Introduction:
The ongoing pandemic has hit every aspect of human life as we know of. One of the facets of the society that it has hit is the economy of the countries. Indian economy was already going through a downfall and COVID-19 too has not been kind to it.
This downfall in economy has impacted almost every major prevalent law of the country and various amendments have been made to such laws to accommodate the current situation. The debt restructuring law of India, i.e., Insolvency and Bankruptcy Code, 2016 (“Code”), has also been amended in the process to cope with the current situation.
By and under an Ordinance dated 5th June, 2020, the Ministry of Law and Justice suspended the initiation of Corporate Insolvency Resolution Proceedings under sections 7, 9 and 10 of the Code for any default arising on or after 25th March, 2020 for a period of 6 (six) months which may be further extended upto 1 (one) year (“said Amendment”).
It was observed in majority of the cases that the completion of an insolvency proceedings generally exceeded the stipulated timeline as given under the Code and during this adversity which has been causing hardships to several businesses in India, the number of insolvency proceedings are likely to rise up. Therefore, in order to prevent trafficking and mass insolvency proceedings, the said Amendment was introduced.
Many views have been taken with regard to the said Amendment.One of the views propose that an alternate reform should be introduced to mitigate the losses which would be suffered by the stakeholders due to the said Amendment.
This article focuses on one of the reforms that can be introduced to prevent future hoarding of cases in the tribunals, i.e., Pre-pack Insolvency. The concept is not new to our legislators. In 2019, the Ministry of Corporate Affairs hadinvited comments from stakeholders,inter alia, on pre-packaged insolvency resolutions.
Jurisprudence behind Pre-pack Insolvency:
Pre-pack insolvency means a pre-planning between the creditor and the purchaser prior to the insolvency proceedings wherein they negotiate on the terms of sale of assets and other requirements before applying to the courts/ tribunals for insolvency proceeding.
The term “Pre-Pack Sale” has been defined by the Association of Business Recovery Professionals (a trade association of the United Kingdom’s insolvency, restructuring, advisory, and turnaround professionals) 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 effects the sale immediately on or shortly after his appointment”.
The practice of pre-pack insolvency was first developed in USA following the enactment of the Bankruptcy Reform Act of 1978. The practice is also prevalent in countries like UK, France, Netherlands and Germany.
The core objective of the Code is reorganization of corporate person while maximizing the value of its assets in a time bound manner and the pre-pack insolvency scheme adheres to and advances this objective of the Code.
The time period to complete the resolution process under section 12 of the Code has been increased from 270 days to 330 days including litigation and judicial process. Even after the extension of the timeline for the completion of the insolvency process, the average time it took to successfully resolve 221 cases by the end of March 2020 was 375 days[1] which is way beyond the stipulated time period provided by the Code.
Highlighting the importance of a swift and time-bound resolution process, the Bankruptcy Law Reforms Committee observed that, “the most important objective in designing a legal framework for dealing with firm failure is the need for speed[2].” By introduction of pre-pack insolvency scheme in the restructuring legislation of India, we would be ensuring speedy and more cost efficient recoveries of businesses and also prevent mustering of cases in the tribunals.
Also, it is an out-of-court process, a private restructuring mechanism which, after negotiations between the corporate debtor and the purchasers, has to get a sanction of the court/ tribunal. Therefore, though being an informal mechanism, it still comes within the purview of the courts and tribunals for their ultimate sanctioning which would be in turn binding on the parties and also keep a check on any misuse of such scheme by the parties.
Attributes of Pre-pack Insolvency:
The most important benefit of the pre-pack insolvency scheme is that it backs the core objective of the Code andif introduced, it will only work to enhance suchan objective. Major features of pre-pack insolvency that would boost the core objective of the Code are:
1. Swiftness and Cost Effectiveness – This process is generally less time consuming and cost effective. The resolution is negotiated by the parties before initiating the insolvency process, and once negotiated, it only has to apply for sanction of the arrangement negotiated from the court/tribunal. Thereby, saving the businesses (especially small businesses) from lengthy proceedings, and also saving their money in respect of the same.
