A sub-committee of the Insolvency Law Committee set up in June 2020 proposed a pre-packaged insolvency option that will allow creditors and debtors to work on an informal plan and then submit it for approval even as the nation braces for a shoot up in bankruptcies once the freeze on filing is lifted.
The Ministry of Corporate affairs has invited public comments and suggestions on the draft regulation latest by January 22, 2021 post which it is expected the firm up. This proposal, if accepted, will become part of the Insolvency and Bankruptcy Code, 2016, according to a statement. The sub-committee has recommended that provision be accepted, and amendment be incorporated in the code, preferably by an ordinance, to implement it. The aim of the proposal is to aid the existing insolvency framework and cut the cost and time of the resolution process.
What is a pre-pack?
There is no exact definition of a pre-packaged insolvency stated in the statute. However, a pre-pack deal can be explained as a kind of restructuring plan which is agreed to by the debtor and its creditors prior to the insolvency filing and then sanctioned by the court on an expedited basis. The incumbent management typically retains control until the final agreement is agreed upon. The informality of the process is aimed at a faster resolution of distressed firms. It is a hybrid of the formal and informal insolvency process and can be applied even before a default. Even in the past, the experts have endorsed such a process citing pile of cases at various tribunals and the indefinite amount of time taken to complete insolvency resolution.
“With considerable learning and maturity of the ecosystem, and a reasonably fair debtor-creditor relationship in place, the ground seems ready to experiment new options for resolution of stress under the Code in furtherance of its objectives,” the sub-committee said in its report which is now public.
Benefits of Pre-pack Insolvency:
- The usual insolvency process begins when the debtor company is already struggling to survive in the business and is unable to carry the regular functioning due to lack of funds and other regulatory compliances. The advantage of pre-packs is that it entails detection that a company needs debt restructuring at an early stage.
- Pre-pack resolution has a tendency to maximize efficiency, cost and flexibility of resolution plans. It has binding nature and the structure of a formal proceeding.
- Minimal depreciation of the asset value of the company
- Similarity to proceedings under the Code that make the approved plan binding on all stakeholders. This reinstates the confidence of the investors.
- Economical and cost-effective, mainly because the resolution is negotiated and agreed upon before initiating the statutory framework.
- Informal proceeding can be kept as secret from the general market. This saves the company from the loss of market support and trust, unlike the conventional resolution process where companies that have IBC petitions pending against them portrays them in the negative light.
Drawbacks of Pre-pack resolution:
- Any negotiation deal agreed to between the parties maybe reneged by any of the parties considering the absence of legislation and any serious repercussion thereto.
- The absence of legislation may even trigger a slew of recoveries from creditors under various laws, leading to a fractured dissolution of the debtor, ending up with the least asset value of the debtor assets. The nature of pre-packs leads to a lack of transparency, where often unsecured creditors feel disenfranchised by the secrecy.
- The regulatory and statutory exemptions that a company enjoys under the CIRP process would also be unavailable for such a process unless it acquires court approval, as there are times when one may not get necessary exemptions without court’s intervention.
Key recommendations of sub-committee of ILC
- Pre-packed insolvency resolution process (PPIRP) framework to be within the basic structure of the insolvency code as an additional option for a resolution that blends both formal and informal options. It can be brought in quickly via an Ordinance.
- PPIRP would pursue the same objectives as the IBC, with checks and balances to prevent any abuse.
- Pre-pack should be available for all corporate debtors and for any stress—pre and post default.
- It may begin by being allowed for defaults from Rs 1 lakh to Rs 1 crore and Covid-19 defaults. This can be followed by defaults above Rs 1 crore, and then defaults from Re 1 to Rs 1 lakh.
- Pre-packs in case of pre-default can be considered if 75% of creditors consent
- The corporate debtor (CD) can initiate pre-pack with the consent of a simple majority of (a) unrelated FCs (b) its shareholders. No two proceedings – pre-pack and CIRP – shall run in parallel. There shall be a cooling-off that a pre-pack cannot be initiated within three years of closure of another pre-pack.
- Corporate debtor to remain in control and possession of current promoters and management during the pre-pack process.
- Moratorium under Section 12 to be available from the pre-pack commencement date till closure or termination of the process but won’t cover essential or critical services.
- Pre-pack shall not end up with liquidation, except when the committee of creditors decides to liquidate the corporate debtor with a 75% voting share.
- Section 29A of the IBC, which prohibits promoters of defaulting firms from participating in the process to continue in the case of PPIRP.
- The resolution value need not necessarily be higher than the realisable value.
- The pre-pack should allow 90 days for market participants to submit the resolution plan to the adjudicating authority, and 30 days thereafter for the authority to approve or reject it. The resolution plan approved by the adjudicating authority will be binding on everyone.
- The Swiss Challenge Model – On commencement of pre-pack, the base resolution plan shall be submitted to the RP. If such plan pays out the dues of OCs fully and the CoC feels that it gives the best value, it may decide to accept the plan. If it does not pay the dues of OCs fully, it shall necessarily conduct a swiss challenge. It shall release the commercials of the base plan and its weighted average score (WAS) as worked out by the CoC and invite resolution plans to challenge the base plan and select the best of them. Such invitation will be made only once.
The CoC now has two plans, the base plan (Plan A) from the promoter / investor and the plan (Plan B) of the swiss challenger. If WAS of Plan B is better than the Plan A by more than X%, Plan B will be accepted. If WAS of Plan B is better than Plan A by less than X%, the promoter /investor would have an option to improve the WAS of Plan A by at least Y% above that of Plan B. Thereafter, the swiss challenger will have an option to improve WAS of Plan B by at least Y% above that of Plan A. Then the promoter/investor would have option to similarly improve its plan further. This process will go on till one of then decides to quit. The opportunity for improvement will be closed in 24-48 hours. The person, who does not quit, becomes the successful resolution applicant. The processes will be backed up by usual legal arrangements to enforce the outcome.
(Annexure – B of Report of the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution)
Take a look at this table in the document shared by the IBBI- Report of the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process.
Read more about the topic in the Notice made by the IBBI at: