The Ministry of Corporate Affairs has invited public comments and suggestions on a proposed pre-packaged insolvency resolution process under the bankruptcy code last week. The government has invited suggestions to the draft regulation latest by January 22, 2021, after which the regulation is widely expected to be firmed up.

The sub-committee of the Insolvency Law Committee (ILC), constituted by the government in June last year, designed a pre-pack framework with the basic structure of the Insolvency and Bankruptcy Code (IBC), and submitted its report in October.

“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 noted in its report which has now been made public.

What is a pre-pack?

A pre-pack or pre-packaged deal is 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.

Benefits of a pre-pack

Compared to a regular corporate insolvency resolution process (CIRP) under the IBC, pre-packs have the advantage of being a more informal process and the possibility of closure in a shorter period of time. “Since the process prior to commencement of formal proceeding is informal, pre-pack provides the stakeholders flexibility in working out a consensual, but efficient, strategy for effective resolution and value maximisation that may be difficult under the formal insolvency procedure,” the report of the sub-committee read. It takes less time because a substantial part of the proceedings is undertaken before the commencement of the formal proceeding by the court. This helps as keeping a stressed company running for longer is not only difficult but also increases the cost of resolution.

Concerns with pre-packs

The nature of pre-packs leads to a lack of transparency, where often unsecured creditors feel disenfranchised by the secrecy. Concerns may also be raised on the valuation process -- and experts feel more can be done to explain the valuation methodology to bring comfort to all stakeholders. Additionally, the insolvency practitioner has no legal requirement to look at the future viability of the new business emerging from a pre-pack sale, and the practitioner’s legal responsibility is to the creditors of the old business. This may be a concern for both transferring suppliers and new ones. The sale of business and assets of the corporate debtor to connected parties has also garnered criticism.

Key recommendations of sub-committee of ILC

(i) 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.

(ii) PPIRP would pursue the same objectives as the IBC, with checks and balances to prevent any abuse.

(iii) Implementation of PPIRP may be phased, starting with defaults from Rs 1 lakh to Rs 1 crore, and then expanded to defaults of over Rs 1 crore.

(iv) Pre-packs in case of pre-default can be considered if 75% of creditors consent

(v) 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.

(vi) Corporate debtor to remain in control and possession of current promoters and management during the pre-pack process.

(vii) 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.

(viii) CoC to take decisions with the approval of the required majority of votes, but the decision to liquidate would require approval by 75% of the voting share. There will, however, be no liquidation where pre-pack was initiated for pre-default stress, default below the threshold for initiation of CIRP and COVID-19 defaults.

(ix) Section 29A of the IBC, which prohibits promoters of defaulting firms from participating in the process to continue in the case of PPIRP.

(x) The resolution value need not necessarily be higher than the realisable value.

(xi) 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.

(xii) The resolution plan approved by the adjudicating authority will be binding on everyone.

First Published:Jan 11, 2021 2:21 PM IST