Government of India is contemplating introducing the concept of pre-packaged insolvency schemes, similar to the practice prevalent in Unites States and UK, wherein the creditors and shareholders are entitled to approach the bankruptcy court with a pre-negotiated corporate reorganisation plan. The underlying objective of introducing this concept is to prevent prolonged and expensive legal battles, which is taking the sheen out of an otherwise robust insolvency regime in terms of Insolvency & Bankruptcy Code, 2016 ("the Code"). The Government is proclaiming that this step will ensure a timely resolution of bankrupt assets, which is crucial to prevent erosion in their value. It therefore becomes relevant, and important, to understand the concept of a 'pre-packaged bankruptcy' and its pros and cons.
- What is a 'Pre-packaged Bankruptcy'?
A pre-packaged bankruptcy is a plan for financial reorganization that a company prepares in cooperation with its creditors that will take effect once the company enters the CIRP. As per the prevalent practice in United States and UK, such a plan must be voted on by shareholders before the corporate debtor files the petition before the competent Court / Tribunal for approval.
The idea behind a pre-packaged bankruptcy plan is to shorten and simplify the bankruptcy process in order to save the company money in legal and accounting fees, as well as the amount of time spent in bankruptcy protection. A proactive company in distress will notify its creditors that it wishes to negotiate terms of bankruptcy before it files for protection in court. These creditors — lenders, inventory suppliers, service providers, etc. — naturally do not like the distressed situation of the company, but may prefer to work with it to minimize time and expenses associated with bankruptcy reorganizations.
The creditors are more likely to be amenable during the negotiations to rework terms since they will have a voice before the bankruptcy filing; the alternative would be a surprise and then a scramble to deal with the delinquent debtor with more uncertainty about how long the process will take. A company and its creditors can expect a resolution within a much shorter time frame under a pre-packaged bankruptcy than a conventional one. The sooner the company can emerge from bankruptcy, the earlier it can implement its reorganization in an attempt to return to healthy business operations.
- Advantages / disadvantages to a pre-packaged bankruptcy:
For parties-in-interest, a pre-packaged or pre-negotiated bankruptcy has several key advantages, which broadly can be summarised as follows –
- One of the foremost advantages of pre-packaged bankruptcy proceedings is saving of expenses and time. The process of entering and exiting a CIRP is smoother, with creditors onboard with a reorganization plan beforehand. In addition, the company can avoid some of the negative publicity that results from a longer drawn-out bankruptcy process involving creditors fighting for their claims.
- At present, companies or creditors have to approach a bankruptcy tribunal to determine the way forward for the defaulting company. The latter gets protection for a maximum of 270 days from recovery of dues in any way. Litigation during this period delays the resolution process in most of the big cases. In some cases, to save viable companies from liquidation, the National Company Law Tribunal (NCLT) excludes the time lost in litigation from the 270 days available for concerned parties to agree on a rescue plan. Under the pre-packaged scheme, the case would reach the bankruptcy court after the parties have agreed on a scheme so that it gets enforceable as soon as possible. Without the court's nod, enforcement becomes difficult, in case one of the parties backs out.
- Outside of bankruptcy, indentures and credit agreements typically require unanimous written agreement of lenders to implement a transaction that affects the fundamental economics of a deal, as all holders have to approve these changes. Failing which, holdouts or non-responsive parties are likely to frustrate the process. However, in a pre-packaged bankruptcy, a corporate debtor, working in sync with the committee of creditors, can implement changes without being hindered by holdouts or non-responsive parties.
- For a corporate debtor, the admission of the corporate insolvency resolution process (CIRP) may be disruptive to key constituencies, such as customers, suppliers and employees. By formulating and obtaining a binding support in favor of a plan, before initiation of CIRP under Ss. 7 or 9, initiated through a pre-packaged bankruptcy, the corporate debtor's business faces significantly less uncertainty and disruption as a result of the bankruptcy case. When the filing is made, the corporate debtor has the opportunity to broadcast a strong positive message to its constituencies, which can indicate that the corporate debtor will be more competitive in the business because it is anticipated that it will have a more manageable capital structure in the immediate future.
- A pre-packaged bankruptcy proceeding also brings with it a major risk, though. If a creditor, either financial or operational, knows that a bankruptcy filing is imminent, it may take an aggressive stance in collecting its dues from the company before the commencement of CIRP. This tough posturing may upset the intended cooperative nature of pre-packaged bankruptcy negotiations. Others may follow suit, causing more financial stress on the company.
- Important considerations for a pre-packaged bankruptcy
- For a company considering a pre-packaged bankruptcy, there are three important considerations:
(1) For most companies facing an impending CIRP, including a pre-packaged bankruptcy case, lenders of capital are not likely to lend to the company. Because an out-of-court, pre-packaged process takes at least several weeks, if not several months, to effectuate, one of the critical questions for the company and its advisors to consider is whether the company has sufficient liquidity for the duration of the pre-filing period.
