All You Need To Know About Pre-Packaged Corporate Resolution

The Ministry of Corporate Affairs (MCA) is reportedly working out a draft scheme on “pre-packaged” resolution for corporate entities in coordination with the Insolvency and Bankruptcy Board of India (IBBI).

It is a newer method of corporate resolution that involves an agreement between the company, its creditors and prospective buyers before the initiation of insolvency proceedings. Let’s take you through its finer points, shall we?

What is a Pre-Packaged Resolution Plan?

Pre-packaged insolvency processes (hereinafter referred to as “pre-packs”) are arrangements in which the sale of all or a part of the company’s business or assets is finalised with a buyer before the appointment of a Resolution Professional (RP) takes place.

The objective is to protect the business from liquidation while taking the interests of creditors into account. Because it commences BEFORE initiation of formal proceedings, it can theoretically reduce time (and money) spent on taking the entire process through litigation.

It is not a novel scheme, but niche. The bankruptcy codes in the USA and UK already have facilities in place for the debtor to initiate pre-packs.

How Does It Work?

Fundamentally, a pre-pack is an instrument of debt-restructuring. The mode of restructuring varies from company to company depending upon the type of business it undertakes, the level of its indebtedness and the stage of financial distress it is in.

The terms of the pre-pack are designed after taking all the above criteria into account. Once the terms are agreed upon and the company files for bankruptcy, the pre-pack is swiftly executed by the RP.

So, the part that sets pre-packs apart from other modes of resolution is the promptness with which they are executed. Also, no court permission is required to initiate the pre-pack process (although it is required to enforce them).

Who Takes Charge of the Distressed Company During the Pre-Pack’s Operation?

It varies across jurisdictions.

USA has a “debtor-in-possession” concept so the company retains ownership and management while finalising the terms of its restructuring. The UK, however, has an “administrator-centric” focus which enables the court-appointed RP to take charge.

India leans towards the UK pre-pack regime in the manner that the central idea behind the IBC was to shift the process of resolution from a debtor-controlled to a creditor-controlled system.

Why Opt For It?

One. Speed. At the core of the corporate resolution process lies the gospel of “value-maximisation” of the distressed company’s assets. With every passing day in the resolution window, the fair-value of the company’s assets depreciates, which is why a scheme involving advanced negotiation of asset values comes in handy.

Speed is a dually-advantageous element here because it benefits not just the company but also the administrators i.e. The courts and tribunals. IBBI data shows that as of June 2020, out of the 2,108 ongoing resolution cases, 1,094 are pending well beyond the IBC-mandated 270 days. Imagine de-cluttering that overburdened roster!

Two. Cost-cutting. Reduces vital litigation costs because most negotiation and documentation of the proposed plan is done out of court.

Three. If imposed as per guidelines, pre-packs would have statutory sanction. Much like an arbitration clause, it will have binding effect on the parties and the debtor will face direct liquidation if it fails to implement its structured obligations.

What To Look Out For?

Lack of transparency is a major impediment to the realisation of pre-packs. The negotiation, by virtue of its preemptive nature is highly confidential, which only the secured creditors are privy to. That leaves out unsecured creditors and shareholders to raise their objections.

The moratorium under Section 14 of the IBC that stays the hand of creditors from enforcing remedies against the debtors may not be available under pre-packs. This could well lead to situations where debtors are negotiating pre-packs and are slapped with bankruptcy lawsuits simultaneously, hence eroding the “reduced litigation” prospects expected from the pre-packs.

Nevertheless, both these challenges can be fixed with appropriate legislative procedures.

Which leaves us with the third headache: Section 29A of the IBC. The high-profile Essar Steel case made this provision popular when the management of debtor company attempted to buy-back its business by bidding as a resolution applicant, effectively giving currency to the term ‘phoenixing’ (promoters deliberately forcing insolvency to buy back assets at reduced price).

However, in the present context, the devil’s advocate would emphasise on the need to dilute Section 29A so that proactive debtors who are in seeming distress can successfully negotiate the terms of insolvency through pre-packs with their creditors without being hamstrung by the section.

Pre-packs In India

IBC has certainly promoted discipline in insolvency proceedings but problems still abound.

With MSMEs suffering greatly on account of the pandemic recently, the need to encourage investor-interest in them becomes primary. Keeping that in mind, reducing the window, complexity and litigiousness in the corporate insolvency process even further couldn’t hurt.

Currently the only out-of-court restructuring processes we have are for large accounts under the RBI-issued “Prudential Framework for Resolution of Stressed Assets”. Plus, going by our creditor-centric approach to corporate resolution, it remains unclear as to what extent the debtor’s bargaining power will prevail at the pre-packs negotiating table.

(FYI: In the landmark judgment Innovative Industries v ICICI Bank Ltd., the Supreme Court said promoters of a debtor company under CIRP have no powers to take any decisions on behalf of the company.)

Another problem that may arise in India is with creditor-approval. The three-fourth majority from financial creditors required under Section 30(4) of the IBC to greenlight a resolution plan could be a sticking point for enforcement of pre-packs. Only a clearly-defined legislation outlining the criteria for enforcement and approval is the remedy.

Since courts in India function according to the values of natural justice, the same principle could be applied to ease resolution proceedings by increasing the discretionary power of NCLT and NCLAT. The key to enforcing pre-packs in India is to effectively strike a balance between statutory regulation and corporate autonomy. It remains to be seen how the draft scheme incorporates the same.

(Originally published November 26th 2020 in transfin.in)