Context: Amid a growing perception that India’s three-year-old insolvency resolution system has been less than productive in saving businesses and aiding lenders to recover their assets, the government has amended the Insolvency and Bankruptcy Code (IBC) through an Ordinance to provide for a so-called pre-pack resolution scheme for micro, small and medium enterprises (MSMEs). The scheme, where only the debtor will get to trigger the bankruptcy process, is expected to yield much faster resolution than the extant corporate insolvency resolution process (CIRP) and cut costs. It could also reduce litigation, often triggered by defaulting promoters to retain control of their firms, and help thousands of MSMEs struggling to cope with the havoc wrought by the Covid-19 pandemic. The IBC (Amendment) Ordinance 2021 comes within two weeks of the lifting of a one-year suspension of insolvency proceedings against Covid-related defaults, amid heightened possibilities of a rise in bad loan cases. In this edition of Big Picture, we will analyse the pre-packaged resolution scheme for MSMEs.
Key Points
Pre-Packs

• A pre-pack is an agreement for the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
• This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
• In India’s case, such a system would likely require that financial creditors agree on terms with potential investors and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).

Need for Pre-Packs

• Slow progress in the resolution of distressed companies has been one of the key issues raised by creditors regarding the Corporate Insolvency Resolution Process (CIRP) under the IBC.
• CIRP is the process of resolving the corporate insolvency of a corporate debtor in accordance with the provisions of the Code.
• Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

Key Features of Pre-Packs

• Pre-Pack usually requires services of an insolvency practitioner to assist the stakeholders in the conduct of the process.
• The extent of authority of the practitioner varies across jurisdictions.
• Pre-pack envisages a consensual process - prior understanding among or approval by stakeholders about the course of action to address stress of a Corporate Debtor (CD), before invoking the formal part of the process.
• No requirement of Court Approval: It does not always require approval of a court. Wherever it requires approval, the courts often get guided by commercial wisdom of the parties.
• Outcome of the pre-pack process, where approved by the court, is binding on all stakeholders.

Advantages of Pre-pack Offer

• Quick Resolution: Pre-pack, which enables a faster resolution, preserves and maximises value (of a company in a stressful state) and increases the possibility of resolution.
• Minimises Disruptions to the Business: Since the CD continues with the existing management during pre-pack, it avoids the cost of disruption of business as it does not shift management to Interim Resolution Professional (i.e. unlike that in the CIRP process) and continues to retain employees, suppliers, customers, and investors.
• Group Resolution: Given that resolution of a group of companies can be value-adding as compared to a separate insolvency proceeding for each company in distress, many jurisdictions are contemplating to make available an enabling framework for the same.
• In the absence of any mechanism to effectively deal with insolvency of a group of companies in most jurisdictions, pre-packs have proved to be very helpful.

Lighter on Courts: The courts usually have limited infrastructural capacity and can perform its obligations within its limits.

• A pre-pack has the potential to reduce litigation, due to its informal and consensual nature. It does not require involvement of the court during the informal part of the process and requires a minimum role of courts during formal process.
• It is necessary to have a functional out of court restructuring process, so that the vast majority of cases are restructured out of bankruptcy, with the NCLT acting as a court of last resort if no agreement is possible.

Drawbacks of Pre-Packs
Lack 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.
• This 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.

Insufficient Marketing: The research shows that where no marketing is carried out pre-packs return less money to creditors.

• No consideration is given to the future viability of the new company: The insolvency practitioner has no legal requirement to look at the future viability of the new business emerging from a pre-pack sale.
• His/her only legal responsibility is to the creditors of the old business.

Road Ahead

• Under the present regime of the IBC, insolvency professionals are still evolving the necessary expertise required over time. Like the law under the UK regime has evolved over time rather than simply promulgated, application of pre-pack insolvency in India will require a much higher degree of expertise of insolvency professionals, as under such resolution methods, they have a much higher degree of control.
• However, with the increase in the trend of out of court settlements, pre-pack insolvency could very well be the next alternative to regular CIRP proceedings.