Saving Financially Distressed Companies: Pre Packaged Insolvency

SAVING THE FINANCIALLY DISTRESSED COMPANIES IN INDIA: A NEED FOR PRE-PACKAGED INSOLVENCY?

by Pallavi Mishra

Introduction

During the COVID-19 crisis, there have been contemplations by the Union Government over the suspension of the application of provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”), which allow for the triggering of the insolvency proceedings, for a period of next six months to one year. While this announcement has come as a rescue call for the corporate borrowers, the creditors, lenders and guarantors will definitely have to find other solutions to reduce the stress of loan repayment. This quest for an alternative is also essential to reduce the backlog of cases and burden upon the Adjudicating Authority once the abeyance of the IBC is over.

An alternate as well as a complementary mechanism to the Corporate Insolvency Resolution Process (“CIRP”) is a Pre-Packaged Insolvency Resolution Process (“PPIRP”) which allows for a similar outcome while leading to the achievement in a much cost-effective, simplified and a shortened manner. A unique benefit of the PPIRP is that it allows for a pre-planned arrangement of assets with an objective of relieving stress upon the company much before the default has actually accrued. In fact, in some jurisdictions, the company is allowed to manage its operations throughout this process and even after the default has occurred.

In a broad area of corporate restructuring, PPIRP is a subset wherein the terms of this restructuring usually takes place prior to the filing of the insolvency procedure. The essence of a PPIRP is that it aims to protect the enterprise value of the business while safeguarding the interests of the creditors.The company in distress notifies its stakeholders and creditors about the proposal to negotiate framework for a resolution plan leading to an out-of-court settlement. The Insolvency Professional (“IP”) so appointed by the creditors then administers the pre-pack mechanism. At times, this process is also inclusive of a pre-arranged sale post the report of a registered valuer, leading to a successful satisfaction of claims of the creditors and a higher chance of them approving the resolution plan in the PPIRP. Once the plan is approved by voting of the creditors, it is filed before the Adjudicating Authority for its approval.

The need and viability for pre-packaged insolvency in India

The implementation of the IBC, though having shown positive results, has not particularly led to a smooth process for approval of the resolution plans. As of January 31, 2020, 3455 cases were admitted under the CIRP. Of these, only 265 could get a resolution plan approved, while 826 of them went into liquidation. An even shocking number to know is that close to 2000 cases are still pending. The rest of the applications were withdrawn and the corporate debtors eventually faced the pressure of restructuring at the whims of the creditors. In 2019, the World Bank had put India at 52nd position in resolving insolvency in the Ease of Doing Business rankings and overall 63rd position in the doing business report (2020). As far as recovery is concerned, India stands at 5%, compared to an average of 20% in the developed economies.

Within the corporate arena, liquidation poses a major threat to any company but unfortunately is the automatic result arising out of a failure of the CIRP. To combat this issue, the PPIRP provides an additional level of protection to the corporate debtors. It is proposed that the PPIRP be introduced in a manner wherein the creditors are mandated to initiate it first. Only upon its failure should they proceed for filing of the CIRP before the Adjudicating Authority. This will allow for a caveat to introduce important changes to the plan in case it fails to get adequate votes or approval by the Adjudicating Authority at the PPIRP stage. It will also stand as a safeguard against liquidation especially in the Micro, Small And Medium Enterprises (MSMEs) wherein there is an acute paucity of investors and liquidation in fact poses a major concern.Another incentive for the creditors to indulge in a PPIRP rather than the traditional CIRP is to avoid the usual media coverage, defamation and elongated harm which is caused to the reputation of the company in a CIRP.

A PPIRP is a viable option even through the eyes of company law as it gives a negotiating table for the formulation of lucrative proposals to the creditors and the corporate debtor. Most importantly, this out-of-court mechanism may be considered to be a “peaceful method of settling the dispute” as often the CIRP has proved to be a reason for deteriorating relations between the creditors and the corporate debtor.

