Pre-packaged Insolvency Resolution Process (Prepack) is a hybrid debt restructuring mechanism that integrates both formal and informal (Out of Court settlement) insolvency proceedings. It provides a framework to reinstate the stature of stressed company by making their business economically viable, which, in turn, will help the creditors to recover their dues timely. Pre-packs help companies facing trauma due to business failure which affects their ability to service the debts timely. The concept of Pre-pack is already prevailing in advanced jurisdictions such as UK, USA and Europe.
The COVID-19 pandemic induced lockdowns halted economic activities across the world till around May 2020 resulting in economic imbalances and drastic contraction of the global economy. Due to this situation, as a temporary precautionary measure, the Ministry of Law and Justice suspended the initiation of corporate insolvency resolution process of corporate debtors under the Insolvency and Bankruptcy Code, 2016 (IBC) to prevent viable businesses from being forced into insolvency due to circumstances created by pandemic. But once this suspension is removed, it is expected that there will be a surge in insolvency applications. So, the government, considering all these facts, formed an Insolvency Law Committee vide an order dated June 24, 2020, to propose a detailed scheme for implementing Pre-pack and prearranged insolvency resolution process as a continuing process to revamp the insolvency process with an objective of rescuing businesses or stressed companies in timely manner especially during the Covid-19 pandemic. Pre-packs are being suggested as an effective mechanism in times of COVID-19. On January 08, 2021, the Sub-Committee of the Insolvency Law Committee (Sub-committee) submitted its report on the Pre-packaged Insolvency Resolution Process inviting comments for such proposal.
SOME OF THE KEY RECOMMENDATIONS OF THE PRE-PACK REPORT
- Availability of Pre-pack: Pre-pack shall be made available to all Corporate Debtors which should be implemented in a phased manner for:
- Defaults ranging from INR 1 lakh to INR 1 crore and Covid -19 related defaults;
- Defaults above INR 1 crore;
- Defaults from INR 1 to INR 1 lakh; and
- Pre-default stress. However, with regard to pre-default stress, consent of higher threshold (say 75%) of creditors to avoid any potential misuse is recommended.
- Initiation of Pre-pack: The Sub-Committee has recommended that Corporate Debtor would be required to obtain prior consent of its shareholders with simple majority, and with simple majority from the unrelated Financial Creditors. In case there are no unrelated Financial Creditors similar approval of unrelated Operational Creditors has to be taken. The Corporate Debtor would need to enclose the evidence of the consents so taken in order to initiate Pre-pack process.
- Prevention of Parallel Proceedings: The Sub- Committee has recommended that Pre-packs and CIRP should not be simultaneously carried out. When corporate debtor is undergoing CIRP, it should not have the recourse under the Prepack mechanism. Similarly, when the Corporate Debtor has already initiated pre-pack, no CIRP should be allowed against such Corporate Debtor as it has the consent of majority unrelated Financial Creditors. The Sub-Committee has further recommended a cooling off period of three years between the two Pre-pack processes i.e., new Pre-pack cannot be initiated within three years of closure of the former Pre-pack.
- Management of the Corporate Debtor: The Sub-Committee preferred a debtor-in-possession model for resolution of stress through prepacks. This model will avoid disturbance to the operations of the Corporate Debtor associated with switching from the current management to the resolution professional (RP). This model will encourage the Corporate Debtor to initiate Prepack, as its management continues to run the business and has high possibility of retaining it through a resolution plan. However, decisions enumerated under Section 28 of the IBC shall be taken only with the approval of the committee of creditors (CoC).
- Appointment of RP: The Sub-Committee recommended that RP shall be appointed with the consent of majority of unrelated Financial Creditors. In case there are no unrelated Financial Creditors, similar approval of unrelated Operational Creditors has to be taken and such appointment shall be subject to the approval of the Adjudicating Authority (AA).
