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

Reading time: 8-10 minutes.

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.

Analysis: Time limits prescribed under the IBC for completion of Corporate Insolvency Resolution process

Reading time: 5-6 minutes.

Corporate Insolvency Resolution Process (CIRP) provides a legal mechanism of recovery for creditors. In the current economic environment in India, where both public and private financial institutions are struggling with bad corporate debts, it is critical to analyse and understand how the courts are enabling implementation of the CIRP in the right spirit and supporting creditors, while ensuring that debtors do not take undue advantage of the process.

What is the time limit for completion of CIRP?

Section 12 of the Insolvency and Bankruptcy Code (IBC) mandates that the CIRP should be completed within 180 days from the date of admission of application to initiate the said process.

As per Regulation 40 of the Insolvency Resolution Process for Corporate Persons Regulations, 2016, the CIRP may be extended by a maximum period of 90 days on the passing of a resolution by the committee of creditors by a vote of 66% of the voting shares. 

The Supreme Court in the case of M/s Surendra Trading Company v. M/s Juggilal Kamlapat Jute Mills Company Limited stated that no extension should be given beyond the period of 270 days and the time limit prescribed under Section 12 must be strictly adhered to.   

What is the time limit for admission of claims of the creditors?

On reading Section 15 of the IBC with Regulation 12 of the IRP Regulations, it may be inferred that the claims of the creditors must be admitted within the 270 days period required for completion of the CIRP.

In practice, however, many creditors do not submit their claims within the prescribed time period and, as per law, their claims cannot be accepted. Importantly, the courts are mindful of the fact that the IBC is still relatively new and the rights of the creditors to their dues cannot be dismissed so summarily. As a result, they have in a catena of judgements sought to interpret these rules so as to provide relief to the creditors.

Which time periods are excluded by the adjudicating authority from the prescribed time limit?

It has been held in Quinn Logistics India Pvt. Ltd. vs. Mack Soft Tech Pvt. Ltd. and Ors. that the adjudicating authority has discretion to exclude certain specific periods of time from the maximum period of 270 days taken to complete the CIRP process.

These time periods, if excluded, will mean that the CIRP process is not over and additional days will be given to complete it. The claims of the creditors will be accepted in such additional periods as well.

For instance, the following periods may be excluded from the time limit prescribed under Section 12 of the IBC:

  • The period for which the CIRP was stayed by a court of law.
  • The period for which there was no Resolution Professional present while the CIRP took place.
  • The period for which an order was reserved by a court of law while the CIRP took place.

In the case of ArcelorMittal India Private Limited vs. Satish Kumar Gupta and Ors. the Supreme Court has laid down that where a resolution plan is upheld by the Adjudicating Authority, the period of time taken in litigation must also be excluded from the counting of the time taken to complete the CIRP.

The court in this case also mentioned, as a side note, that the Tribunals should not be so stringent about the time taken to complete the CIRP, and must be flexible so as to accommodate the needs of the creditors.

The judges in the case of Vikram Bajaj vs. Committee of Creditors Anil Special Steels Industries Ltd. relied on the Quinn Logistics and Arcelor Mittal judgements and have laid down that any delay taken in approving the Resolution Plan must also be excluded from the CIRP.

Thus, from the aforementioned three judgements, it can be seen that depending on the circumstances, certain periods of time may be excluded from the CIRP process.

Can the claims in the books of accounts be Admitted even after the expiry of time limit?

The IBC lays down that claims of the creditors cannot be accepted after the time limit under Section 12 has expired. However, the judges in the case of Symphony Ltd. v. Chhaparia Industries Pvt. Ltd. and Ors. noted an exception to the said rule.

It was observed that even if the receipt of claims was beyond the statutorily accepted limit, the debt can still be repaid if it is mentioned in the books of accounts of the company undergoing the CIRP.

The court believed that if the claim was already part of the financial records of the insolvent company, i.e., the books of accounts, then the said company is liable to repay those debts irrespective of whether the creditors made a formal claim of the same within the 270 days time period.

It has also been seen in the case of SBI v. ARGL that the IRP even after submission of Resolution Plan and completion of the CIRP has been espoused with the duty to accept and collate more claims. Thus, the time limit is not sacrosanct and can be adjusted.

Why did the Union Cabinet extend the CIRP time limit to 330 days?

The original intent of the lawmakers who drafted the IBC was that the time limit under Section 12 be strictly followed. The reason for such a fixed cap was to ensure that the CIRP process does not get unnecessarily prolonged and that the creditors make a conscious effort to make their claims well in time.

However, they were not able to anticipate that there might be certain hinderances in the CIRP process, which could cause it to get delayed. The courts stepped in and laid down that all such delays must be excluded from the counting of the 270 days time period.

The courts had observed that such time limits cannot be mandatory but only directory. It is indeed essential to ensure speedy disposal of the CIRP, but in the process, the claims of a creditor cannot be ignored.

The makers of the IBC were not happy with the various loopholes in the law and the subsequent interpretations by the courts as it has led to inordinate delays in the completion of the CIRP process. Moreover, according to news reports, more than one-third of the ongoing CIRP cases have exceeded the time limit of 270 days.

Therefore, the Union Cabinet has recently approved a new time limit for the completion of CIRP. This time limit is of 330 days and is inclusive of any delay in litigation and other judicial processes. The aim of the Union Cabinet in making this change is to maintain the sanctity of the timelines and to maximize the outcomes envisioned in the code. The lawmakers clearly seek to ensure speedier resolution of cases involving corporate debtors.

In conclusion…

All ongoing cases will be covered under the new amendment. A company could be sent for liquidation, if the resolution process takes more than 330 days. The only thing which now remains to be seen is whether the intent of the drafters gets materialised in the judgments of the courts, or whether the courts find any room for expansive interpretation beyond the intent of the lawmakers.

-This article is brought to you in collaboration with Aryan Vij from National Law Institute University (NLIU), Bhopal.