Challenges to implementation of PPIRP in India

The increased role of the IP:A PPIRP would require an increment in the roles of the Insolvency Professional in terms of the discretion he would acquire in managing the plan as well as his advisory role and the role as an administrator. Previously, in Essar Steel, objections were raised upon the increased discretion given to the IPs. A suggested way out of this would be to receive assistance from a more qualified person such as a registered valuer who can simultaneously work with the IP in the formulation and approval of the PPIRP. Specific guidelines to govern their conduct may also be introduced in this regard.

Connected party Pre-packs and Role of Promoters: Essar Steel had widely discussed and deliberated on the issue of the promoters buying-back through bidding as a resolution applicant. This was seen as a promoters’ method of undermining the entire CIRP. Pursuant to this Insolvency and Bankruptcy Code was in fact amended to introduce Section 29A which effectively aims to prohibit such transactions by promoters.

It may be stated that Section 29A is an obstacle to implementation of PPIRP in India as mostly the corporate debtor would be in charge with minimal and merely administrative role played by the IP. Thus, Connected Party pre-packs which is an established concept in the UK may find it difficult to be implemented in India.

Unanswered questions on Specificities: For the implementation of PPIRP in India there are still a bunch of unanswered questions on the implementation, amendment of existing regulations, and introduction of new guidelines on the functioning of the Insolvency Professionals and so on. Some of the major issues which will require a consideration are as follows:

  1. Whether the immense discretionary power to approve the PPIRP plan should rest with the NCLT or should be delegated to a more specific authority?
  2. While PPIRP has been addressed, should provisions for pre-arranged salealso be introduced?
  3. What are the incentives to the Committee of Creditors to actively participate in the PPIRP instead of initiating CIRP as otherwise the entire PPIRP shall be rendered futile.
  4. What is the stance on the connected party pre-packs and the role of Promoters in PPIRP?
  5. Upon termination of the PPIRP, within how many days the creditor will have a right to initiate a CIRP?
  6. Whether the Debtor-In-Possession (DIP) concept should be followed while the PPIRP is in progress?
  7. What measures can be taken to ensure strict confidentiality of the PPIRP?
  8. How should the claims of unsecured/ operational creditors be treated?
  9. Whether moratorium under section 14 of the Code would trigger automatically on initiation of PPIRP?

Inspiration from other jurisdictions

In the UK as well as the US, the PPIRP can be initiated by the creditors as well as the debtor company itself. Upon filing of the insolvency, the insolvency practitioner (who may later be appointed as the administrator) advises and executes the pre-packs immediately after his appointment. In the UK, the conduct and role of the insolvency practitioner/administrator is guided by the Statements of Insolvency Practice 16 (“SIP 16”) standard. In contrast to this, the US Bankruptcy Code particularly provides for a “Debtor-in-Possession” concept which permits the company to be an active participant throughout the restructuring under the PPRIP. Additionally a “US Trustee” works merely as an amicus in the entire process. With regard to the sale of assets and connected pre-packs, the SIP 16 provides for a “pre-pack pool” consisting of business professionals who review the decisions of the company for the asset sale and ensure that the interests of all the stakeholders have been addressed. A moratorium may only be imposed after the approval by the Adjudicating Authority.

Conclusion

Considering that our IBC heavily borrows from the foreign jurisdictions of pre-dominantly the UK and the USA, it is definitely a consideration for the government to incorporate a PPIRP into the code. In fact, it had also invited the comments of the stakeholders in this regard. Introduction of PPIRP is the need of the hour in the COVID-19 situation wherein the traditional CIRP process has been put on hold. The formal framework is yet to be notified by the Insolvency and Bankruptcy Board of India.

Views are personal.

Image credits: Business Law Today

ABOUT THE AUTHOR

Pallavi Mishra pursuing law from Hidayatullah National Law University, Raipur.

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