Context: Recently, the Ministry of Corporate Affairs (MCA) has set up a committee to look into the possibility of including what are called "pre-packs" under the current insolvency regime to offer faster insolvency resolution under the Insolvency and Bankruptcy Code (IBC).
About Pre-Pack

• It is a pre-planned process in which a financially distressed company and its creditors reach an agreement with a buyer for its sale prior to initiating insolvency proceedings.
• The sale then takes place on the date of initiation of insolvency proceedings or after the appointment of insolvency administrator.
• In India’s case, such a system would likely require the approval of the resolution plan from the National Company Law Tribunal (NCLT).
• The pre-pack would act as an important alternative resolution mechanism to the CIRP and would help lower the burden on the NCLTs.
• The process needs to be completed within 90 days so that all stakeholders retain faith in the system.
• Global Scenario: The pre pack system of insolvency proceedings has become increasingly popular in the UK and Europe over the past decade.

Key benefits of a Pre-Pack

• Pre-packs avoid lengthy negotiations with creditors after the commencement of insolvency proceedings enabling expeditious insolvency resolution with minimal involvement of courts and tribunals.
• In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached.This is necessary because Transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.
• The pre-packs would mostly be used for businesses that are running, the investors would likely need to maintain good relations with operational creditors.
• Confidentiality: The element of confidentiality prevents destruction of value that takes place on the proclamation of insolvency.
• Sanction of appropriate authority under the statue: The other forms of restructuring do not possess sanctions from appropriate authority but pre-packs work within the fold of statutory schemes, which makes the outcome binding on all the stakeholders.
• Reduction of cost & time in litigation: The pre-pack process has recognition across the globe and the need for a pre-pack process in India is necessary to revive the debt ridden corporates.

Need of Pre-packs in India

• The IBC has a positive impact on the promoters of the corporate debtors in terms of repayment, liquidation is a grave threat to Corporate Insolvency Resolution Process (CIRP).
• If the CIRP fails that would lead to liquidation which is not good for our economy’s health it might be seen as the best option in the short-run but will have a deep devastating effect for the corporates in the long-run.
• The necessity of the pre-pack is that, there is a possibility that before the pre-pack stage the corporate debtor may enter into management buyout for the transferring of the assets to another entity.
• The risk of the aforementioned situation would not arise if the pre-pack is approved by the Adjudicating Authority.

Key drawbacks of Pre-Pack

• Lack of Transparency: The key drawback of a pre-packaged insolvency resolution is the reduced transparency compared to the CIRP as financial creditors would reach an agreement with a potential investor privately and not through an open bidding process.
• Issue of fair treatment: The system of pre-packs could lead to stakeholders such as operational creditors raising issues of fair treatment when financial creditors reach agreements to reduce the liabilities of the distressed company.
• Legitimacy of Surety: There may be questions of whether secured lenders have been fair to other creditors.
• Hesitation from the Banking Sector: The bankers themselves may hesitate to restructure liabilities outside of an open bidding process for fear of their decisions leading to investigations by agencies.
• Unlike in the case of a full-fledged CIRP which allows for price discovery, in the case of a pre-pack the NCLT would only be able to evaluate a resolution plan based on submissions by the creditors and the investor.

About Corporate insolvency resolution Process (CIRP)

• It requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company which is time consuming.
• Even under the CIRP financial creditors make up the committee of creditors which votes to decide the distribution of the proceeds of any resolution plan.
• Cases that take more than 90 days  time should be taken through the normal CIRP.
• Operational creditors tend to get worse recoveries in cases where the company is no longer operational.
• Transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.

About Insolvency and Bankruptcy Code(IBC)

• It was implemented through an act of Parliament in 2016.
• It provides for a time-bound process to resolve insolvency and the code applies to companies, partnerships and individuals.