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: Insolvency and Bankruptcy Code (Amendment) Act, 2020

Reading time: 8-10 minutes.

The Insolvency and Bankruptcy Code (IBC) in 2016 was passed by Central Government in order to determine claims including indebted companies. This was expected to handle the awful advance issues that were influencing the financial framework. Two years on the IBC has prevailing in an enormous measure in forestalling corporates from defaulting on their credits. The IBC procedure has changed the debtor-creditor relationship.

Various significant cases have been settled in two years, while some others are in cutting edge phases of goals. The Government has introduced different amendments with the IBC now and again to make it increasingly powerful. The most recent changes to the IBC under the Insolvency and Bankruptcy Code (Amendment) Act, 2020 (“Amendment Act”) were instituted and notified on March 13, 2020. The Amendment Act brings into impact different key corrections to the arrangements of the IBC so as to fill certain holes and address different difficulties being looked in the corporate insolvency resolution process system.

Reasons for the introduction of the Act

The NCLAT in Essar Steel Judgment had given equality as far as status to the operational loan creditors and moneylenders by seeing that the council of the creditors has given unfair arrangement to operational lenders and in like manner proceeded to alter the Resolution Process. This judgment activated for the amendments in the code by the Central Government.

The act tries to evacuate bottlenecks and smooth out the corporate bankruptcy goals process. It aims to give assurance to new proprietors of a credit defaulter company against prosecution for wrongdoings of past proprietors.

Objectives of the amendment

The objective of the amendment was to remove difficulties, while it is expected that the amendment will have a retrospective impact to the extent possible, the Amendment Act hints that the different provisions of the Amendment Act shall be effective from different dates; and where the effect is retrospective in nature, it shall be deemed to be effective from the date the particular section originally came into force.

   The Act addressed three issues. First, it strengthens provisions related to time-limits.  Second, it specifies the minimum payouts to operational creditors in any resolution plan.  Third, it specifies the manner in which the representative of a group of financial creditors (such as home-buyers) should vote. 

Salient features of the proposed IBC Amendment Act 2020

  • Introduction of alternative schemes

The Amendment Act has amended the Code to include alternative restructuring schemes such as mergers, demergers and amalgamations as part of the resolution plan.

  • Extended Deadline

The Amendment Act has amended the Code by broadening the time limit taken for execution of corporate insolvency goals process from 270 days to 330 days however this time of 330 days has likewise incorporated the time spent in suit or some other legal procedure after a goals plan is conceded under the Code. This amendment made the resolution procedure increasingly effective and financially reasonable for the creditors.

  • Voting by Lenders’ Trustees/ Agents

 The Amendment Act rebuilt voting by trustees/operators designated as delegates by financial creditors of a similar class under section 21 (6A) of the Code. Such trustees/operators of financial creditors of a similar class can cast vote in accordance with the decision approved by the highest voting share (more than 50 %) of financial creditors on present and voting. The thought is to settle on dynamic simpler regardless of whether countless they don’t take part in casting a voting.

  • Distribution of Claims

The Amendment Act has given a particular arrangement to financial creditors who have not voted for the resolution plan and operational creditors for accepting in any event the sum that would have been received by them if the sum to be appropriated under the resolution plan had been circulated as per Section 30 read with Section 53 of the Code or the sum that would have been get if the liquidation estimation of the corporate debtor  had been dispersed as per Section 53 of the Code, whichever is higher. This will have retrospective effect where the resolution plan has not achieved conclusiveness or has been bid against.

Further, the Amendment Act emphasize the situation of creditors in a resolution procedure under Section 53 of the code by giving a made sure about loan boss higher need over the unbound and other operational leasers.

  • Grant of Power to Committee of Creditor

The Amendment Act has granted powers to the Committee of Creditors by permitting it to decide how claims will be dispersed on the basis of commercial consideration.

  • Resolution Plan shall be Binding on all Entities

The Amendment Act has clarified that the resolution plan shall be binding on all stakeholders, including the Central Government, any State Government or local authority who have claims against a corporate debtor.

  • Liquidation

The Amendment Act provided a Committee of Creditors may take the decision to liquidate the corporate debtor, at any time after the constitution of Committee of Creditors and before the preparation of Information Memorandum (a document prepared by a resolution professional with details and information about the formulation of a resolution plan).

The Central Government by introducing this Amendment Act wants to speed up the bankruptcy resolution process s which has been delayed in various ongoing cases due to the involvement of courts and rectification of irregularities, thereby affecting the efficiency and intention of the Code since the law came into force in 2016.

Critical analysis

The Act presently gets the truly necessary lucidity connection to the application of the Bankruptcy Code to personal guarantors, who currently fall inside its ambit. The subject of use qua personal guarantors to corporate debtor will require some extra clearness including the triggers.

The method of reasoning for including application of Bankruptcy Code to partnership and people is perhaps at the same time to encourage initiation of Part III of Bankruptcy Code identified with insolvency and bankruptcy of individuals.

