Pre-packs: The support system for corporates during the pandemic

Introduction

Amid the glaring COVID-19 crisis, the litigation sector has encountered major setbacks. In addition to this, the courts have restricted hearing to urgent matters only. The existing burden of pendency of cases is likely to shoot up considering the drop in Courtroom hearings. Under such a circumstance, the Government has decided to consider the “Pre-Packaged IBC”[i] deals to ease the burden of IBC tribunals and expedite fast-tracking of the processes. Although the present-day Insolvency regime is a great improvement on its predecessors, it still leaves a lot of ambitious desires in terms of the ‘recovery rate’, ‘swiftness’ and ‘ease of resolution’. The Pre-Pack plan aims precisely to fill in these gaps to build around value preservation and to find out a timely, out of the court resolution.

Pre-packaged scheme:

Pre-Package is a particular type of arrangement whereby, a stressed company under the Code negotiates a sale with the purchaser involving all or part of a company’s business or assets before filing for insolvency. It is a legal way of selling the business as a going concern to a trade buyer or third party. The negotiations for the sale take place before an administrator or IRP is appointed. However, to avoid any risk, the above condition is subject to the scrutiny of the Insolvency Professional before the court approves the pre-pack. For the said sale deal, the consideration is held in an escrow account and upon the permission of Insolvency Professional, the deal is carried out further.

The necessity for pre-packs in India

Corporate Rescue has always been a prominent feature of Insolvency Laws in many jurisdictions whereby Pre-pack scheme emerges as a tool to salvage the status of the company that might otherwise go into insolvency to make it a viable business again.

In India, the Insolvency and Bankruptcy regime is governed by the IBC, 2016. The main goal[ii] of the IBC is to ease the process of resolution. The present framework was drawn to reduce the time and money spent in court proceedings and legal battles. This way one can directly move to a fair resolution for the company.

However, there are certain loopholes in the Code. According to the report submitted by the NCLT[iii], till December 2019, the tribunal has admitted 3254 companies for resolution under the said act. Out of these, mere 246 cases were closed on appeal or review and 780 of them were headed for liquidation. According to the World Bank’s Doing Business Report 2019[iv], on average, it takes around 4.3 years for a creditor to recover its debt in India.

Apart from the long litigating years, there are other threats too.  Upon the failure of CIRP, Liquidation is a grave threat which is followed. The high frequency about Liquidation may not be viable or a desirable solution in the business community. Then there are factors like time and cost which are a herculean obstacle even for big companies and business entities.

These issues call for a cost-effective, and timely resolution with minimal court interference, which is provided for, by the Pre-pack scheme.

Advantages of Pre-Pack deals

  • Ensures Continuity of the business-In normal processes, a very little incentive is provided to the promoter to contribute towards the process of Insolvency which further risks the process of “asset-stripping” and brings down the business to a standstill. However, a pre-pack would allow a scheme whereby there is an assurance that the business might continue while preserving the value to maximise recovery for the lenders.
  • Better returns to Creditor– During the Resolution process, the value of the assets of the company erodes, leading ultimately to a lesser payment to the creditors from the proceeds of the resolution plan. Now, since in a Pre-pack scheme the value will be determined beforehand ( before the assets of the company lose the value), the depreciation will not affect the valuation.
  • Cost effective-The time, money and resources which were earlier used to fight legal battles will be saved. In addition to that, there is a lot of fees involved through which the professionals are hired to carry out the entire process which can be mitigated through pre-packs.
  • Positive Outcome-The surety of outcome is more crystallized since the plans have already been discussed before both parties and sanctioned by the Resolution Professional whom himself ensures that everything is done according to the procedure and must be legally tenable.
  • Saves from Prolonged Litigation-The process solves a lot of burdens that was earlier carried by the NCLTs. Earlier there were different stakeholders to carry out the different filing sorts of Applications to delay or suspend the process. The above leads into prolonging of the proceedings to the extent where loss is incurred by every stakeholder. The Pre-packaged scheme will help to reduce the workload and provide for a more efficient resolution.
  • Goodwill is Maintained: The following scheme allows a large part to take place outside the statutory process, it helps to avoid the publicity that is attached to the formal proceedings hence preserving the element of confidentiality. This helps in keeping the goodwill of the company intact and prevents further losses. In addition to this, the Confidentiality of the business related to the company is maintained.

