The Insolvency and Bankruptcy Code, 2016, has boosted the industry in terms of either reviving the company in question or faster liquidation of the same without letting them deteriorate. Essentially it has brought down the timeline for recovery/ resolution from decades to a few years at the most. However, at the same time, the process under the IBC requires both time and money to fructify considering the direct and indirect costs involved. Litigation would be an initial cost in terms of engaging lawyers, accountants, RPs and their teams; indirect costs would include loss of business of the corporate debtor and loss of business because a company is undergoing CIRP, loss of goodwill, etc.
There are also the out of court debt restructuring mechanisms that have been prescribed by the Reserve Bank, which generally involve a creditor consortium to try and resolve the stressed debtor. However, this method lacks the legal sanctity that the process under IBC enjoys and on a practical level, it becomes challenging to come through with such debt restructuring. Consider, for example, the corporate debt restructuring process 'CDR' that RBI had initiated in 2001. Figures state that approx.. only Rs. 85k crores were successfully resolved out of debt worth 1.84 trillion. A large flaw of the scheme was the tendency of banks to "pretend and extend". What it means that since banks were exempted from declaring a company NPA so long as the company was under CDR, banks fell into a tendency to keep on extending the corporate CDR process while never showing NPA on record.
An answer to shortening the timelines even further while at the same time maintain legal sanctity could very well be through the mode of pre-packaged insolvency or bankruptcy which would permit an even faster method of resolution of stressed assets, through its timely detection. This is very important as most IBC matters are highly contested, and there are hardly any companies which don't object to initiation of CIRP. Pre-packs can be thought of as an amalgamation of the court oriented process under IBC and the out of court debt restructuring involving lender banks. The process under pre-pack insolvency envisages formation of a resolution plan to resolve the corporate debtor's stressed assets and debts, before the initiation of a formal provision bound court process before the NCLT. A plan would be 'negotiated, circulated to creditors, and voted upon before a case is filed.'1
One of the most significant differences between CIRP and a pre-pack is the investor support that a pre-pack could potentially enjoy. Because of its very nature, a pre-pack has to have a very high level of support from its stakeholders, thereby ensuring the highest chances of revival of the company. This is a necessity as without promoter cooperation; it would be nearly impossible to negotiate a pre-pack. It has to be observed that a robust framework for pre-pack, like that under the Insolvency and Bankruptcy Code, 2016 would push debtors to settle their debts out of court voluntarily
BASIS OF POTENTIAL LAW – USE IN USA AND UK
The US has a more of a bankruptcy oriented approach where, most of the times, the debtor can be permitted to sell all or nearly all of its assets before confirmation of a reorganised plan if there is sufficient 'business justification' to do so.
The US generally has three modes, (i) pre-packaged bankruptcy, (ii) pre-arranged bankruptcy, (iii) Pre-Plan Sales.
Both, pre-packaged and pre-arranged bankruptcy, under US law are considered more efficient compared to their normal bankruptcy proceedings under their US Bankruptcy Code (the former takes roughly 4 months compared to the latter's 7 months).
Pre-negotiated proceedings tend to be better protected from hold-outs by dissenters, as the concept of cramdown is available against minority dissenting creditors. Under Indian law, cramdown was referred to and explained in the judgment of Essar steel2, where the majority were permitted to cramdown on minority shareholders so that a plan could be achieved. This segregation is actually similar to the CIRP process under IBC in India, but without the formal requirements of the provisions.
The main difference between pre-packaged and pre-arranged bankruptcy under US laws is that the former requires that the plan is formulated, circulated and found conforming with all interested parties, which would include impaired or affected parties as well. The Court does not approve the disclosure statement; however, it does require adherence to the fundamental law of having 'adequate information' about the plan. Thereafter, the plan goes to court for final approval. The latter involves, circulating and negotiating with only the major interested parties, but voting would come after the plan and disclosure statement attain sanctity of the court. Approval has to go from at least 2/3rds of a voting class of creditors, parties, before the approval of the Court is sought. (Donald Trump incidentally used the very same Chapter 11 bankruptcy proceedings, to shed his debts and yet retain control.)
Pre-plan sales, in brief, would be where the process permits the debtor to sell all or nearly all of its assets, without the major provisional or statutory requirements under a typical Chapter 11 reorganisation. After an essential notice of 21 days to all creditors and affected parties, without the necessity of consent, the debtor may proceed to sell. We can see a prime misuse in this method since there is the possibility of connected parties taking over and accordingly the courts there had initially allowed such pre-plan sales, only as emergency measures so that the asset value could be saved from quick deterioration in peculiar cases. However, the view there has changed, in as much as the court does not require the same standard of emergency measures, and allow sale where it can be justified as a 'good business decision'. Such sales are typically carried out through an auction and the debtor target stalking horse bidders, so that the prospective buyer can carry out the necessary due diligence without any formal procedure. Post negotiating a primary bid, the debtor files for bankruptcy.
