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Explained: What are pre-packs under the present insolvency regime?

In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached.

Written by Karunjit Singh , Edited by Explained Desk | New Delhi |
July 28, 2020 11:31:37 am
Insolvency and Bankruptcy Code, Insolvency and Bankruptcy Code pre-pack, IBC pre-packs, agreement to resolve insolvency, Indian Express The proposed pre-packaged resolution would likely be subject to approval by the NCLT. (Getty Image/File)

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), while maintaining business continuity and thereby preserving asset value and jobs.

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 with 738 of 2,170 ongoing insolvency resolution processes having already taken more than 270 days at the end of March. Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

What is a pre-pack?

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). This process would likely be completed much faster than the traditional CIRP which requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company.

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“The process needs to be completed within 90 days so that all stakeholders retain faith in the system,” said Dinkar Venkatasubramanian, partner and national leader, restructuring and turnaround services, EY adding that cases that take more than this time should be taken through the normal CIRP.

Venkatasubramanian also said that pre-pack would act as an important alternative resolution mechanism to the CIRP and would help lower the burden on the NCLTs.

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What are the other key benefits of a pre-pack?

In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached. Venkatasubramanian noted that 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.

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What are some of the drawbacks of pre-pack?

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. Experts said 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.

“There may be questions of whether secured lenders have been fair to other creditors,” said Manoj Kumar, partner at law firm corporate professionals while also noting that bankers themselves may hesitate to restructure liabilities outside of an open bidding process for fear of their decisions leading to investigations by agencies.

Kumar also noted that 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.

What mechanisms would protect unsecured operational creditors like suppliers of goods and services?

The proposed pre-packaged resolution would likely be subject to approval by the NCLT. Notably, 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.

Venkatasubramanian noted that as pre-packs would mostly be used for businesses that are running, the investors would likely need to maintain good relations with operational creditors.

“You can’t run a business without operational creditors. If you have to continue to buy from raw material providers and service providers, you have to give them a fair deal,” said Venkatasubramanian noting that operational creditors tend to get worse recoveries in cases where the company is no longer operational.

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