Incorporation of proprietorship firms is an invite step. Since generally medium and little ventures in India chip away at a proprietorship model, it was basic to smooth out the system for insolvency and bankruptcy of proprietorship firm. While the amount of loan profited by such proprietorship is similarly less, the number of proprietorship firms benefiting advances is altogether high. Further, since such proprietorship firms don’t have an essential enactment administering compliances, the odds of default in reimbursement of credit is higher. In any case, considering the idea of rebuilding required for proprietorship is not quite the same as the rebuilding required for an company, there might be requirement for cut outs to the current code for such proprietorship firms as far as costs, time and remembering the business condition they work in and such cut outs might be centered more around conference approach. It will likewise must be seen whether the insolvency and bankruptcy procedures for proprietorship firms will be carried on under Part III of the Bankruptcy Code or will new provisions be inserted for the reasons for such procedures.

Under the Code, the financial creditor may record an application before National Company Law Tribunal (NCLT) for starting the bankruptcy resolution process. In the wake of finding the presence of default which is to be done within 14 days, a Committee of Creditors comprising of Financial (CoC) creditor is established for selections with respect to bankruptcy resolution. The CoC will delegate a resolution proficient who will introduce a resolution plan to the CoC. The CoC must affirm a resolutions plan, and the resolutions procedure must be finished within 180 days. The period can be reached out by a time of as long as 90 days if the expansion is endorsed by NCLT. If a resolutions plan is dismissed by the CoC, the debtor will go into liquidation. The code gives an Order of need to the circulation of assets if there should be an occurrence of liquidation of the debtor.

The amendment gives an unequivocal and express position to the Committee of Creditors of the loan defaulting company over the circulation of proceeds in the resolution procedure. Further, Section 31(1) is amended such that the Resolution Plan affirmed by the Adjudicating Authority will be official on Central Government, State Government or the Local Authority. The further impact of the amendment gives that the request for need in dispersion of liquidation resources ought to be kept up in use of circulation of bid amount of Resolution Plan. This is finished by inserting ” the manner of distribution proposed, which may take into account the order of priority amongst creditors as laid down in sub-section (1) of section 53, including the priority and value of the security interest of a secured creditor” in Section 30(4).

To safeguard the interest of the operational creditor the amendment states that the operational creditors should receive an amount which should be higher than the amounts receivable under liquidation, and the amount receivable under resolution plan, if such amount were distributed under the same Order of priority as under Section 53.

With regard to the voting by the representative of the financial creditors, the acts states that such representative will vote on the basis of the decision taken by a majority of the voting share of the creditors that they represent. The amendment also sets a new deadline i.e. of 330 days for completion of the resolution process.

Conclusion

Some of these amendments can have adverse effects too, but as the time changes and the functioning of the market players changes it is really important for the government to change its laws accordingly to stand at par with the market and function globally with ease.

While the act is designed to streamline the process of credible bidding by removing the backdoor entry of promoters (and connected persons), the impact of the Act in ensuring effective sale of stressed assets is yet to be seen. Imposing such wide eligibility criteria as sought to be done by the Act, will restrict the number of participants and may affect price discovery.

A portion of these amendments can have unfriendly impacts as well, however as the time changes and the working of the market players transforms it is extremely significant for the legislature to change its laws in like manner to remain at standard with the market and process universally easily.

While the demonstration is intended to smooth out the procedure of credible bidding by evacuating backdoor entry of promoters (and connected persons), the effect of the Act in guaranteeing successful sale of stressed assets is yet to be seen.. Forcing such wide qualification rules as looked to be finished by the Act, will confine the quantity of members and may influence value revelation.

Author: Shreya Chatterjee from Adamas University.

Editor: Arya Mittal from Hidayatullah National Law University, Raipur.

Explained: Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019

Reading time: 6-8 minutes.

The Union Cabinet recently approved various amendments to the Insolvency and Bankruptcy Code (IBC) during its recent meeting on 11th December, 2019; these have been brought about through the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019.

The main aim of the amendments is to remove hiccups arising during the insolvency resolution process and make it all the more smoother in order to achieve the objective of the Code.

The amendments also seek to make it convenient to do business; the changes have been brought about to help with investment, especially in those sectors which are currently facing trouble, as well as to protect all the corporate debtors while additionally also preventing bankruptcy proceedings filed out of malice or incomplete information.

The amendments approved by the cabinet mainly seek to reconstitute sections 5(12), 5(15), 7, 11, 14, 16(1), 21(2), 23(1), 29A, 227, 239, 240, and insert new section 32A in the Insolvency and Bankruptcy Code, 2016.

These amendments will basically seek to redress bottlenecks, align the Corporate Insolvency Resolution Process (CIRP) while also providing security to last mile funding to inject and promote investments in financially insecure sectors.

Background in brief: Why is the change being made?

The Insolvency and Bankruptcy Code, 2016 (Code) is one of the most essential steps taken by the Government in order to deal with the manifold increase in the level of distressed debts occurring in India.

