Renewing the debate on Pre-Packaged Insolvency in India: A case for ‘Atmanirbhar’ financially distressed companies

The COVID-19 pandemic and the subsequent national lockdown has affected the Indian economy adversely, causing financial hardships to several businesses across the country, especially to those who were already under distress.

In the wake of the prevalent situation and to prevent mass insolvency proceedings, the President promulgated an Ordinance to the effect that no Application under Sections 7, 9 or 10 of the Insolvency and Bankruptcy Code can be filed for a period of 6 months (if extended up to 1 year) for any default occurring after March 25.

While the reform received mix response from various stakeholders, it is an opportune time to revisit the IBC process and the pending reforms. These reforms could explore some alternative solutions to the conventional corporate insolvency resolution process (CIRP) for resolution of distress rather than complete suspension of the initiation of IBC proceedings. Otherwise, it could end up causing huge losses for a number of stakeholders due to depletion of assets.

Taking note of the existing situation, it is the right time to revitalize the debate over the introduction of pre-packaged insolvency (pre-packs) and codifying the same into the scheme of the IBC. While India might have still not recognised pre-packs in its legal framework, the discussion on the subject is not new. In the past, the Ministry of Corporate Affairs (MCA) in 2019 had invited comments on pre-packs from all stakeholders. The Bankruptcy Law Reforms Committee had also deliberated on the introduction of pre-packs as part of the Code. But till date, it has still not been given any formal recognition.

Before we plunge into an analysis of the pre-packs and their viability in the Indian legal framework, it's worthwhile to have an understanding of pre-packs and the surrounding jurisprudence.

What are pre-packs?

It is a mechanism encouraging concerned stakeholders in the restructuring process to mutually negotiate the terms of restructuring, generally prior to the commencement of insolvency proceedings. While the parties can agree for a mutually cognizant resolution plan, it is expected that the formal recognition to the said plan would be given by the court.

Contrary to the popular perception, it is essentially not a complete out-of-court settlement between the parties involved, and the interference of courts/tribunals would be required for final implementation of the pre-packs. Therefore, it can be said that it will be a hybrid process involving out-of-court settlement along with mutual settlement of the terms of restructuring between the debtors and the creditors. The court’s oversight is also necessary to ensure that no prejudice is caused to any stakeholders due to the terms of the restructuring arrived at and that everyone is treated fairly.

This might be a novel mechanism for restructuring in India, but it is already prevalent across many jurisdictions like US, UK, France and Germany. Pertinently, the practice of pre-packs was first introduced in the US, following the enactment of the Bankruptcy Reform Act of 1978 which expressly allowed for pre-packs. In fact, pre-packaged proceedings have been considered more effective than both, the formal reorganisation proceedings under Chapter 11 of the US Bankruptcy Code and pure out-of-court restructurings.

While the practical aspect of the pre-packs differs across these jurisdictions, the major implementation remains the same coming out as a popular method of corporate rescue.

Pre-packs proposition in India

In India, the average time taken for completion of the process for resolution crosses the stipulated timelines under the IBC Code, 2016. Due to this, the government has been contemplating introducing pre-packs as an alternative to help in reducing these timelines significantly.

Apart from reducing the timelines, it will also be a welcome relief for the adjudicating authorities who are already overburdened with a large number of pending cases of such nature. Thus, it will not only promote cost and time efficiency by cutting litigation cost and less filings, it will also help in de-clogging the whole overburdened NCLT ecosystem.

In the wake of COVID-19 pandemic, considering the fact that banks are already under pressure and facing distress, the current blanket ban on fresh insolvency proceedings under Sections 7, 9 and 10 might not be a good step as it might lead to way of creating unscrupulous borrowers and will consequently increase more stressed debt levels at banks.

Given the above background, it might be the right time for the government to formally introduce pre-packs with a proper mechanism in place. This could achieve the dual objective of promoting debt enforcement and restructuring and mitigating the impact of COVID-19 on financially distressed businesses. Also, this process might be agreeable to both the debtors and the creditors.

It may be relevant to consider the model India adopts. Would India adopt the US Bankruptcy Code which explicitly prescribes for three different types of pre-packs i.e. pre-packaged bankruptcy proceedings, pre-arranged bankruptcy proceedings and pre-plan sales? Or should India incorporate its own set of independent framework for pre-packs?

To pre-pack or not to pre-pack

Just like any other course of action or new reforms, pre-pack has its own share of advantages and disadvantages. Apart from being less time-consuming and cost effective than the formal CIRP process, pre-packs also give much required flexibility to debtors and creditors to formulate the terms of restructuring and help them in exercising greater control over the process.

The most coveted benefit of pre-pack is that it promotes confidentiality during the whole negotiation process, thereby avoiding adverse publicity of the company, which will eventually mitigate the risk of image deterioration of the company.

Formal insolvency proceedings often lead to layoffs in the company due to reduced operation of the business and poaching of employees by competitors of the debtor company. A pre-pack mechanism can help in reducing these risks and provide job security for employees since the outcome of a pre-pack is rescuing the business of the company rather than the company itself, thereby enhancing debt collection of the company.

Apart from the various benefits it offers, it also associates itself with some risk and challenges, which is important to be highlighted for a fair analysis. The major demerit of the pre-packs is connected to one of its advantages i.e. confidentiality, which makes the process less transparent. It could lead to a situation where the debtor could use the process to his advantage wherein he ends up giving information of the mutual negotiation to only few of the financial creditors and agreeing to a resolution plan only with them. Thus the interests of other stakeholders would be negated and genuine restructuring would not be possible.

Implementation and future of pre-packs

Considering the fact that India does not have any prior regulatory experience with respect to pre-packs and there exists no legal framework for the same, the introduction of pre-packs in India would essentially require some serious contemplation and due diligence.

Introduction of such a mechanism for big corporates might be a risky option if not implemented well without knowing its effects. Therefore, India can consider a phase-wise introduction of pre-packs. Upon getting favourable and successful outcomes in the first phase, based on the regular analysis of the process, the mechanism can be further expanded to other sectors.

Given the fact that this would be a new reform that comes with its own sets of challenges and risks, it is suggested that in the first phase, the pre-packs are introduced in the Micro, Small and Medium Enterprises (MSMEs) sector, given the fact they have less number of financial creditors.

Conclusion

Whether the government introduces pre-packs or not, only time will tell. But in the above backdrop, it can be certainly said that during such unprecedented times, the introduction of pre-packs becomes more imperative in order to strike a balance between objectives of government and the corporates.

As it was rightly pointed out here, this is a season of Atmanirbharta (self-reliance). Therefore, pre-pack is one of the steps that will reduce the dependency of the financially distressed companies on the adjudicating authorities and help them in becoming financially self-reliant by following a self-regulated method rather than conventional court bound proceedings.

The author is an alumnus of Institute of Law, Nirma University. He currently practices law before the Supreme Court of India, Delhi High Court, and various forums across Delhi.