From the data available it was seen that, on an average, the pre-pack insolvency in the United States of America completed within thirty to ninety days. By minimizing a debtor’s time in bankruptcy, a pre-pack insolvency limits the administrative costs that a debtor would otherwise have to incur during a formal insolvency proceeding[3].
If the scheme of pre-pack insolvency is to be introduced in India, it would reduce the time taken for resolution and also cut off the major costs spent during the insolvency proceedings.
2. Confidentiality- Confidentiality is one of the greatly desired benefit of this process. During a formal insolvency proceeding, there is a chance of adverse publicity hampering the image of the corporate debtor resulting in diminishing of the value of the assets of the corporate debtor due to the stigma attached to the formal insolvency proceedings.But pre-pack process promotes confidentiality and thereby preventing such deterioration of company’s image and value of assets as a going-concern business.
3. Authorization/ Sanction- One might fear that this out-of-court negotiation might lead to the misuse of the resolution process by the corporate debtor and the purchaser but even being an informal process, once an arrangement has been negotiated by the corporate debtor and the purchaser, the resultant arrangement would need to be sanctioned by an appropriate statutory authority (in India, that would be National Company Law Tribunal) and such sanction shall be binding on all the stakeholders.
Pre-packing in India:
India does not have any prior experience with the pre-pack insolvency and major amendments would have to be made in order to accommodate this reform. We could take the models of pre-pack insolvency in the US or the UKas a base and mould it according to our needs into the existing mechanism.
A phase-wise implementation would help in understanding the working of the pre-pack insolvency mechanism in a better way. Therefore, the introduction of this mechanism in India could be started with the small sectors that have a fewer financial creditor, and after analyzing the fruits of such introduction and upon satisfactory results, the same could be expanded to different sectors. Apart from that, major amendments would also have to be introduced into the Code.
Recommendations for Implementation:
Some key mechanismsin relation to pre-pack insolvency which could be made part of the Code are as follows:
1. Initiation: Under the pre-pack mechanism, the decision to initiate pre-pack insolvency could be taken either by the corporate debtor or the creditors of the corporate debtor. In case the former initiates the process, requisite resolutions of shareholders and the board of directors should be passed and in case of initiation by the latter, understanding of all creditors would be crucial. When a decision to initiate pre-pack insolvency has been made by the concerned party, it shall be the duty of the corporate debtor that each of the creditors and the stakeholder of the company is notified of the transaction.
The hallmark of the pre-pack insolvency mechanism would be to impose a moratorium or a stand-still period during which no creditor of the company shall be allowed to independently initiate an insolvency proceeding by filing an application with the adjudicating authority during an on-going pre-pack arrangement so as to prevent undermining of the process.
In the UK,in order to prevent such creditors from initiating a formal proceeding in the courts, the creditors enter into an agreement such as a waiver or forbearance agreeing to modify or waive their rights to collect debts[4]. Such a similar mechanism could be introduced under the Code, like an affidavit from all the creditors declaring to not file a formal proceeding if a pre-pack mechanism is already in process.
The dissenting creditors or other stakeholders would always have an option to objectwhen the arrangement has been presented before the adjudicating authority for final approval.
2. Appointment of an Insolvency Professional (“IP”): When an insolvency proceeding is initiated against a company, an interim resolution professional (later on an IP) is appointed under the Code for managing its affairs. Similarly, in the pre-pack mechanism when the corporate debtor or the creditors decide to initiate pre-pack insolvency, they shall appoint an IP from the pool of the professionals, i.e.,the IPs registered with the insolvency professional agencies. The IP then shall be responsible to give effect to a viable pre-pack arrangement ensuring that such proposed arrangement is reasonable to the interests of all stakeholders.
