Last year, the Indian government suspended the initiation of new insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (IBC) in relation to the defaults occurring on or after 25 March 2020 so as to protect the Indian companies in view of the economic stress caused by the Covid-19 pandemic. With the suspension of new insolvency proceedings in relation to the Covid-19 defaults, the option to resolve the Covid related defaults under the IBC framework is no longer available to the lenders. While (a) the prudential framework issued by the Reserve Bank of India (RBI) on 7 June 2019, (b) the scheme of arrangement under the provisions of Companies Act, 2013 (CA, 2013) and (c) one-time debt restructuring scheme issued by the RBI, are some of the alternatives available to lenders for resolution of stressed assets, however, each of these alternatives have their own limitations. The Indian government, therefore, constituted a sub-committee (Sub-committee) of Insolvency Law Committee (ILC) to suggest a suitable framework for pre-packaged insolvency resolution process.
Pre-pack offers an effective and speedier framework for resolution of stressed assets. It is essentially a combination of out-of-court/information restructuring process and judicial process. The terms of restructuring are usually negotiated and finalised in advance between the creditors and the debtors, and such terms, once approved by the courts or tribunals, become binding on the debtors, creditors and all other stakeholders.
The Sub-committee, after analysing the pre-packs available in other jurisdictions and keeping in mind the core objectives of the IBC, which include revival of corporate debtors and value maximisation, has recommended a 'debtor-in-possession' model of pre-packs in its report dated 31 October 2020.1
Set out below is a summary of the key recommendations of the Sub-committee on the pre-packed insolvency resolution framework:
- Eligible Entities: While the Sub-committee deliberated on the issue whether the pre-packs should be made available to MSMEs only or non-MSMEs also. However, in case the pre-pack is made applicable to MSMEs only, it would require determination of status of entities which could in turn make the process complicated. The Sub-committee has, therefore, recommended that the pre-packs should be available to all the corporate debtors.
- Categories of defaults covered: The Sub-committee has recommended the phase wise implementation of pre-packs in respect of all defaults including Covid-19 defaults. As per the recommendations of the Sub-committee, pre-pack may be introduced in phases: (i) defaults ranging from INR 100,000 to INR 10 million and Covid-19 defaults, (ii) defaults above 10 million, (iii) defaults upto INR 100,000, and (iv) Pre-default stress (with the consent of 75% of creditors to avoid any potential misuse).
- Approvals needed to initiate Pre-packs: In order to initiate the pre-packs, the corporate debtor would require certain approvals from its stakeholders. The corporate debtor would need to obtain prior consent of (i) simple majority of its shareholders, and (b) simple majority of the unrelated financial creditors (FCs) (or unrelated operational creditors (OCs) if the corporate debtor does not have any unrelated FC). The corporate debtor would need to enclose the evidences of the consents so taken to initiate pre-packs.
- Committee of Creditors (CoC): In the pre-pack process, CoC would be constituted by the resolution professional (RP) within seven (7) days of the pre-pack commencement date basis the list of claims provided by the corporate debtor and verified by the RP. If, however, the RP receives any claim post expiry of the seven (7) days period, then RP would consider the claims and reconstitute CoC, as may be required. This will, however, not affect the decisions taken by the CoC prior to such re-constitution. The CoC would have powers, amongst others, to (i) approve or reject the resolution plan, (ii) decide on the critical matters set out under Section 28 of IBC, (iii) terminate the pre-pack process, and (iv) decide on the liquidation process of the corporate debtor at any time during the pre-pack process.
- Management and Control of Corporate Debtor: Unlike the usual corporate insolvency resolution process (CIRP), where the RP is vested with the power of management and control of business affairs of the corporate debtor, pre-pack envisages a 'debtor-in-possession' model wherein the promoters shall continue to manage and control the business affairs of the corporate debtor during the pre-pack process subject to the condition that the matters set out in Section 28 of the IBC (which matters include change of capital structure of the corporate debtor, undertaking any related party transactions, raising interim finance etc.) would require approval of the CoC as in the case of CIRP.
- Quick and Simplified Processes: In case of CIRP, the RP prepares the information memorandum (IM) which is made available to the CoC and the prospective resolution applicants to enable them to take informed decisions. However, since pre-pack will be initiated by the corporate debtor with the consent of the majority of shareholders as well as the FCs, the Sub-committee has recommended that the corporate debtor would prepare a draft information memorandum which shall be certified by the chairman/managing director on behalf of the board of directors for its completeness and accuracy. This draft IM will be handed over to the RP on the pre-pack commencement date. Further, the Sub-committee has also recommended a simplified and faster claim verification process to reduce the time involved in the processes.
- Appointment of RP: Since the corporate debtor would need, amongst others, approval of FCs before initiating pre-packs, the Sub-committee has recommended that in pre-packs, there is no need to appoint an interim resolution professional (IRP) and that the RP can be appointed right at the commencement of pre-packs. While in case of CIRP, the CoC has the power to replace the RP, the Sub-committee has further recommended that in case of pre-packs, RP once appointed should not be replaced except in case of death or incapacitation as the replacement of RP in pre-packs could derail the process and it may then be difficult to complete pre-packs within the shorter time frame as envisaged under pre-packs.
- Role of RP: Unlike CIRP, the IRP/RP would not have any
power to interfere in the management and the control of corporate
debtor as the existing promoters would continue to run the
corporate debtor. As per recommendations of the Sub-committee, the
role of RP will be, inter alia, to ensure transparency and fairness
of the process, safeguard the interests of stakeholders, business,
and the public, and ensure compliances with the law as regards the
process such as collating and verifying the list of claims against
the corporate debtor, constituting the CoC, and inviting resolution
plans from prospective resolution applicants, wherever
RP may attend the meetings of the board of directors in the capacity of an observer but he will not have any voting rights. Further, he will assist the CoC and the corporate debtor in negotiating and finalising the resolution plan. In addition, the RP will have the powers to make necessary applications to the adjudicating authority (AA) in case of avoidance transactions as in the case of CIRP.
