Pre-Packaged Insolvency: A Solution in the times of COVID-19

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The COVID-19 outbreak and the ensuing lockdown have affected the Indian economy adversely, causing financial hardships to several businesses across the country. In the wake of the prevalent situation and to prevent mass insolvency proceedings, the President has promulgated an ordinance and suspended the filing of new cases under the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as “IBC”). The said Ordinance disallows filing new applications under Sections 7, 9, or 10 of the IBC, for 6 months, for any default triggered by the COVID-19 crisis occurring on or after 25 March, 2020. The decision to suspend IBC will provide some breathing space to the businesses. However, once the suspension is lifted, the tribunal i.e. National Company Law Tribunal (hereinafter referred to as “NCLT”) will be flooded with insolvency applications. Thus, it is an opportune time to revisit the pending reforms and explore alternative solutions to the conventional corporate insolvency resolution process (hereinafter referred to as “CIRP”).

Pre-packaged insolvency process (hereinafter referred to as “pre-packs”) is one such reform that would solve the problem of mass insolvency proceedings post COVID-19, and consequently help decrease the burden on the NCLT. The government is planning on introducing the pre-packs under the scheme of the IBC. This article will discuss the scheme of pre-packs in detail and highlight its impact on the Indian insolvency regime. It will discuss the possible benefits and advantages of pre-packs. But more importantly, the article focuses on the challenges and issues that need consideration before implementing the scheme in the Indian scenario.

What is Pre-Packaged Insolvency?

A “Pre- Packaged Insolvency” is an arrangement, where the sale of all or part of a company’s business or assets is negotiated with a purchaser before the appointment of an insolvency professional as the administrator. The actual sale is then executed on the appointment and approval of the insolvency professional (hereinafter referred to as “IP”). The pre-pack mechanism essentially facilitates the formulation of a resolution plan before any formal proceedings. This arrangement reduces the time and money spent on court proceedings and directly moves to getting a fair resolution for the company. The main objective of pre-packs is to strike a balance between the interests of the creditor and protect the business from liquidation.

This might be a novel mechanism in India, but countries like the United States of America (USA) and the United Kingdom (UK) have successfully implemented it in their respective insolvency practices. Since India has no regulatory experience with pre-pack, a new framework or amendments to the existing provisions of the IBC would be required to implement the scheme in the current insolvency framework.

Implementation of Pre-Packs in India

The Bankruptcy Law Reform Committee, tasked with contextualizing the IBC, has recommended pre-packs as a viable alternative to the conventional CIRP in India. According to the report submitted by the Committee, the pre-pack plan can be allowed under the NCLT supervised scheme of arrangement. Under this arrangement, the pre-pack plan would be subjected to prior approval of the creditors and the relevant stakeholder before being presented to the NCLT. Further, the NCLT would approve the plan only after scrutinizing and ensuring that the plan satisfies the basic requirement as may be prescribed under the IBC. Therefore, the pre-pack scheme would essentially follow the procedure under IBC, while still preserving the business of the Corporate Debtor.

Advantages of Pre-Package Scheme

Apart from preserving the business of the company and protecting it from potential liquidation, pre-packs possess many benefits that are very hard to ignore. Firstly, they would provide a better return to the creditor. In the current insolvency mechanism, often during the CIRP, the value of the assets gets depreciated which eventually results in lesser pay to the creditors from the proceeds of the resolution plan. But in the pre-packs mechanism, the value of the assets will be negotiated in advance, therefore, providing better returns to the creditors.

Secondly, it’s significantly less time-consuming and inexpensive in comparison to the formal insolvency proceedings, because all the essentials of the pre-packs, like negotiation and documentation of the proposed plan, are done beforehand. This reduces the total cost involved in the process and preserves the value of the business which can be crucial for the survival of small businesses.

Lastly, pre-packs would operate within the fold of the statutory scheme. As opposed to a private restructuring process, pre-packs would function as a statutory backed resolution process under the IBC. This implies that pre-pack would be subjected to the approval of the NCLT and consequent to the approval, all the stakeholders would be bound by the resolution plan. This would mitigate the threat of subsequent challenge and non-compliance by the creditors.

