prpri PRE-Packs: Next Step in Insolvency? PRE-Packs: Next Step in Insolvency?

Dated: 23.05.2020

Miss Ankita Agarwal

Miss Ankita AgarwalIntroduction to Pre-Packs

The term ‘pre-pack sale’ has been defined by the Association of Business Recovery Professionals in the United Kingdom as, ‘an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an Administrator, and the Administrator affects the sale immediately on, or shortly after, his Appointment‘.

Statement of Insolvency Practice 16 England and Wales (“SIP 16” in short) defines the term “Pre-Pack sale”as “an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser prior to the appointment of an administrator and the administrator affects the sale immediately on, or shortly after, appointment.”

The practice of pre-packs was first developed in the US, following the enactment of the Bankruptcy Reform Act of 1978. Soon, it became so popular that in 1993, nearly one-fifth of all public bankruptcies were pre-packaged. The practice of pre-packs is widespread in the UK, Netherlands, France and Germany.

In India pre-packs would mean that the corporate debtor or material assets of the corporate debtor can also be sold to the existing directors/promoters operating under a new company, which is usually resorted to if the business is facing serious problems and creditor threats. The director/promoter of a failed business may wish to purchase its assets or business in order to form a new company. Currently, this practice is barred as Section 29A of Insolvency and Bankruptcy Code, 2016 makes the directors/promoters or related parties of the corporate debtor to bid on them or present a Resolution Plan for them.

Pre Pack Scenario in India

Pre-packs can help maximize the value for various stakeholders by containing the erosion of value caused by disruption, delay and insolvency. In the Indian context, this would also allow the focus to be on the resolution, allowing adequate time and access for diligence and enabling alternative capital providers to participate in the process.

Under a pre-packaged bankruptcy process, a Company would prepare a resolution plan in cooperation with Creditors, which would come into effect once the Company enters the Corporate Insolvency Resolution Process (CIRP).

Prepackaged insolvency resolution would allow the creditors and the shareholders with a pre-negotiated Corporate Reorganisation Plan to approach the NCLT. It could be taken forward as an important option in the times to come. As mentioned in the advantages above, this will aid the existing framework and cut costs and the time taken during the resolution process.

The Ministry of Corporate Affairs (MCA) has already invited comments from stakeholders on pre-packaged insolvency resolution amongst other issues related to the Insolvency and Bankruptcy Code, 2016, and the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016. This move was to speed up the process of insolvency and shall result in timely resolution and value maximization which are two main objectives of the Code.

 In India, the concept of Pre-Pack is needed due to the uncertainty of the resolution process but will present its own set of problems such as moving the process from being creditor centric presently to being debtor centric.

Given the current situation wherein, because of the effect of the COVID-19 pandemic, the provisions for initiating fresh insolvency is suspended for a year, the need of the hour is quick resolution while keeping the companies afloat and the simple solution to this huge problem may just be introduction of pre-packs in the Indian market.

To understand a bit more of how the pre-packs would function, let us take a look at the Statement of Practice 16 for England and Wales which outlines the process and advantages of a Pre-Pack administration.

Statement of Insolvency Practice 16

SIP 16 was introduced to increase transparency by enhancing the amount of information that is to be provided to the Creditors and the Company’s directors. The role of the Insolvency Practitioner (IP) becomes limited to advising the Company about any pre-administration marketing that should comply with ‘marketing essentials’ (details of which are given in the SIP) and that any valuations should be carried out by appropriate Independent Valuers who hold adequate professional indemnity insurance.

The Enterprise Act, 2002 of United Kingdom had introduced changes to make the insolvency process less time consuming and easier. The Act or any other legislation does not specifically contain the provisions or procedure for how the pre-pack sales are to be carried out, however, the Statement of Insolvency Practice 16 (SIP-16) of UK and Wales provides for a broad guideline on how to implement the same.