- Role of RP: The Sub-Committee recommendations have curtailed the role of RP limited only to overseeing the Pre-pack process and to ensure that the dealings are fair and transparent. RP guides the Corporate Debtor in all tasks prior to initiation of the Pre-pack process and assists the stakeholders in the formulation and approval of a resolution plan. But unlike the CIRP, the RP will not have the responsibility of running the business of the Corporate Debtor nor will take possession and custody of assets of the Corporate Debtor. RP should ensure that the Pre-pack process has been carried out in fair and transparent manner, safeguard the interests of stakeholders, business and the public, and ensure that it complies with all the applicable laws as regards to the process.
- CoC: The RP should constitute CoC comprising of unrelated Financial Creditors. In case there are no unrelated Financial Creditors similar approval of unrelated Operational Creditors has to be taken within seven days of the prepack commencement date based on the list of claims provided by the Corporate Debtor. Any claim received after the said seven days period will be considered after verification and the CoC will be reconstituted accordingly.
- Approval by the CoC: The Sub-Committee has recommended that the resolution plan shall be approved by the CoC with 66% of voting share of those creditors who are present and voting. The resolution plan once approved by the CoC would then require approval of the AA. The resolution plan approved by the AA will be binding on the Corporate Debtor and all other stakeholders. However, regarding liquidation of the Corporate Debtor, the Sub-Committee has recommended that approval by the CoC with 75% of voting power is required.
- Timelines: The Sub-Committee recommends that not more than 90 days should be allowed for market participants to submit their resolution plan to the AA and thereafter 30 days for the AA to approve or reject it.
- Resolution Applicants: The Sub-Committee recommends that the resolution applicants for Pre-pack resolution should meet the requirements as provided under Section 29A of the IBC.
- Recommendations for value maximization: The Sub-Committee recommends that the Prepack should start with a base resolution plan prepared by the Corporate Debtor management preferably in consultation with stakeholders, which should be placed before the RP within 2-3 days of Pre-pack commencement date. The Pre-pack should offer two optional approaches namely, (i) without Swiss challenge but no impairment to the Operational Creditors; and (ii) with swiss challenge with rights of Operational Creditors and dissenting Financial Creditors subject to minimum as provided under the IBC.
THE PROS & CONS OF PRE-PACK
Under the current regime, the insolvency would begin at a stage where the debtor company is unable to carry regular functioning because of lack of funds or regulatory hurdles; however, Pre-pack allows such companies to undergo debt restructuring at an early stage while still continuing to work normally and maintain confidentiality. Due to the inherent flexibility in the Pre-pack scheme and the legal sanctity adduced, binding nature of approval plan, this will ensure continued credibility of the company in the market, minimum depreciation of asset value and the confidence of the employees or business partners. Prepack process is proposed to be time conducive, cost-friendly and negotiation-friendly as the proceeding will be informal.
While there are several positive aspects of Pre-pack, it can simultaneously lead to several issues due to its informal setting. Since there is no protection from prosecution under law as available under Section 14 of IBC, a Pre-pack can cause recoveries from creditors under various laws completely diluting the mandate of structuring with ease and deeply impacting asset value. Unsecured creditors will be at a disadvantageous position leading to acrimonious action. The Pre-pack can also work like a back-door to the restrictions imposed under Section 29A of IBC for the promoters.
The Pre-pack process being a faster mechanism will aid the financial creditors in recovering their dues as it integrates both the formal and informal insolvency processes causing minimal disruption to the operations of the corporate debtor's business. It acts as an effective tool by not permitting the corporate debtor to erode its value drastically. Thus, the pre-packs will be of greater help for the financial creditors in recovering their dues especially during this Covid-19 pandemic scenario. However, there are a few points which need to be taken care of before finalising the pre-pack framework especially with regards to operational creditors, who do not have any role to play in the negotiation part or with reference to their share down the line in the whole prepack process. Further, pre-pack lacks transparency, which would be a bigger problem since the existing management would be in-charge of the operations of the corporate debtor and the RP has limited role in overseeing the process. The pre-pack process can be more streamlined with lower involvement from the NCLT, but the parties need to focus on good corporate governance and not try to circumvent any of the processes defined under pre-pack regulations as this would bring increased scrutiny from NCLTs and defeat the purpose of pre-packs. Pre-packs may assume greater importance if the government decides to extend the suspension of insolvency initiation beyond March 2021.
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