- Moratorium: As in the case of CIRP, the Sub-committee has recommended that in case of pre-packs also, the moratorium should be made applicable subject to the condition that moratorium should not cover essential goods or services since in pre-packs, the business and operations of the corporate debtor would continue to be under the control of the promoters only.
- Resolution Applicants: The Sub-committee noted that in case of MSMEs, certain relaxations are already available to the promoters of the MSMEs from the provisions of Section 29A of the IBC. Therefore, the Sub-committee has recommended that while the pre-pack envisages a base resolution plan to be submitted by the promoters, there is no need to dilute the provisions of Section 29A of the IBC. Therefore, the promoters and other resolution applicants, who are desirous of submitting the resolution plan, should not be disqualified under Section 29A.
- Resolution Plan: The Sub-committee has recommended
that the pre-packs should offer two (2) optional approaches: (i)
without swiss challenge method but no impairment of OCs, and (ii)
with swiss challenge method subject to the OCs and dissenting FCs
being offered at least the minimum amount as per Section 30(2)(b)
of the IBC.
While the first approach would enable an informal restructuring/resolution plan to have all the benefits available under the IBC framework (once such resolution plan is approved by the CoC and the AA), the second approach is expected to maximize the value of the corporate debtor which is one of the core objectives of IBC.
Further, the pre-pack envisages the appointment of two (2) registered valuers who will determine the fair value and liquidation value of corporate debtors. However, the resolution value offered by the resolution applicant may be less than the liquidation value in view of the judgment of the Supreme Court delivered in the matter of Maharasthra Seamless Limited versus Padmanabhan Venkatesh & Ors.2
- Approval of Resolution Plan: The Sub-committee has recommended that under the pre-packs, the resolution plan would need to be approved by the CoC with 66% of voting share of those creditors who are present and voting (as against the 66% voting share requirement stipulated in case of CIRP). The resolution plan once approved by the CoC would then require approval of the AA. The resolution plan, once approved by the AA, would be binding on corporate debtor and all stakeholders as provided in Section 31 of the IBC.
- Timelines: Pre-pack framework, being a combination of
informal and judicial process, aims to fast track the resolution of
the corporate debtor within a period of ninety (90) days from the
prepack commencement date. The Sub-committee has recommended a
period of ninety (90) days for the market participants to submit
the resolution plan, and a period of thirty (30) days for the AA to
approve or reject a resolution plan submitted before it.
The pre-pack process would close if (i) no resolution plan is received by the CoC, or (ii) no resolution plan is approved by the CoC, or (iii) no resolution plan is approved by the AA, whichever is earlier.
- Liquidation of Corporate Debtor: The Sub-committee has
recommended that the CoC may at any time during the pre-pack
process decide to liquidate the corporate debtor for any reason
including commercial considerations, conduct of the corporate
debtor etc. Any decision to liquidate the corporate debtor would
need to be approved by the CoC with 75% voting share.
However, with a view to prevent the misuse of pre-pack, the Sub-committee has recommended that the liquidation process cannot be initiated in respect of (i) pre-default stress, (ii) defaults below the threshold of initiation of CIRP (which is INR 10 million at present), and (iii) Covid-19 defaults.
- Avoidance of Multiple Proceedings: The Sub-committee has further recommended that pre-packs and CIRP should not run parallel. Where a corporate debtor is undergoing CIRP, it should not have the recourse to pre-pack. Similarly, where the corporate debtor has already initiated pre-pack, no CIRP should be allowed against such corporate debtor. The Sub-committee has further recommended a cooling off period of three (3) years from the date of closure of pre-pack process before a corporate debtor initiates another pre-pack.
The pre-pack mechanism will certainly help the bankers and the financial institutions in the resolution of stressed assets in a post Covid-19 era. It is a cost effective mechanism and is likely to result in quicker resolution of insolvency cases. However, set out below are some thoughts which may be relevant for consideration of the government and the regulators while finalising the fine print of the framework:
- The pre-pack envisages a base resolution plan to be offered by the promoters but at the same time, there is no compulsion that the resolution plan value should match the liquidation value or the fair value, which value would be determined by the registered valuers. Since the pre-pack mechanism offers a chance to the existing promoters to retain control over the corporate debtor, the promoters should not be allowed to offer anything less than the fair value of the corporate debtor (or at least the liquidation value). This may help maximise the value of assets of the corporate debtor, which is one of the core objectives of the IBC.
- The public shareholders are rarely offered anything in a resolution plan. Therefore, the proposal of initiating the pre-pack process should also require prior approval of 'majority of minority' shareholders. Further, if a resolution plan offered by the promoters envisage any capital structuring and affects the rights of public shareholders, then such resolution plan should require approval of 'majority of minority' shareholders (as in the case of scheme of arrangement under Section 230-232 of CA, 2013).
- If the promoters (i) do not have any intention to offer a resolution plan, or (ii) are ineligible under Section 29A of the IBC, then such promoters should not be allowed to continue in the management and control of the business affairs during the pre-pack process. While the Sub-committee has recommended certain checks and balances to ensure a certain degree of CoC's control over the business affairs and conduct of the corporate debtor, the prospective resolution applicants may have certain apprehensions about quality of assets and business position of the corporate debtors if the ineligible promoters are allowed to continue in the management and control of the corporate debtor.
1 The report submitted by Sub-committee on pre-packed insolvency resolution process can be accessed at the following link:
2 (2020) 11 Supreme Court Cases 467
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