3. The seal of adjudicating authority: The sanction feature by an adjudicating authority the informal arrangement arrived to by the debtor, creditors and other stakeholders is what,inter alia,makes the pre-pack insolvency an attractive process for debt restructuring. One of the major concerns with the pre-pack insolvency could be the confidentiality of the process as, wherein it is possible that while formulating an arrangement, interests of small stakeholder like the employees and other operational creditors could be easily neglected and the terms of the arrangement might not be beneficial to them. In order to prevent such state of affairs, the final approval by the adjudicating authority plays a vital role in the pre-pack insolvency mechanism. The adjudicating authority while approving the arrangement proposed by the debtor and the creditors shall satisfy itself that the interests of all the stakeholders have been considered. It shall be the adjudicating authority’s sole discretion to entertain any objections from the dissenting creditors, if any, and if it decides to do so, it should limit its analysis to the particular facet of the arrangement.
The sanction by the adjudicating authority would build up the confidence in pre-pack insolvency mechanism[5].
Conclusion:
During the current economic downfall, many companies or businesses might go under insolvency proceedings and a complete ban of 6 (six) months for initiating the insolvency proceedings would only add to this chaotic situation. Therefore, an alternate reform that would promote debt enforcement and restructuring and also ease the impact of the pandemic on the distressed businesses like pre-pack insolvency should be introduced.
Also, upon failure of the formal corporate insolvency resolution process under the Code, the only option remaining under the Code would be liquidation of the corporate debtor which is not a feasible option in the long run for the small companies like MSMEs and startups as their chances of ending into liquidation increases due to the dearth of investor interest in their assets since the value of assets diminishes during formal insolvency proceedings. The same is not viable for big companies as well due to time and cost factors. Since the commencement of the Code inDecember, 2016, 914 companies have ended in orders for liquidation by the end of March, 2020 whereas only 221 ended in approval of resolution plans[6]. The introduction of pre-pack insolvency would prove useful for preventing corporate debtors from going into liquidation and also act as a tool to revive the corporate debtor and remedy the financial stress that it is undergoing in a time and cost effective manner.
The major concern in the whole pre-pack insolvency scheme regimen would be the confidentiality it provides to the parties; the process ends up being less transparent. The parties might misuse this feature to their advantage and conceal the information of resolution from other parties thereby neglecting the interests of various stakeholders, especially the unsecured creditors.
If and when the government decides to introduce this mechanism into the debt restructuring laws of the country, harmony will have to be created between the reforms and the existing laws. It would be a task to marry the pre-pack insolvency mechanism into the prevailing laws.Major amendments will have to be made to the Code. Therefore, a phase wise introduction like a patch test as suggested above should be made in order to evaluate and weigh in the benefits and drawbacks of the mechanism.
As the Code has already grown since its implementation, such reforms would only add to the advancement of the Code and help in reducing the reliance of the debtors upon the adjudicating authorities which would alsogive the adjudicating authorities time to clear out the backlog of pending cases.
[1] The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, January- March 2020, Volume 14.
[2] Ministry of Finance, The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design (2015) Executive Summary.
[3] SIPI India, Pre-packaged Insolvency Resolutions: A way forward, March 2019.
[4] Pre-packaged bankruptcy arrangements in the Indian context. https://cbcl.nliu.ac.in/insolvency-law/pre-packaged-bankruptcy-arrangements-in-the-indian-context/
[5] Insolvency Procedures- Investigating the Pre-Pack Paradigm in India; Sanjana Rao; February 24, 2019.
[6] Supra 1
Author Bio
Good article. However certain improvements can be done in existing IBC to make it more effective particularly its time bound completion. The arbitrary appointment of RPs is another major reason for the above delay in completion of CIRP. The appointment of RP in any case should be decided upon the history of handled cases by RP, complexity and size of the CD etc. A novice RP should not be given a big and complex case to begin with.
Very informative and well compiled.
Very informative article in simple language, useful during this tough Phase. Thanks Anamika Ballewar for such a nice Article.
Very well researched and relevant in today’s condition.
Very informative and well researched.