Pre-packs – A Speedy Resolution Process?

Akriti Shikha analyses the concept of pre-packs and summarises the recommendations of the sub-committee report pertaining to the option of introducing a pre-packaged insolvency resolution process.

Introduction

Keeping in mind the economic slowdown due to the current COVID-19 outbreak and the burden of Adjudicating Authority under the Insolvency and Bankruptcy Code, 2016 (“the Code”), the sub-committee of the Insolvency Law Committee chaired by Dr. M.S. Sahoo, Chairman of the Insolvency and Bankruptcy Board of India, which was set up on June 24, 2020 explored the option of introducing pre-packaged insolvency resolution process (“Pre-Pack/s”). On January 8, 2021, the sub-committee issued a report on Pre-Packs within the structure of the Code for public comments and recommendations which was required to be submitted by January 22, 2021 (“the Report”).

About Pre-Packs

It is a form of corporate rescue, wherein the Corporate Debtor and its creditors enter into an agreement for the resolution of the debt of such distressed Corporate Debtor, prior to filing of the insolvency application before the Adjudicating Authority. It combines the features of both informal i.e., out-of-court and formal i.e., judicial insolvency proceedings, thus providing a hybrid framework which would empower the stakeholders to resolve the stress of a Corporate Debtor as a going concern.

Benefits of Pre-Packs

• It enables a quicker resolution and is cost-effective, as compared to the traditional Corporate Insolvency Resolution Process (“CIRP”) prescribed under the Code. It reduces the legal cost involved in the formal procedure and the insolvency professional cost since there is no shift in the management from Insolvency Resolution Professional to Resolution Professional (“RP”) and then to the successful Resolution Applicant. It, therefore, avoids disruption of business of the Corporate Debtor.
• The Corporate Debtor retains control over its existing management i.e., its employees, suppliers, customers, and investors until a final agreement is reached between the parties.
• It preserves and maximises the economic value of the Corporate Debtor since such value would be determined beforehand, the possibility of liquidation of the Corporate Debtor is minimized and thus, this would ultimately yield better returns to the creditors.
• This scheme will reduce the litigations before the already burdened Courts as it is an out-of-court restructuring plan.
• It ensures that the business of the Corporate Debtor continues as a going concern and thus, increases employment retention notwithstanding its level of stress.

Issues with Pre-Packs

• The nature of Pre-Pack proceedings leads to a lack of transparency compared to a full-fledged CIRP as financial creditors would reach an agreement with a potential investor privately and not through an open bidding process.
• In the case of a pre-pack, there is no legal requirement provided for the insolvency practitioner to look at the future viability of the new business emerging from a pre-pack sale, but only to the creditors of the old business.
• Pre-Pack allows the Adjudicating Authority to only evaluate a resolution plan based on submissions made by the creditors and the investor, instead of a price discovery as in the case of CIRP.
• There are concerns that it may not be able to balance the interests of both the operational and financial creditors as the operational creditors neither would have much say in the negotiation nor they would be given a fair share, thus the plan would be biased towards secured creditors.
• There is a high possibility that related parties may take advantage of Pre-Pack in order to benefit from the re-engineering of the balance sheet, especially to undercut their business competitors.

