Getting a move on: Is it time for pre-packaged insolvency in India?

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Getting a move on: Is it time for pre-packaged insolvency in India?

While restructuring outside the Code is a possible option, it would not offer certain benefits available under the Code, such as the moratorium on legal proceedings and the relaxation of/exemption from statutory provisions or approvals.

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The Insolvency and Bankruptcy Code, 2016 (Code) in India has undoubtedly proved to be successful. Not only has the Code drastically reduced the time taken for insolvency resolution (from 4.3 years to 1.6 years), it has also significantly improved recovery rates for creditors (from 26.5 to 71.6 cents on the dollar).

Moreover, the Code’s success has resulted in the National Company Law Tribunals (NCLT) and the National Company Law Appellate Tribunal (NCLAT) being inundated with cases. However, unavoidable delays in resolution due to the ongoing Covid-19 crisis will certainly increase the pressure on the Tribunals, and could thereby jeopardize the gains from the Code’s implementation. Though the Central Government is bringing an ordinance to suspend fresh filings under the Code for a six-month period, its impact in easing the Tribunals’ workload by mitigating Covid-19-related financial stress and promoting restructuring outside the Code is yet to be seen.

While restructuring outside the Code is a possible option, it would not offer certain benefits available under the Code, such as the moratorium on legal proceedings and the relaxation of/exemption from statutory provisions or approvals.

Further, the outcome of such restructuring does not have the same binding effect as resolution plans under the Code. It therefore becomes imperative to consider and adopt novel resolution mechanisms under the Code which can ease the pressure on the Tribunals by promoting speedy insolvency resolution in a manner that reduces the Tribunals’ supervisory role.

A pre-packaged insolvency (a pre-pack) is one such novel resolution mechanism which has been used extensively in the United States and the United Kingdom since the 1980s. A pre-pack is a pre-planned process in which a financially distressed company and its creditors reach an agreement with a buyer for its sale prior to initiating insolvency proceedings.

This is often done with the involvement of an insolvency practitioner who is subsequently appointed as the administrator/bankruptcy trustee of such company. The sale takes place on the date of initiation of insolvency proceedings or the appointment of the administrator/bankruptcy trustee, or soon thereafter, and the sale proceeds are distributed amongst stakeholders in the order of priority.

Pre-packs avoid lengthy negotiations with creditors after the commencement of insolvency proceedings, enabling expeditious insolvency resolution with minimal involvement of courts and tribunals. Moreover, pre-packs allow pre-emptive resolution of distress as they can be arranged even before formal defaults have occurred.

A financially distressed company can continue its operations during the period leading to a formal default, and even thereafter, without the resultant reputational risks, business disruptions, or value erosion.

The Bankruptcy Law Reforms Committee which prepared the first draft of the Code had deliberated on the introduction of pre-packs as part of the Code. However, the Committee felt that further consultation with stakeholders and a separate set of rules governing pre-packs were required before pre-packs could be introduced.

Now that a robust jurisprudence has developed under the Code, which clearly delineates the roles and responsibilities of various participants and the safeguards for protection of stakeholders, the time is ripe to consider and adopt pre-packs. This would not only further reduce the time taken for insolvency resolution and permit greater value maximisation, but also substantially reduce the burden of Tribunals.

The challenge then lies in marrying the pre-pack mechanism with the existing resolution mechanism under the Code, so that necessary statutory compliances and safeguards for ensuring transparency and protection of stakeholder interests are not skirted. For this purpose, a suitable set of Regulations will have to be introduced. A few guidelines follow:

a. The corporate debtor (prior to the occurrence of a formal default) or financial creditor(s) holding a certain percentage of debt (upon the occurrence of a formal default) should be able to appoint an insolvency professional to administer the prepack mechanism.

b. The insolvency professional then constitutes a committee of creditors of the corporate debtor based on information available with the corporate debtor.

c. The insolvency professional invites bids, skilfully balancing adequate marketing and limited disclosure to avoid reputational risks and loss of employment or customer confidence.

d. An independent valuation exercise of the corporate debtor should also be carried out.

e. Once a resolution plan is negotiated between the committee of creditors and potential buyers, this plan should be approved by at least two-thirds of the committee.

f. Subsequently, the insolvency professional should file the resolution plan for the NCLT’s approval within a specified period.

g. A detailed disclosure statement should be filed along with the resolution plan. It should provide details on the independent valuation, the marketing exercise, the rationale for using the pre-pack mechanism and the alternatives considered, and how the interests of all stakeholders have been considered.

Since the resolution plan has the prior approval of the committee of creditors, there should be no need for interventions by the NCLT at various stages in the resolution process. Once the resolution plan is filed before the NCLT, a moratorium under the Code may be imposed pending consideration.

During this period, claims and objections to the resolution plan should be invited from all creditors of the corporate debtor. This would ensure that operational and other creditors, who are not involved at the pre-filing stage have an opportunity to present their objections. After duly hearing such objections and ensuring compliance with statutory requirements, the NCLT should approve the resolution plan.

Pre-pack mechanisms can have a far-reaching impact on corporate rescue in India. If implemented well, it will promote early debt restructuring in a manner that best achieves the Code’s objectives.

Source- Economic Times.