Many business owners often have questions regarding the I&B codes. One of the most consistent ones among them is the query regarding pre-pack insolvency. This query has gained momentum since the economic disruption caused by the COVID-19. The ongoing pandemic has hit every aspect of human life as we all know of. One of the facets of the pandemic is that it has severely hit all the major economies of the world. The Indian economy was already going through a downfall and COVID-19 too has not been kind to it. This downfall in the economy has impacted the govt. to think of amendments in almost every major financial law of the country. Various amendments have been made to some of the laws to accommodate the present situation. The debt restructuring law of India, i.e., Insolvency and Bankruptcy Code, 2016 (IBC), has also been amended within the process to deal with the present situation.
By and under the Ordinance that the Government came up with on 5th June 2020, the Ministry of Law and Justice suspended the initiation proceedings of Corporate Insolvency Resolution Proceedings (CIRP) under Sections 7, 9, and 10 of the IBC. This scrapping of insolvency initiation was for any default arising on or after 25th March, 2020 till a period of six months which can be extended to one year as per the Government's decision.
It was observed in a majority of cases that the insolvency proceeding generally took more time in completion than the stipulated timeline suggested under the IBC. Also because of this adversity which has been causing hardships to many small and medium businesses in the country, the number of insolvency proceedings was likely to shoot up. Thus, to stop mass insolvency proceedings against small businesses, the said Amendment was enacted.
Many views have been given by experts concerning the said Amendment. One of the views proposed the introduction of an alternate reform to mitigate the losses which might be incurred by the stakeholders (creditors) due to the Amendment.
This article focuses on one of the reforms which might be introduced to stop mass insolvency case filing with the tribunal in future. The reform is well known as Pre-pack Insolvency. The concept isn't new for our legal experts and legislators. In 2019, the Ministry of Corporate Affairs (MCA) had invited views from stakeholders on pre-packaged insolvency resolutions. Let us understand the reform in the following sections.
The Legal System behind Pre-pack Insolvency:
Pre-pack insolvency means planning between the creditor and the debtor before the insolvency proceedings wherein they negotiate the terms of assets sale and other necessary requirements before applying to initiate the procedure in adjudicating authority.
The term “Pre-Pack Sale” is defined as “an arrangement under which the sale of all or some parts of the company’s business or assets are negotiated with a purchaser before the appointment of an insolvency administrator. The insolvency administrator starts the sale procedures immediately or shortly after his appointment to save time. Thus, pre-pack insolvency procedures are considered a more efficient way of debt restructuring for corporates.
The pre-pack insolvency procedure was first developed and implemented in the USA following the period where the Bankruptcy Reform Act of 1978 came into effect. The practice is also quite prevalent in major economies like the UK, France, Germany, and the Netherlands.
The core objective of the IBC is the reorganization of the corporate in a way to maximize its asset's worth in a time-bound manner and thus, the pre-pack insolvency procedures seem like an optimum method to achieve the prime objective of the I&B Codes.
The time period to finish the insolvency resolution process as per section 12 of the IBC has been increased from 270 days to 330 days. The period includes time taken in litigation and the judicial process. Even after the extended time was granted for the completion of the insolvency procedures, the typical time it took to resolve 221 cases by March 2020 was 375 days. This is way beyond the stipulated time provided by the IBC.
Highlighting the importance of a quick and time-efficient resolution process, the Bankruptcy Law Reforms Committee (BLRC) has stated that the objective of designing a legal framework to handle a firm's debt restructuring or dissolution is to swift in action. By introducing the pre-pack insolvency scheme within the restructuring legislation of our country, we might ensure speedy and more cost-effective recoveries for companies and also prevent the accumulation of cases within the tribunals.
Also, it is an out-of-court mechanism to restructure a debt which is done after negotiations between the debtor and the creditors. Although it is an off-the-cuff mechanism, the pre-pack insolvency still comes within the purview of the courts and tribunals for their final approval. However, the processing here will be much faster as all the required work for resolution has been already done.
Attributes of Pre-pack Insolvency
The biggest advantage of the pre-pack insolvency proceeding is that it fulfills the core objective of the IBC (resolving insolvencies in lesser time) and if introduced, it'll only work in favour of the objective. The major feature of pre-pack insolvency is that it might boost the core objective of the IBC. Let us understand other features of the pre-pack insolvency and where it might help.
Confidentiality: Confidentiality is one of the great and desired advantages of this process. During a proper insolvency proceeding, there's a chance of adverse publicity for the debtor company hampering its image and may lead to diminishing the worth of its assets. This happens due to the stigma attached to the formal insolvency proceedings. However, the pre-pack insolvency process promotes confidentiality and thereby prevents such deterioration of the company's image and value of assets.
Swiftness and Price Effectiveness: This process is less time-efficient and price-effective. The resolution is pre-negotiated by both parties before initiating the insolvency process. Once negotiated, it only needs to apply for approval of the arrangement from the Court/Tribunal/AdjudicatingAuthority. Thereby, it saves the companies (especially small businesses) from lengthy court proceedings and insolvency management procedures. This saves their money as less time means low degradation in the value of the asset.
