The pre-pack insolvency resolution process allows corporate debtors to take the wheel and steer their way out of tricky situations, but its success will depend on how certain roadblocks are bypassed. Akaant KM reports
Unprecedented times on account of covid-19 have wreaked havoc for governments around the world. Many countries that chose to opt for a lockdown strategy for containment had to pay the price of shutting down their economies. The Reserve Bank of India (RBI) has referred to the UN estimates that more than 200 million people may be thrust into extreme poverty worldwide by 2030 on account of the pandemic. It has also noted the findings of an International Monetary Fund study, based on historical experience, that social unrest surges 14 months after a pandemic and peaks at 24 months.
Taking this into account, the government has worked to keep pace with the trajectory of the covid-19 curve. Among the measures undertaken, the government, with respect to commercial enterprises, made major alterations to the Insolvency and Bankruptcy Code (IBC) whereby:
(1) the pecuniary jurisdiction to invoke the IBC was raised from a default of ₹100,000 (US$1,370) to a minimum default of ₹10 million;
(2) the provisions for fresh initiation of insolvency proceedings with respect to any default arising on or after 25 March 2020, for a period of six months (and extendable up to one year) stood suspended;
(3) the RBI announced a loan moratorium from 1 March 2020 to 31 August 2020, along with an asset classification dispensation and special resolution framework for covid-19-related stressed assets; and
(4) under Aatma Nirbhar Bharat Package 1, an emergency credit line guarantee scheme for micro, small and medium-sized enterprises, among other relief measures, was provided.
During this time, the Ministry of Corporate Affairs, via an order dated 24 June 2020, constituted an insolvency law committee to suggest a regulatory framework for the pre-pack insolvency resolution process. As a result, a detailed report was submitted suggesting that the contours of the pre-pack framework should be based on the following core principles that formed the bedrock of the IBC, namely:
(1) financial creditors must have extensive control over the distressed company during resolution and the authority to decide its fate;
(2) the corporate debtor has to undergo a moratorium during the resolution period; and
(3) the outcome of resolutions should be binding on all concerned.
Pre-pack models suggested
A “pre-pack” is more of a generic term than a precise technical one. The UN Commission on International Trade Law (UNCITRAL) uses the term “expedited reorganization proceedings”, while the US calls it a “pre-packaged insolvency resolution”, the UK terms it a “pre-pack sale”, and Singapore envisages it as a “scheme of arrangement”.
The fundamental idea of a pre-pack, however, is that it is a restructuring plan agreed to between the debtor and its creditors prior to the insolvency filing. It is in the nature of a relatively informal, hybrid and debtor-driven pre-insolvency process with the idea of providing for a speedier resolution of debt-ridden companies.
The objective of the pre-pack model suggested for the Indian legal regime is the rehabilitation of the corporate debtor, which inevitably focuses more on the resolution of debt, as opposed to the sale of assets or business. As a result, if the committee of creditors (CoC) does not approve any resolution plan, then the pre-pack process is to close down and a corporate insolvency resolution process (CIRP) may be initiated.
Initiating a pre-pack
The model suggested by the insolvency law committee provides that the pre-pack option can be made available for all the corporate debtors, but in the initial phase, it can be implemented in respect of defaults from ₹100,000 to ₹10 million, and covid-19 defaults for which the IBC provisions are not available. Similarly, it was proposed that, for the beginning only, the corporate debtors should be eligible to initiate the pre-pack process, provided the corporate debtor has the consent of its shareholders, as well as the unrelated financial creditors separately, by way of a simple majority. The pre-pack process is never to run in parallel to the CIRP under the IBC, and a cooling off period of three years was suggested between one pre-pack and another
Process and approvals
The model envisages the approval of the adjudicating authority, the National Company Law Tribunal (NCLT), for a successful completion of a pre-pack process. But before the application seeking initiation of the pre-pack process is submitted to the NCLT, the committee suggested that tasks such as the approval of shareholders and unrelated financial creditors, updating of records and information, identifying the resolution professional, and the preparation of the base resolution plan should all be completed.
For the same, the CoC entrusted with the task of collating all the claims of unrelated financial creditors needs to properly constitute their class and seek the requisite approval for initiating the pre-pack process – as well as submit all the relevant information and records to the corporate debtor. The reasoning was that, since the pre-pack is an initiative of the corporate debtor, it can properly undertake those tasks and should be responsible for the performance of those tasks.
