by Swapnil singh, a student of fifth year at rmlnlu, lucknow
Implementation of Insolvency and Bankruptcy Code, 2016 (“IBC”) has shown favorable outcome with India’s rank improving from 136 to 108 in 2018 to 52 in 2019 in the ‘Resolving Insolvency’ bracket of the Ease of Doing Business ranking, released by World Bank. IBC has exponentially reduced the time taken for an insolvency resolution. However, in the current crisis and lockdown, the resolution process will undoubtedly suffer an inexorable delay.
The Central Government’s decision to suspend any fresh filing under Section 7, 9 and 10 for next six months which may be extended up to a year is seen as step in the positive direction but the fact that instead of solving a lot of issues, it is putting them on a back burner which will ultimately lead to a greater number of cases and increased burden on the Tribunal.
Considering this and the persistent resolution delay in cases under IBC by NCLT, without any alternative mechanism for resolution of distress could lead to rapid depletion in asset value and huge losses for a number of stakeholders. Pre-packs are seen as a desirable solution to be incorporated to solve this issue and there are certain issues which will pose a challenge to smooth implementation of pre-packs within the existing regulatory system.
The concept of pre-packaged insolvency
Pre-packaged insolvency, often referred to as “pre-pack sale”, has been defined by the Association of Business Recovery Professionals (a trade association for 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”. It is different from traditional bankruptcy because in a case of a pre-pack the restructuring takes place prior to filing of application before the adjudicating authority.
With the suspension of IBC, it becomes pertinent that alternative solutions to address the stress in the system be explored and pre-packs are a promising option due to its strongly built around the tenets of value preservation and timely resolution, which form the lifeblood of any insolvency law. In the Indian scenario, if introduced, it will be a subset of the existing pre-insolvency resolution instruments therewith providing financial creditors and corporate debtor a platform to negotiate in advance on the resolution strategy of the corporate debtor with the advice of an Insolvency Professional, before the filing application under IBC.
The possibility of pre-packs to be introduced under IBC has always been a topic of debate in the Bankruptcy Law Reforms Committee (BLRC) and it was advanced that Indian market is not developed enough to go for pre-packs. However, NCLT has time and again recognised that the corporate insolvency resolution proceeding(“CIRP“) is broad enough to include a discussion and negotiation done beforehand, about the resolution plan. In the case of Essar Steel Ltd an objection was raised on the that application for commencement of CIRP pointing out that admitted Essar was already negotiating with its lenders. NCLT rejected the objection stating that these negotiations can later become basis of resolution plan under IBC. It is pertinent to note that in Lokhandwala Kataria Construction Pvt. Ltd. v. Nisus Finance and Investment Managers LLP, the Supreme Court used its power under Article 142 of the Constitution to accept the out of court settlement for the benefit of all the stakeholders and for meeting the ends of justice.
India has taken some steps in the direction of outside restructuring when Reserve Bank of India introduced Bank-led Resolutions through Prudential Framework for Resolution of Stressed Assets wherein a bank can try resolution before formally filing for insolvency but it only covers RBI-regulated creditors. The Ministry of Corporate Affairs has also invited comments from stakeholders regarding the introduction of pre-packs in India.
Challenges in India
Introduction of pre-packs in India will require developing a robust jurisprudence to address the number of challenges that will arise thereafter. To safeguard and protect interest of each stakeholder while maintaining transparency, following challenges will have to be worked upon:
Role of Insolvency Resolution Professional and Shield of Moratorium
Currently under IBC, Interim Resolution Professional (“IRP”) is appointed as soon as the application is admitted and is given the responsibility to manage the business of the debtor during the whole CIRP process. However, during a pre-pack process, the role of IPR will be performed by the debtor as he would ensure that interests of all stakeholders are taken into consideration similar to the ‘Debtor-in-Possession’ concept in US. There have been a lot of objections regarding debtor managing the whole process without any interference from NCLT.
A shield of moratorium helps the debtor once proceeding is started under Section 7 and Section 9 of IBC. In absence such an automatic stay on the legal proceedings for pre-pack under IBC, nothing would stop the creditors from approaching the tribunal at any stage of the negotiations. This will put the company in a vulnerable position as the creditors can enforce their rights and remedies anytime while the corporate debtor is negotiating a pre-pack resolution.