Existing Challenges to the Pre-Pack Process

  • Intervention by NCLT- Once a Pre-pack is entered into, it does not attain finality even if it is agreed upon by the majority of creditors and is subject to the approval of NLCT. The Interim Report of the Bankruptcy Law Reform Committee[v] as on February 2015 suggested that the Indian market is not sophisticated enough to go for an Out-of-the-Court resolution mechanism and NCLT has to act as a watchdog to protect the interests of all stakeholders.
  • Management by the debtor-Under IBC, the control of the company is taken over by the IRP after the moratorium period begins. However, the pre-packs intend to reduce the role of IRP, and the task of managing the company is shifted to the debtor who is entrusted to obtain an amicable understanding between all the creditors. However, there is a strong objection to allowing the debtor to hold the reigns of the Company, since it may compromise the interests of other stakeholders, which is otherwise duly taken care of by the IRP.
  • Sale of Assets a threat to creditors-Although the idea of the sale of assets to repay the creditors is an accepted concept, yet there is a possibility that some creditors might be apprehensive in doing so. The reason behind this is simple, as the assets might be the only security against the debtor. On the same grounds, it can be concluded that the unsecured creditors will be left with no say in the matter thus ultimately looking forward to CIRP.
  • Lack of cooperation from the creditors- Pre-pack is largely a debtor initiated process. The creditors have the option to seek remedy under IBC under which they are given prime importance. Hence, they do not have any incentive to cooperate and may later on press charges and go for CIRP, which may render the entire exercise of a Pre-pack futile. 

The Way Forward

Although the pre-pack plan is advantageous in many aspects, there is a need to crystalize the same to ensure its viability in the long run. Here are several aspects which shall be considered before we adopt the said plan.

  1. In India, there is a requirement for specialized Bankruptcy judges, equipped with the know-how to determine the effectiveness of a Pre-pack scheme.
  2. There is a need to specify the ambit of the powers that the IRP can exercise in the case of success/failure of the Pre-pack scheme. For the same, guidance can be taken from Statements of Insolvency Practice 16 (SIP 16)[vi] applicable in the UK.
  3. There is a requirement that to make this process pragmatically possible-the creditors should be discouraged to object to the scheme after a certain point. There should be a moratorium-like handcuff preventing the creditors to move legally until the Pre-pack is scrutinised by the NCLT.
  4. There is a need to figure out the stage at which the said scheme should step in. Introducing the scheme during the negotiation process may result in a compromise with the confidentiality of the scheme. At the same time, reviewing the business after the transactions have been initiated will have little impact and will only create further issues.
  5. The IRP should look upon the arrangement ensure that it is fair not only to the creditors but also to the other stakeholders, and is not carried in a manner which would prove to be prejudicial to anyone’s interests.

Conclusion

Pre-pack plans have gained a fair bit of success in the US and UK regime. It is a highly effective tool to ensure that the Resolution Process is carried harmoniously, taking into consideration the interest of all stakeholders. However, since the Pre-pack Mechanism is relatively new and untested in the Indian market, it is recommended that Pre-packs are first tested in a controlled environment before they are fully made operational in the Indian domain. Running such tests before its official roll-out in the market will expose us to such issues which remain under the sheets at present. In the light of the setbacks that the litigation and corporate sectors, both have faced during the pandemic, it is best suited that the pre-pack be put to trial. Not only will it lift some burden from the courts, it will also give the stakeholders of the stressed companies a fair chance to bargain through an out of the court settlement.

[i] https://www.livemint.com/news/india/govt-plans-pre-packaged-ibc-deals-to-ease-caseload-11588789472048.html, (Govt. Plans Pre-Packaged IBC Deals To Ease The Caseload).

[ii] https://ibbi.gov.in/webadmin/pdf/whatsnew/2019/Jun/190609_UnderstandingtheIBC_Final_2019-06-09%2018:20:22.pdf, Understanding The Insolvency And Bankruptcy Code, 2016.

[iii] https://www.ibbi.gov.in/uploads/whatsnew/e4e03c8ac9dc4441c79718f12283e8c8.pdf, The Quarterly Newsletter Of The Insolvency And Bankruptcy Board Of India, Vol.13.

[iv] https://www.doingbusiness.org/content/dam/doingBusiness/media/Annual-Reports/English/DB2019-report_web-version.pdf, Doing Business 2019, Training For Reform 16th edition (World Bank Group).

[v]  https://www.finmin.nic.in/sites/default/files/Interim_Report_BLRC_0.pdf, Interim Report Of The Bankruptcy Law Reform Committee, February 2015

[vi] https://insolvency-practitioners.org.uk/uploads/documents/f30389ce35ed923c06b2879fecdb616a.pdf, statements of insolvency practice 16 (Pre-Packaged Sales In Administration).


ABOUT THE AUTHORS

Ashika Jain

ashika jain

Ashika is a second-year BBA LLB student from Gujarat National Law University, Gandhinagar.

Lakshay Garg

lakshay garg

Lakshay Garg is a third-year BCom LLB student from Gujarat National Law University, Gandhinagar.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s