Key recommendations of the Report on Pre-Packaged Insolvency Resolution Process

TITLE	RECOMMENDATION
Availability	Pre-pack shall be introduced in four phases: - Default ranging from INR 1 lakh to INR 1 crore and COVID-19 defaults. Default above INR 1 crore. Default from INR 1 to INR 1 lakh. Pre-default stress. Pre-Pack shall be available for all Corporate Debtors and can be commenced if the condition of the first phase is met i.e., if defaults are between INR 1 Lakh and INR 1 Crore and for COVID-19 defaults.
Initiation	Unlike CIRP, the Corporate Debtor shall initiate the Pre-Pack with consent of simple majority of its unrelated financial creditors or its shareholders. To curb the misuse of Pre-Pack, the default shall be the basis for initiation of Pre-Pack. Both CIRP and Pre-Pack proceedings shall not run in parallel under the Code as it shall create legal ambiguity and uncertainty. There shall be a cooling off period that a Pre-Pack cannot be initiated within three years of closure of another Pre-Pack, while in CIRP, the cooling off period is that of twelve months between two CIRPs.
Tasks before commencement	The framework shall specify the necessary requirements for making a Pre-Pack application, but at the same time provide the flexibility of compliance with such requirements, for instance, the requirements pertaining to approval of the proposal to initiate Pre-Pack in the board meeting and general meeting of shareholders, engagement with creditors for approval, identification of an insolvency professional to act as RP of the Corporate Debtor, preparation and updating of records and information, preparation of resolution plan, amongst others.
Extent of involvement of the Adjudicating Authority	The concerned parties shall approach the Adjudicating Authority twice i.e., first, at the pre-admission stage wherein the Adjudicating Authority will order moratorium and appoint RP, and second, for approval of the Pre-Pack resolution.
Management of the Corporate Debtor	Unlike CIRP’s approach where there is Insolvency Professional-in-possession with creditor-in-control, there shall be a hybrid approach in Pre-Pack of debtor-in-possession with creditor-in-control, which means that the Corporate Debtor retains the possession of the management. However, the Corporate Debtor must take prior approval of the Committee of Creditors (“CoC”) with respect to decisions in matters enumerated under S. 28 of the Code such as raising interim finance, creation of security interest, change in capital structure etc.
Resolution Professional	The RP is to be appointed by Corporate Debtor, with consent of majority unrelated financial creditors. The RP shall safeguard the interest of the public by ensuring compliance with law as well as fairness in the Pre-Pack process. It is pertinent to highlight that no specific provision is recommended regarding removal or replacement of the RP, excluding the cases of incapacitation or death.
Committee of Creditors	The CoC shall be constituted within 7 days prior to commencement of Pre-Pack process. Like in CIRP, the CoC shall approve or reject a resolution plan by 66% majority. In addition, it shall also approve decisions relating to termination of Pre-Pack proceedings, liquidation of the Corporate Debtor, and decide matters under S. 28 of the Code. However, the threshold for approval by CoC for liquidation of the Corporate Debtor shall be 75% of voting shares of CoC (instead of 66%, as provided in CIRP), highlighting that the primary objective of a Pre-Pack is resolution, with liquidation being the last resort.
Pre-Pack Process	The RP shall publish the public announcement on an electronic platform for the information utility to reach the creditors of the Corporate Debtor for the purpose of submission of details of their claim. Once the claims are submitted, the sub-committee has recommended that a set of regulations should be introduced for verification of claims and that in case, the Corporate Debtor wilfully provides any false information or omits any important information about any claim, then it shall be criminally liable for the default. The Corporate Debtor shall draft an Information Memorandum and once it is certified by the Chairman or the Managing Director, it shall be forwarded to the RP. The RP shall appoint two independent registered valuers to assess the liquidation value and the fair value of the Corporate Debtor. S. 14 of the Code, which specifies the moratorium, as currently applicable in CIRP shall also be available till the closure of Pre-Pack process. It shall, however, not cover essential services. The potential resolution applicants shall meet the requirements provided under S.29A of the Code.
Timeline	The Pre-Pack shall allow a maximum of 90 days for submission of the resolution plan to the Adjudicating Authority, and 30 days for its approval (as opposed to 330 days for a CIRP).
Value Maximisation	Pre-Pack shall start with a base resolution plan, which will come either from the promoters if they are eligible and interested or from creditors including another person arranged by the creditors, and the same shall be submitted to the RP. If such plan pays out the dues of Operational Creditors fully and the CoC feels that it gives the best value, it may decide to accept the plan. However, a swiss challenge would be conducted if it does not pay the dues of Operational Creditors fully. This is unlike CIRP wherein the invitation for resolution plans is a public process.

Conclusion

The framework proposed by the sub-committee enables swift resolution through an amendment to the Code which is a viable alternative to the current CIRP and shall provide a quicker resolution process by lessening the burden of the Adjudicating Authorities and provide value maximisation of the Corporate Debtor. However, given the fact that Pre-Pack is not a public bidding process, it would be critical for the Adjudicating Authority to satisfy itself that the interests of all stakeholders are considered prior to approving the Pre-Pack.