Involvement of Promoters
One of the reasons for the directors of a corporate debtor to undertake a pre-pack is to regain control of its business or assets, however, under a different identity. It is arguable that this roundabout manner of regaining control of the debtor company can result in circumvention of the insolvency laws. This concept is very popular as ‘phoenixing’ in the UK. This can raise a problem in cases where the company is facing huge losses primarily due to promoter or managerial inefficiency.
Pre-packaged insolvency is a debtor-initiated process by a go-ahead company in distress which is willing to negotiate with its lenders, before the initiation of a formal CIRP under Section 7 or 9 of the Code. Hence, Section 29A of the Code will not be applicable as it to the pre-packaged insolvency process. Therefore, taking into consideration the aforementioned premises, it may be inferred that if a provision similar to Section 29A is made applicable to the entities willing to go for pre-packaged insolvency, it may tend to defeat the very objective of such a scheme as it would act as a barrier in a pre-pack process where the debtor is mainly in charge of management and negotiations.
Lack of Cooperation and Sale of Assets
Pre-packs are supposed to work on a degree of cooperation from side of both the corporate debtor and the creditors. The management of the debtor having the control of the process, if doesn’t share all the information with the creditors or if creditors are unable to come together due to their varied interest, it will be difficult to come to a conclusion.
Further, sale of assets by debtor to another company before filing insolvency application can be one of the tools of pre-pack restructuring. The earning from these sales goes to the creditors, this helps in keeping the company afloat without any hassle arising due to dilution of assets’ value or loss of clientele. Sometimes due to contractual terms, creditors possess the right to give consent before debtor can dispose-off any asset. If the creditors become apprehensive, either in the divestment or because of the fact that the debtor is facing bankruptcy, it will jeopardise the whole process. Moreover, unsecured creditors will be left outside the picture, having absolutely no say in the matter as they wouldn’t have any contractual right.
Lack of transparency and the plight of Operational Creditor/ Unsecured Creditors
Pre-pack processes are usually confidential and do not involve open bidding process. These arrangements are usually agreed by the management of the corporate debtor and, therefore, there may be a possibility that the interests of the management and the secured creditors will be placed at a higher pedestal than that of the unsecured creditors/operational creditors. The independent Graham Review Report into Prepack Administration of June 2014 noted that the “lack of transparency disenfranchises creditors, especially unsecured creditors particularly where the purchase is being made by a connected party.”
The potential harm of lack of transparency also comes into picture if undervalued transactions are involved. The wealth maximisation model focuses on the idea that creditors would prefer a system that keeps the size of the pool of assets as large as possible. This raises real doubts about the objective of wealth maximisation owing to the lack of transparency and open marketing of the business. There may also be instances where the business of the corporate debtor may be transferred to entities without keeping in mind the interests of the creditors or other stakeholders.
Such a transaction would not carry the seal of approval of a court (unless the same is undertaken as a court approved scheme such as a scheme of arrangement under the Companies Act, 2013) and would, therefore, to that extent, be open to challenge by creditors if they were to object to such a transaction and require clawback, which is a safeguard provided to creditors under the Code. IBC provides for a claw-back in cases where any transactions are found to be preferential, undervalued, extortionate or undertaken to defraud creditors. An avoidance application is filed before the NCLT for appropriate relief, including for the transaction to be set aside.
With the suspension of any fresh filing under IBC, it is time to strengthen the outside restructuring process in India. This will make sure that instead of piling up of cases, there will actually be timely resolution of any insolvencies and bankruptcies. Pre-packs will have far reaching impact on corporate rescue in India but it has to be done with correct implementation, keeping in mind the Indian market and stakeholders. It is pertinent to note that this model has been there in the UK and the US for quite some time, for this reason there needs to be an in-depth study of both the jurisdictions to see what lessons can we learn from them.
The system does come with its own challenges but if implemented well, it will help in smoothening the resolution plans while promoting the idea of keeping company as a going concern. This will help in retention of jobs and repayment of dues to the creditors. With the current ongoing crisis, it is safe to assume that it will have far more benefits and yield more fruitful outcomes.