The timeline prescribed under the pre-pack mechanism is 90 days for market participants to submit the resolution plan to the NCLT and 30 days after that for the NCLT to approve or reject it. Suggesting a debtor-in-possession model, the insolvency law committee advocated for certain features to put the creditors in control of those tasks. Therefore, while the management keeps in control of the corporate debtor, certain actions cannot be taken without the approval of the CoC. For instance, tasks mentioned under section 28 of the IBC, such as raising interim finance, creating security interest over the assets of the corporate debtor, and changing the capital structure of the debtor, among others.
Resolution professional and CoC
Since the corporate debtor is to remain in management, the role of the resolution professional as envisioned under the IBC stands reduced to a greater extent. The resolution professional is still entrusted with the crucial task of ensuring transparency of the process, and safeguarding the interests of stakeholders, business and the public. Apart from that, the resolution professional is responsible for collating and verifying the list of claims against the corporate debtor, as well as constituting the CoC, and inviting resolution plans from prospective resolution applicants.
In the event that the resolution professional finds that the process of a pre-pack is not conducted fairly, it may file applications before the NCLT impugning such conduct of the debtor. However, the resolution professional is specifically precluded from questioning the manner in which the debtor conducts its business.
The CoC is the mind of the entire process, whose core role under the IBC is sought to be embedded, even in the pre-pack scheme. Its approval is required to initiate the pre-pack, appoint a resolution professional, and conduct the matters under section 28 of the IBC. Apart from this, the CoC decides whether to:
(1) approve or reject a resolution plan;
(2) terminate the pre-pack process; and
(3) liquidate the corporate debtor, but with a 75% majority.
Where the corporate debtor does not have any unrelated financial creditors, then unrelated operational creditors may constitute the CoC
Essential tasks under pre-pack
The pre-pack operates on similar lines as the IBC, with respect to a public announcement to give notice of its commencement, imposition of a moratorium, collation and verification of the claims of creditors by the resolution professional, and the valuation of assets by two registered valuers.
The difference comes at the stage of preparation of the information memorandum, where instead of a resolution professional, the corporate debtor is to prepare the information memorandum certified by the chairperson or managing director on behalf of the board of directors.
The most crucial difference between a pre-pack and the CIRP under the IBC is the deviation from resolution of a corporate debtor through market forces. In the latter, anyone can approach to bid for the corporate debtor, whereas, in the former, a conscious decision was made keeping in mind the nature of pre-packs. In a pre-pack setup, a base resolution is to be provided by the promoter and the same will meet a Swiss challenge from another bidder/ resolution applicant who will keep challenging the other to find the best deal for the CoC.
The pre-pack mechanism is generally touted to be a natural progression in the insolvency and bankruptcy regime of a nation. India, due to certain peculiarities, certainly has had its own fair share of deviations from international best practices. Prime among them is the incorporation of section 29A in the IBC, which is to bar erring promoters from bidding for the company. The insolvency law committee has suggested that this should also be kept for pre-packs.
On the other hand, experts and the minority members of the committee have advocated for watering down section 29A(c), which excludes promoters having non-performing asset accounts from participating as a bidder. The argument is also with respect to the pre-packs being touted as a hybrid informal mechanism introduced to relieve stress for genuine businesses. In such a case, it is suggested that promoters, even if in financial trouble, but not mala fide in their duties, should be allowed to participate. The most important illustrations here are in the telecoms sector and power corporations, where extraneous factors play a more significant role.
Furthermore, the pre-pack mechanism may be limited in its application. While the insolvency law committee purports that section 29A disqualification shall remain, it also purports that a base resolution plan shall be prepared. If a promoter is eligible, then the base resolution plan can be introduced by it, otherwise the CoC and the resolution professional proceed with selecting another base resolution plan. The issue is that if the promoter is disqualified to begin with, and it is only the corporate debtor itself that can initiate the process of the pre-pack, it may be difficult to convince the promoters to invoke the pre-pack mechanism, fearing a loss of control.