This Code provides for a time-bound insolvency resolution process for delinquent corporate debtors and at the same time replaces it with a creditor-in-possession model in which a committee of creditors (CoC) is set up to take decisions regarding the operations of the corporate debtor, which also includes evaluating prospective resolution plans for resolving the corporate debtor’s account.

This Code was an exceptional step towards resolution of stressed assets. However, particular exigent inconsistencies and gaps became glaringly evident when several legal proceedings were initiated with corporate insolvency resolution processes (CIRP), making it all the more necessary to furnish amendments to bridge these gaps.

The amendment was also urgent and the need of the hour in light of the fact that there have been various judicial decisions as well as cases, pending and ongoing, which are being viewed as antithetical to the Code’s enshrined objective of protecting the creditors and debtors.

To mainly address some of these issues, the cabinet passed the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 which, when approved by the President, will become effective from such date that the Central Government may notify and will hopefully bridge the gap between the discrepancies.

Salient features

  • This amendment is broadly being brought about to the Insolvency and Bankruptcy Code (IBC) to secure resolution applicants from criminal proceedings against offences that may have been committees by previous managements or promoters by insertion of the new Section 32A, which is one of its major features. It will “ring-fence” victorious bidders from any offences committed by the management prior to them while providing speedy and assured resolution mechanism to reassure buyers of any stressed assets which are involved.
  • It will also put in place additional thresholds for financial creditors being represented by authorized representatives to tackle frivolous initiation of the resolution process, thereby putting in place a secure mechanism.
  • It also takes care that the base of a corporate debtor’s business will not be threatened by frivolous issues and can continue to be hassle free by keeping licenses, permits, concessions, clearances, etc. updated and ensuring that these can neither be terminated or suspended, nor their renewal denied during the moratorium period.
  • This amendment will also prevent government agencies from attaching the assets of an insolvent debtor who is engaged in the bankruptcy resolution process for any prior offences, which in turn, will make the stressed asset more favorable for potential buyers. These features have been included to help companies such as Bhushan Power, REI Agro and Rotomac Global and their like which are undergoing the process of insolvency resolution.
  • This amendment also provide that a financial entity, which is under the regulation of a financial sector, will no longer be considered a related party to the corporate debtor just because it had acquired shareholding through a conversion of debt into equity or instruments convertible into equity shares. This change would ensure that they are not barred from resolution process because of such a relation.
  • The Bill also aims to amend the Code to provide some minimum thresholds for particular strata of financial creditors to set off the insolvency resolution process.  With regard to real estate projects, if an allottee (person to whom a plot, apartment, or building has been allotted to or sold) wants to initiate a resolution proceeding, the application should be filed jointly by at least 100 allottees of the same real estate project or 10% of the total allottees under that project, whichever is less.

Critical analysis

  • Under the original Code, if the insolvency resolution process (IRP) is not appointed in the order admitting application under section 7, 9 or 10, the insolvency commencement date shall be the date on which such IRP is appointed.

The  second amendment removes this clause and goes back to the start, to ensure that CIRP shall be taken to begin from the date of admission and not from date of appointment of IRP, in case the two differ.

  • While Section 11 of the Code does not categorically stop a corporate debtor from initiating insolvency against another, there were some discrepancies wherein this right of the corporate debtor tended to be denied by the Adjudicating Authority/ Appellate Authority. In order to establish the particular objective and to remove the anomaly arising regarding the validity of an application of a corporate debtor against another corporate debtor, this Amendment Bill provides the said intent
  • In order to provide ease of doing business and make sure that a corporate debtor is able to hold his status even after commencement of CIRP, the Amendment Bill provides for protection of the corporate debtor from suspension and/ or termination of its licenses/ permits/ concession, in cases where such suspension or termination takes place just because of initiation of insolvency proceedings. This comes with a condition that the corporate debtor should have made no defaults in payment for such benefits during the moratorium period
  • This amendment completely removes the liability of a corporate debtor with respect to any offences committed prior to the commencement of CIRP, subject to certain conditions.
  • Under the said amendment, the Central Government is empowered to make certain rules with regard to the changes occurring in the Bill; the Central Government will, by way of rules, prescribe the transactions, on completion of which the financial creditor will not be treated as related party of corporate debtor.

Conclusion

The Insolvency and Bankruptcy Code (Second Amendment) Bill, 2019 continues to make great strides in the legislative arena to deal with issues that keep cropping up in relation to stressed companies or those undergoing resolution proceedings.

By providing means to identify last mile funding cases as interim finance, the Amendment helps to rehabilitate stressed entities in a regulated manner while safeguarding interests of both the sides. Further, by increasing the scope of moratorium, the Amendment protects the sanctity of the rescue operations as envisaged by the IBC.

Separately, the immunity granted in terms of various provisions enshrined shall act as a facilitator for cleaner acquisitions, thereby incentivizing higher bids and promoting an investor-friendly regime.

Author: Akanksha Batra from Symbiosis Law School, Pune

Editor: Ismat Hena from Faculty of Law, Jamia Millia Islamia.