From the info available it has been seen that the pre-pack insolvency procedure within the United States of America takes only thirty to ninety days. This can be achieved in our country too. By minimizing a debtor’s dissolution time in bankruptcy, pre-pack insolvency limits the executive costs that a debtor would otherwise have to incur during a proper insolvency proceeding. So, if the scheme of pre-pack insolvency is to be introduced in India, it will reduce the time taken for resolution and inhibit spending during the insolvency proceedings.
Authorization/Sanction: One might assume that this out-of-court negotiation may lead to misuse of the resolution process by the debtor company and the creditor. However, even though it is an off-the-cuff process, once an arrangement has been negotiated by the debtor firm and the creditor, it must be approved by an appropriate statutory authority (in India, that authority will be National Company Law Tribunal) and only the authority’s decision will be final in the case.
Pre-packing in Our Country:
Indian businesses don't have any prior experience with the pre-pack insolvency and major amendments are needed to be made to accommodate this reform. We could take inspiration from the models of pre-pack insolvency used in the US or the UK as a base and mold it as per our needs in the prevailing mechanism.
A phase-wise implementation could help in understanding how pre-pack insolvency mechanisms will work in our country. Therefore, the introduction of this process in India should be started with the tiny sectors that have fewer financial creditors. After analyzing the results of such implementation, the same process could be expanded to larger sectors. Consequently, we might have to introduce major amendments within the existing IBC to accommodate this procedure.
Recommendations for Implementation:
Some key recommendations concerning pre-pack insolvency procedures which might be made a part of the IBC are as follows:
Initiation of Insolvency: Under the pre-pack insolvency process, the choice to initiate pre-pack insolvency is taken either by the debtor or the creditors of the debtor firm. In case the former initiates this process, the requisite resolutions from shareholders and the board of directors of the debtor form must be passed. If the initiation of the procedure is done by the creditor, then the agreement of all the creditors is crucial in the matter. If the decision to initiate this process has been made by any concerned party, it will be the duty of the corporate debtor to inform each creditor and the stakeholder of the debtor firm of the decision.
The hallmark of this mechanism is that it imposes a moratorium or a stand-still period during which no other creditor of the corporate will be allowed to independently initiate insolvency proceedings by filing an application to the adjudicating authority. This is why informing all the creditors prior to the pre-pack procedure is necessary.
In the UK, to stop any creditor from initiating another proceeding within the courts, all the creditors enter into an agreement of waiver or forbearance agreeing to switch or waive their rights to gather debts through a separate insolvency procedure initiated from their side. Similar mechanisms could be introduced under the IBC, like taking affidavits from all the creditors declaring that they will not file for an insolvency proceeding if a pre-pack mechanism is already in progress. The dissenting creditors or other stakeholders could be given a choice to object if the arrangement presented before the adjudicating authority for approval doesn't meet their demands.
Appointment of an Insolvency Professional (IP): When an insolvency proceeding is initiated against a corporate, an interim resolution professional is appointed as per the IBC to manage debtor company's affairs. Similarly, within the pre-pack mechanism, when the corporate debtor or the creditors plan to start pre-pack insolvency, they must appoint an IP who should be registered with the insolvency professional authority. Post that, the appointed IP will be responsible to come up with a viable pre-pack arrangement ensuring that such a proposal incorporates the interests of all stakeholders.
Approval of Adjudicating Authority: The sanction/approval feature by an adjudicating authority/tribunal for the informal arrangement proposed by the debtor, creditors, and other stakeholders in pre-pack is what makes this process so amazing for debt restructuring. One of the main concerns regarding pre-pack insolvency is the confidentiality of the method. Also, it's possible that while formulating a proposal, the interests of small stakeholders like the employees and operational creditors might be neglected or the terms of the proposal won't be beneficial to them. To stop such a scenario, the ultimate approval from the adjudicating authority is a must in this process. The adjudicating authority while approving the proposed arrangement will inspect whether the plan satisfies the interests of all the stakeholders or not. Also, it will be adjudicating authority’s sole discretion to address any objections from any dissenting creditor.
To Summarize:
Considering the present economic downfall, it is possible that many companies or businesses go under insolvency proceedings and an entire ban of a year on these proceedings will only increase the chaos. Therefore, an alternate reform to promote debt enforcement and restructuring in a small time frame is required. This will ease the impact of the pandemic on distressed companies.
Also, upon failure of the corporate insolvency resolution process (CIRP) under the IBC, the sole option remaining is the liquidation of the debtor as per the IBC. This isn't a feasible option for tiny businesses like MSMEs or startups as their chances of falling into liquidation increases due to a lack of investor's interest in their assets. The introduction of pre-pack insolvency procedures would prove useful to such companies as it may prevent them from going into liquidation and also act as a tool of revival.
A major concern with the whole pre-pack insolvency regime is whether and will be able to prevent any misuse by debtors. The parties involved might misuse its feature to their advantage and conceal the knowledge of resolution from other parties to neglect the interests. Thus, If the government decides to introduce this mechanism into the existing debt restructuring laws of the country, harmony needs to be reached with the existing laws. It will be a task to combine the pre-pack insolvency mechanism with the prevailing laws. Major amendments are required in the Codes for this purpose. Thus, a phase-wise introduction that can act as a litmus test for the arrangement should be made to weigh the benefits and disadvantages of the process. As the IBC has already improved so much since its inception, such reforms would only work in its advancement and help in reducing the reliance of the debtors and creditors on the adjudicating authorities. This will give the adjudicating authorities more time to finish the backlog of pending cases.