Process of Implementation

For a “Pre-pack Sale” to take place in the UK, certain steps are to be taken. These steps are as follows:

Firstly, a resolution is required to be passed by the Directors of the Company regarding its financial position. This Resolution shall involve appointment of an Insolvency Practitioner (IP) for advising on the matters regarding the sale.

Secondly, the IP, after going through the financials of the Company should provide the Directors different options available with them, one of which shall be a “Pre-pack sale”.

Thirdly, if a Pre-pack sale administration is decided upon, then the IP has to identify potential buyers. SIP 16 provides for how compliance is to be done by the IP during the process.

Fourthly, IP has to evaluate the Company by appointing Independent Valuers. The Directors will then prepare a Statement of Affairs and mention if any connected party shows interest in acquiring the business then the same information is to be provided to the pre-pack pool of creditors.

Lastly, the IP as an Administrator will make sure that the assets or business of the Company is sold and as per SIP 16 will then have to provide a detailed explanation and justification to the Directors of the Company as to why the pre-pack option was chosen.

The pre-packs have a lot of advantages, such as, keeping the company as a going concern, and thus, keeping in place customer confidence, jobs of employees, suppliers and other stakeholders. It is also a tool that provides for value maximization and cost saving by reducing the cost it takes for the Administrator to keep the company trading. It is also useful in situations where the company undergoing insolvency proceedings has a dominant Intellectual Property or a strong brand as it keeps the company going without disrupting the procedure.

SIP 16 details out the compliance standards and principles that the IPs need to follow once they are Administrators of a pre-pack sale. The Statement of Insolvency Practice (SIP) 16 was introduced on 1st November 2015 in the UK, and provides for detailed guidance for insolvency practitioners involved in a pre-pack administration process.

SIP 16 also mentions that when a business is being sold to a connected party, in order to assist with his reasoning, the IP should attach a “viability statement” to the SIP 16 Statement prepared by the connected party and the statement should demonstrate how the company will survive for at least 12 months from the date of the statement and what the new company will do differently.

Implementation in India

For the concept of Pre-pack to be introduced in India, certain concerns will need to be addressed such as concerns of Creditors. The insolvency law in India right now is majorly creditor based with every decision in the Corporate Insolvency Resolution Process requiring ratification from the Committee of Creditors. In the process of pre pack where the marketing and the decision making will be done by the debtor and the Insolvency Professional before the insolvency is triggered, poses a risk to leave out the best interests of the creditors in the process. The confidence of the creditors is also likely to not vest in the debtor. This problem can be partially solved by having the creditors be involved in the voting like under Insolvency and Bankruptcy Code, after the process has been triggered. The framework made for Pre packs may also include safeguards for Operational Creditors to be mandatory in the process.

In India, currently as soon insolvency is triggered the debtor is displaced from their company and the Insolvency Professional takes over, however, in case where a pre-negotiated plan is submitted, the corporate debtor is allowed to remain in possession of the business, under the supervision of an independent insolvency professional, appointed as chairman of board of directors, which helps in prevention of disruption in cases, and maintains the confidence of the creditors that the whole process is being carried out with transparency.

Pre-Packs in Insolvency are the way forward for Indian Insolvency as it introduces benefits of less litigation, quick resolution, less displacement of employees and management, reduced chances of companies undergoing liquidation and no dealing with unpredictable resolution applicants.

However, since it is a new concept, there will be a number of issues that would need to be addressed such as the possible conflict of the pre-packaged administration with Section 29-A of Insolvency and Bankruptcy Code 2016 as the purchasers can be related or connected to the corporate debtor which will allow them to buy the business at a discounted value, thereby jeopardizing the rescue of the business and rights of the creditors; disregarding the rights of unsecured creditors and unduly widening the gap between financial and operational creditors is also a major concern.

Therefore, a proper framework for the process and implementation along with the rights and duties of each stakeholder involved will need to be rolled out by the Government before any reliance can be placed on the solution of many problems, a pre-packaged sale.

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