The pre-pack insolvency under UK laws is a little similar to CIRP in India in that it has the appointment of an insolvency practitioner as an administrator who helps in the negotiation and arrangement of the rescue plan for a debtor, before formal administrative proceedings. Otherwise, the mode of pre-packs is rather similar to that in the USA with the exception that an expert is involved in the initial restructuring and preparing of a plan before undergoing any formal procedure. Another aspect is that the disclosure here has to highlight the marketing activities that the administrator has undertaken and a detailed narrative and justification as to why a pre-packaged sale was undertaken at all. Such disclosure is not for the creditors to oppose the sale, but instead, such information can be used to challenge the administrator's conduct.
As of today, there is no proper framework in India which governs pre-packaged insolvency. However, there is a framework suggested by the Vidhi Centre for Legal Policy3. They have devised similar structures which would fit the existing IBC framework and have been categorised as (i) PPIRP – Pre-Packaged Insolvency Resolution Process, (ii) PAIRP – Pre Arranged Insolvency Resolution Process, and (iii) Pre-arranged sale.
PPIRP has been promulgated for cases where the debtor generally has a single or very few lenders having the requisite high majority debt holding. This would allow the negotiation and finalisation of a resolution plan by the CoC before a formal process. Where there are several lenders/creditors, PAIRP would be the preferred method, as a negotiation between creditors will be better served under the court's formal scrutiny. PAS would only be utilised and useful where the debtor is in imminent danger of rapid asset value erosion.
PROS OF ADOPTING PRE-PACK INSOLVENCY
- Business Continuity - Conventional insolvency process is usually at a stage where the debtor company is already down in the dumps and is unable to carry on it's regular functioning due to lack of funds or complicated regulatory requirements. Part of the secret behind pre-packs is that it entails detection that a company needs debt restructuring at the earliest stage. Therefore, when identified at an early enough stage, even undergoing insolvency through a pre-pack will permit a company to continue its regular working.
- Maximises the efficiency, cost and flexibility of resolution plans, along with the binding nature and structure of formal proceedings. (out of court process + court sanctity + high degree of employee retention)
- Minimal depreciation of the asset value of the company
- Similar to proceedings under the IBC, which make the approved plan binding on all stakeholders (Increases investor confidence).
- Less time consuming, cost-friendly mainly because the resolution is negotiated and agreed upon before initiating the statutory framework. A lot of times, speedy disposal through pre-pack may be the difference between small businesses thriving after undergoing the process, compared to companies ending up in liquidation under CIRP
- Confidentiality in terms of informal proceedings - This does not mean that shareholders are unaware of the proceedings. The rule of negotiating a plan, circulating to creditors and voting, is always applicable. However, the information can be kept away from the general market. It is a very real fear for any company undergoing CIRP that it loses market support and trust. Even big, healthy companies are wary of having any IBC petitions pending against them as it could portray them in a negative light, which is why they usually rush to quash or settle them.
CONS OF ADOPTING PRE-PACK INSOLVENCY
- A structured and negotiated deal between the parties is likely to be reneged by any of the parties involved since there is a lack of serious repercussions, in the absence of statutory basis.
- Dissenting creditors may hijack a negotiation to delay coming to a consensus. Moreover, in the absence of protection from prosecution under law (similar to section 14 moratorium), a pre-pack negotiation 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 UK mode of pre-pack receives only the approval of secured creditors, so there is always the possibility that unsecured creditors will be left high and dry. Further, since a pre-pack is negotiated when the management of the CD is still on board, there is always a chance that the value which is technically due towards unsecured creditors, will be captured or stolen by related parties of the management. This would be like a back door to promoters of a company, which otherwise the Code forbids strictly through Section 29A. This could essentially proliferate bad businesses as connected parties would be taking over the business, meaning thereby, that there is no genuine restructuring. Rather, the debtor gets an opportunity to escape his debts.
- There is a possibility of 'phoenixing'. This refers to companies which are not really insolvent, but just technically insolvent and are allowed to run down to the point of winding up, and then through pre-pack are restructured, arising out of the ashes of the former company, with near-identical persons managing the new company, under a very similar name.
- 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. This is a reason why the JET airways out of court settlement did not work, as they could not get the necessary exemptions without court intervention. In fact, before it plunged into CIRP, JET was in negotiations with Etihad which was looking to invest. However, a pre-condition by Etihad was that it may be exempted from making an open offer under the SEBI (Acquisition of shares and Takeover) Regulations. Under the Code, this would have been possible. Of course, a CIRP process does not necessarily mean clear exemptions.
CONCLUSION
Under the present regime of the IBC, insolvency professionals are still evolving the necessary expertise required over time. Like the law under the UK regime has evolved over time rather than simply promulgated, application of pre-pack insolvency in India will require a much higher degree of expertise of insolvency professionals, as under such resolution methods, they have a much higher degree of control. Moreover, creditors will have to develop a level of trust not only in such insolvency professionals but also the framework put into place so that there is cohesion between creditors at the time of negotiation and approval of plans. At the same time, corporate debtor companies have to be aware of their own self-worth as they have to identify and execute proper decisions to undergo pre-pack insolvency without resorting to desperate acts of litigation to prevent it.
However, with the increase in the trend of out of court settlements, pre-pack insolvency could very well be the next alternative to regular CIRP proceedings.
Footnotes
1. John D. Ayer et al, 'Out-of-court Workouts Prepacks and Pre-arranged Cases A Primer', (2005 April) ABI Journal (https://www.abi.org/abi-journal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer)
2. (2020) 8 Supreme Court Cases 531
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