Challenges to and Suggestions for Implementation of the Pre-Pack Scheme

1.      Moratorium

In the regular insolvency proceedings under Sections 7 or 9 of the IBC, an automatic stay i.e. moratorium comes into effect, in terms of Section 14. The moratorium prohibits the creditors from enforcing remedies against the corporate debtor and its assets. However, a debtor seeking pre-packs may not have the protection of a moratorium. This would give rise to a situation where the creditors can approach the Courts or Tribunals and enforce their remedies, while the debtor is negotiating a pre-pack resolution. Such additional litigation would not only threaten the assets of the debtor, but also force the company into CIRP or liquidation. To mitigate such a threat, the Government must introduce a provision or extend the protection of moratorium to the pre-pack mechanism. This would allow the debtor to focus on coordinated restructuring and restrain the creditors from enforcing remedies against the debtor’s assets.

Alternatively, in the absence of moratorium, the debtor could regularly communicate with the creditors and try maintaining its credibility to avoid any such situation that could defeat the pre-pack resolution. This would require the debtor to accommodate the interests of creditors and share all the necessary information with the creditors. However, achieving such cooperation among creditors and debtor is easier said than done. In the absence of a moratorium, the creditors can break off the negotiation at any-time and enforce their rights, thereby defeating the entire pre-pack resolution. Therefore, the protection of the moratorium will be instrumental in reaching a successful resolution under the pre-pack mechanism.

2.      Lack of Transparency

The confidential nature or lack of transparency is another challenge to the implementation of the pre-pack scheme. Since the process of entering into the pre-pack arrangement is opaque and receives only the assent of the secured creditors, there are not enough incentives to consider the stakes of unsecured creditors. In such cases, the assets of the debtor company may be transferred without realizing the value payable to the unsecured creditors. Moreover, the confidential nature of the scheme would deny such creditors the opportunity to object to the transaction. Thus, adequate remedies and recourse must be introduced in the pre-pack scheme to protect the interest of unsecured creditors. A reasonable timeframe must be provided for the unsecured creditors to file claims and raise objections to the plan. Additionally, the mandate to obtain approval from the NCLT would prevent such unjust transactions by stakeholders and address the concerns of unsecured creditors. This would be important to help creditors develop confidence in the new procedure.

3.      Section 29A of the IBC

Section 29A would also acts as a major hurdle in the introduction of pre-pack schemes in India. This provision was introduced by the Insolvency & Bankruptcy Code (Amendment) Act, 2018, and it prohibits the existing management or promoters of the debtor company from regaining control over the assets of the company. It essentially stops the backdoor entries of the defaulting promoters back to the management. Since the pre-pack scheme is a debtor initiated process, it would be the promoters who are in-charge of the process and not the IP. The promoters negotiate with the creditors to retain control of the business and keep it as a going concern. This would go against the basic essence of Section 29A and, thus, disallow corporate debtors from formulating a resolution plan with the creditors.

It can be argued that such an evasive manner of regaining control under the pre-pack scheme would result in circumvention of insolvency laws. However, if the inability to repay the debts is caused by factors like sluggish economic growth (caused by pandemic like COVID-19), then allowing the existing promoters to retain control would be economical. This would ensure continuity of the business activity and minimize the interruption.

The Government must therefore, dilute section 29A in order to implement the scheme of pre-packs in India. The reason to dilute section 29A is to encourage proactive debtors (in distress) to negotiate the terms of insolvency with their creditors. If a provision similar to Section 29A is made applicable to the entities willing to go for pre-packaged insolvency, it may tend to defeat the very objective of such a scheme. Thus, pre-packs must be free of section 29A.

Conclusion

The COVID-19 pandemic and the ensuing lockdown has posed challenges for Governments around the world. With every economic activity coming to a halt, businesses are facing severe financial crisis and are pushed into insolvency. The pre-packs scheme, if introduced, will act as a catalyst in helping those businesses survive.

Since India does not have any prior regulatory experience with pre-packs, the introduction of this scheme would require some serious contemplation and due diligence. The Government must conduct a comprehensive study and ensure that all the problems are eliminated and a better mechanism is put in place.

The pre-packs scheme, if implemented in a proper and time-bound manner, would justify and strengthen the pre-IBC resolution mechanism in India. Therefore, it is of the utmost importance to take such effective measures to remove the state of uncertainty and safeguard the interest of the creditors during such unprecedented times.

Author: Vedaant S. Agarwal from National Law University, Jodhpur.

Editor: Astha Garg, Junior Editor, Lexlife India.

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