(2) Upon the admission of petition under Section 7 or Section 9, an automatic stay i.e. moratorium will come into existence pursuant to Section 14 of the Code, which prevents creditors from enforcing remedies against the corporate debtor and its assets. No specific order of a court is required to obtain the stay. The automatic stay / moratorium, prohibits the commencement or continuation of all pending suits or proceedings against the corporate debtor that could have been or were commenced prior to the commencement of the CIRP, which includes execution of existing judgment / decree and any act to obtain possession of property of the corporate debtor or perfect a lien against debtor's property. As such, the existence of moratorium is a powerful protection for the debtor, which forces creditors into a single, organized proceeding, allowing the debtor to concentrate its efforts on a coordinated and holistic restructuring. However, in a pre-packaged bankruptcy, during the period when the company formulates, negotiates and documents the proposed plan, the company does not have the protection afforded by the moratorium, which means that creditors can enforce remedies against the company and its assets at any time outside the insolvency process. For example, prior to the initiation of a bankruptcy case, a creditor can seek to obtain a judgment on a claim against the corporate debtor and attach assets, etc. To avoid and mitigate any such possibility, the corporate debtor will need to communicate regularly with its creditors, maintain its credibility during this period and monitor potential situations that could upset the pre-filing status quo.
- Pre – packaged bankruptcy: Another form of debt restructuring, or something different?
Prior to 12.02.2018, the stressed asset resolution process was running on the wheels of several tailor-made schemes such JLF (Joint Lenders Forum), CDR (Corporate Debt Restructuring) and SDR (Strategic Debt Restructuring), etc. However, with IBC coming into force, the Reserve Bank of India withdrew these schemes and introduced a revised framework for resolution of stressed assets with effect from 12.02.2018. In terms of revised framework, the Lenders are required to identify incipient stress in loan accounts immediately on default by classifying stressed assets as special mention accounts (SMA) as per the specified categories. It is here where the difference lies between debt restructuring schemes and the pre-packaged bankruptcy process. While the debt structuring schemes were all lender-initiated processes, the pre-packaged bankruptcy process is a debtor-initiated process. Under the stressed assets resolution framework, all the lenders are required to put in place Board-approved policies for resolution of stressed assets, including the timelines for resolution. As soon as there is a default in the borrower entity's account with any lender, all lenders − singly or jointly – have to initiate steps to cure the default. The resolution plan (RP) may involve any actions / plans / reorganization including, but not limited to, regularisation of the account by payment of all overdue amounts by the borrower entity, sale of the exposures to other entities / investors, change in ownership, or restructuring.
However, pre-packaged bankruptcy is a process wherein a proactive company in distress will notify its creditors that it wishes to negotiate terms of bankruptcy before it files for protection in court. As such, it would be a process which will take effect prior to initiation of CIRP under Ss. 7, 9 or 10 of the IBC.
- Will 29A will still be applicable?
As mentioned above, pre-packaged insolvency process is debtor-initiated process by a pro-active company in distress willing to negotiate the terms of insolvency with its lenders, before initiation of a formal CIRP under Ss. 7or 9 of the IBC. As such, it would be a right available to an entity in distress prior to initiation of formal CIRP. Hence, Section 29A is unlikely to be applicable in a pre-packaged insolvency process. In fact, it would not be incorrect to state that if a provision akin to Section 29A is made applicable to the entities willing to go for pre-packaged insolvency, it may tend to defeat the very purpose / objective of such a scheme.
In fact, a pre-packaged insolvency process, resolution plan process (and hence Section 29A), and withdrawal of CIRP (Section 12A), would be available at different stages of an insolvency resolution process. If one reads each of them, harmoniously, then it would become clear they fall in different compartments being applicable in different situations. From the scheme of things discernible from the provisions of the act and the nature of remedy, it appears that a pre-packaged insolvency process would be a right available to debtor-in-distress to put his house in order before the entity is admitted into insolvency. Once the entity is admitted into insolvency (pursuant to either S.7 or S.9 petition), then the corporate debtor is entitled to seek a withdrawal / termination of the process with the approval of 90% of the creditors (albeit prior to issuance of EOI, and not later). Once the stage of EOI is over and the stage of submission of resolution plan is reached, compliance of Section 29A would become imminent. Therefore, there may not be any overlap among the three processes, and each may appear to operate in different spheres. However, all would depend upon the fine prints once the scheme is rolled out.
- Likely timelines for roll out...
At the moment, the Government of India is evaluating this concept basis the successful and unsuccessful cases that have taken place in the United States and UK, as the primary objective is that any such pre-negotiation process among the shareholders has to be transparent. The Insolvency and the Bankruptcy Board of India ("IBBI"), the key body responsible for implementing India's bankruptcy regime i.e. the Insolvency and Bankruptcy Code, 2016 is likely to be entrusted with this exercise. It is expected that IBBI may come up with a discussion paper, inter alia, inviting suggestions on key objectives. Only time will tell that pre-packaged insolvency process, which are common in developed insolvency jurisdictions, will actually be able to work its way in India where the insolvency practice is still at a nascent stage.
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