There is another issue that may decide the success of a pre-pack mechanism, i.e., whether regulatory and statutory waivers, traditionally enjoyed by successful resolution applicants under the CIRP process of the IBC, will be available in a resolution under the pre-packs. For instance, in the matter of Ultra Tech Nathdwara Cement Ltd v Union of India, where Ultra Tech had taken over Binani Cement after emerging as a successful resolution applicant, and had paid the dues to the Goods and Service Tax Department in terms of the resolution plan. However, despite the resolution plan being executed, the tax authorities raised numerous demands on Ultra Tech for dues owed by Binani prompting the former to approach Rajasthan High Court. The high court, following the law laid down by the Supreme Court in the Essar case, gave effect to the theory of a “fresh slate”, and quashed the demand notices of the Goods and Services Tax Department issued against Ultra Tech Nathdwara Cement.
In the author’s opinion, these motivations will also play a crucial role, and may also be available, since the final approval of the resolution plan by a judicial forum (the NCLT) should cater to this concern. This factor is not available in the RBI guidelines for restructuring, or any other form of asset reconstruction.
Certain other considerations shall still be sustained, for instance, confidentiality of the process inevitably means that the shareholders will be kept out of the negotiations. However, that there is a public announcement to be made of the initiation of the process, and a prior approval of shareholders to initiate it, is a safeguard intended to precisely cater to that issue. This feature to keep the CoC in control forms the core of the IBC as well. In fact, in the code, the creditors are not just in control, but also in possession of the corporate debtor through the resolution professional.
There is also the issue of ambitious and overzealous timeframes suggested for pre-packs. Let us take the facts and figures of the resolution processes under the IBC, which is for 270 days. As of December 2020, there were about 308 CIRPs that were successful, and the same took an average of 441 days for conclusion of the process. Similarly, there were about 1,112 unsuccessful CIRPs, which ended up in orders for liquidation, which took on average 328 days for their conclusion.
There were 181 liquidation processes that had closed with the submission of final reports and they had taken on an average of 380 days for closure. The overburdened NCLTs and its lack of judicial and technical members have exacerbated the situation. In these circumstances, as the insolvency law committee itself acknowledged, there is a need to substantially increase the bench capacity of the NCLTs.
Another important factor is to ensure that the information utilities work to their optimum levels. The idea behind an information utility is to supply and receive information filings required under the code. The information utilities will provide information regarding the full liabilities that are entered into by financial firms through filing of contracts and securities. As pre-packs are intended to operate with stricter timelines, it is essential that all the lenders (at least the financial creditors) file their amounts due with the information utility so that less time is consumed for the purposes of collating and the verification of claims.
In the author’s opinion, the introduction of pre-packs and their success can only be judged once they are implemented. The proposal, however, seeks to provide flexibility and a shorter timeline, compared to the CIRP regime under the IBC. The pre-pack mechanism seeks to address the issues experienced internationally, such as that of “phoenix companies”, where a new company is formed to take over the assets of the corporate debtor, while the old company is left with all the liabilities.
The suggested pre-pack mechanism categorically purports only the resolution of a corporate debtor, as opposed to any sale of assets or businesses of the corporate debtor, thereby seeking to circumvent the issue of phoenix companies.
Furthermore, there is a higher probability of the success of a pre-pack that ensures the highest chances of revival of a debtor primarily on account of the high level of support it derives from its stakeholders. The same certainly is a huge takeaway, since the liquidation of a corporate debtor has resulted in abysmal returns for creditors, compared to a successful resolution process of a debtor.
While it is also opined that getting a simple majority approval from the creditors for triggering pre-packs may be a challenge in circumstances where the class of creditors is diverse – say, debentures holders and financial institutions, among others. It is again submitted that such issues will get ironed out only once the pre-pack mechanism is put into effect.
It is important to consider that once the moratorium on the provisions of the IBC is lifted, there will be a need for an informal process. The pre-pack proposal currently aims to do two things:
(1) provide for the cases that are excluded on account of an increase in the pecuniary jurisdiction, as well as the defaults subsequent to 25 March 2020 – the date from which initiation of CIRPs was suspended; and
(2) create a database and legal infrastructure for other cases so that they can also be brought within the coverage of a pre-pack mechanism.
Akaant KM is a practising lawyer before constitutional courts and company law tribunals. He is the author of the commentary titled Insolvency and Bankruptcy Code – Law and Practice, which can be accessed here. He is also a visiting faculty at NUJS Kolkata and can be reached at firstname.lastname@example.org.