Sized Enterprises, dated April 4, 2021

According to Section 240A of the Code, MSMEs are required to comply with its provisions (MSMEs). Resolution under the Code, particularly via CIRP, may not be practical for a Micro, Small, or Medium-Sized Enterprise (MSME) due to its low capital requirements and simple organizational structure. The simplified method of resolving stressed assets is through prepack, especially in light of the higher default level from 1 lakh to 1 crore (by virtue of the announcement of 24th March 2020), which exempts MSMEs from the terms of the code.

It is important to note that the Government has fixed the minimum threshold default at Rs 10 lakh for pre-packs for MSMEs in respect of defaults of Rs 10 Lakhs or more, as per Notification dated 9th April 2021.

Conclusion

Due to the growing demand for Prepack as well as the many advantages it offers, a growing number of business entities are turning to Prepack as a solution to their insolvency issues. Aside from the incentive that the control of the CD will be with the debtor, it gives a cost-effective and pleasant option. In India, the current framework is only for micro, small, and medium-sized enterprises (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 pre pack with safeguards to ensure that there is a time-bound, quick, and effective resolution of debts.

References

[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%20ias#:~: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 

This article has been authored by Ananta Kashyap, a law graduate from Lloyd Law College.