UNDERSTANDING PREPACK RESOLUTION

Since then, the IBC has moved on and benefited with the help of the rich source of knowledge as provided by jurisprudence. After all, it was time for Government to take steps that would further improve the ease of doing business. Especially with the impact of the pandemic, there is every possibility that businesses will suffer from greater stress due to external reasons beyond their control. This could also put many businesses into greater trouble, making them go through the stress of insolvency through the Courts.

The IMF, through its ‘Special Series on Covid’, identifies three potential phases of the crisis, viz., a first phase where there is a need for interim measures to halt insolvency and debt enforcement activity; a second phase, in cases of severe crisis, where transitional measures may be required to respond to the wave of insolvency cases, including special out-of-court restructuring mechanisms; and a third phase in which countries strengthen their regular debt resolution tools to address the remaining debt overhang and support economic growth.

While the harsh truth of such turmoil is flailing and failing businesses, the pressing need is to allow genuine businesses to sustain themselves and provide options for them to recoup and bounce back. Legislative options may create a lucrative, conducive environment to rescue those affected in these challenging times. ‘Prepack’ emerges in the midst of all this as a decoction which combines the formal and informal option to lessen the burden. Addressing this necessity, the Ministry of Corporate Affairs constituted a sub-committee on 24th June, 2020 to propose a detailed scheme for implementation of prepacked and prearranged resolution processes.

As of today a company in stress in India has four options: the Compromise and Arrangement scheme under the Companies Act, 2013; the Corporate Insolvency Resolution Process (CIRP) under the IBC; RBI’s prudential framework for early recognition, reporting and time-bound resolution of stressed assets; and fourth, the out-of-court settlement framework. The then Finance and Corporate Affairs Minister, the Late Mr. Arun Jaitley, once said, ‘I think today may not be the right time to go in for this discussion (informal option) because of the huge rush of companies coming to the insolvency process, but once this rush is over over the next couple of years, and business comes back to usual, honest creditor-debtor relationship is restored on account of IBC, a situation may arise when we may then have to consider a need to marry the two processes together so they may well exist simultaneously’. Thus, the necessity to introduce an ecosystem of informal options was foreseen at the time of legislation of the IBC and prepack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings1.

GETTING TO KNOW ABOUT PREPACK
Prepack is a process to conclude in advance an agreement by a company which is stressed before moving for statutory administration of the same. This provides it an opportunity to continue its business as a going concern and enables the promoter to rationally decide the options, and to save the time and money cost, along with erosion of goodwill, had this been routed through the CIRP channel.

The United Nations Commission on International Trade Law (UNCITRAL) in its ‘Legislative Guide on Insolvency’ uses the word ‘Expedited reorganisation proceedings’ and Paragraph 76 defines prepack as ‘to involve all creditors of the debtor and a reorganisation plan formulated and approved by creditors and other parties in interest after commencement of the proceedings. Reorganisation may also include, however, proceedings commenced to give effect to a plan negotiated and agreed by affected creditors in voluntary restructuring negotiations that take place prior to commencement, where the insolvency law permits the court to expedite the conduct of those proceedings’.

The USA was the first to introduce prepack in the Bankruptcy Reform Act of 1978. It soon gained momentum with more than 20% of the bankruptcies going through prepack2.The plan ‘is negotiated, circulated to creditors and voted on before the case is filed’3.

With a slight variation, the United Kingdom requires an administrator to conclude the sale. The Insolvency Practitioners Association issued a Statement of Insolvency Practice which defines prepack sale 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, appointment.’

In Singapore, the Insolvency, Restructuring, and Dissolution (Amendment) Bill, 2020 proposes to introduce a new prepack scheme for micro and small companies in the Covid-19 environment. An automatic moratorium would come into play when a company is accepted into the scheme. There would be no requirement to convene a meeting of the company’s creditors. Instead, the Court can approve the scheme, provided that the company can satisfy it that if a meeting had been called a majority representing at least two-thirds in value of the creditors would have approved the proposed scheme.

BENEFITS OF PREPACK
Faster resolution and cost effective: The greatest advantage of prepack lies in early disposal of the case. A majority of the terms are negotiated at the stage before the same are administered by the courts, which allows sufficient time for the debtor to fructify the negotiations. The time taken in courts reduces substantially, together with an increase in the possibility of a resolution. This eventually reduces the cost of administrator / Insolvent Professional (IP) consultant. On the other hand, increase in the time involved in the process of resolution would mean that the CD may have to sustain the stress until the resolution, which in turn reduces the value of the business and also the overall chances of resolution. After introduction of the IBC, the time for resolving insolvency also came down significantly from 4.3 years to 1.6 years. Now, prepack intends to bring it down even further. In countries which are in advanced stages of implementation of the insolvency law, such as the UK and the USA, the time of resolution in prepack can be as low as a few hours!

Goodwill retention and value maximisation: The threat to any business during the resolution process is the disruption that it causes on its normal business, which eventually threatens and hampers its goodwill. Even the Act tries to resolve this concern by introducing a moratorium on admission of CIRP, but the concern is that of loss of goodwill which would otherwise impact the right resolution options. Prepack as an option would enable the CD to safeguard the goodwill which otherwise would be impacted in the formal process.

Increases the possibility of resolution: Once a debtor opts for CIRP, he loses control of the decision-making process which goes to the creditors. It is believed that the defaulting debtor must not be in control of the decision-making process, but then this reduces the possibility of resolution and leads to liquidation. The incidental option for a defaulting debtor in CIRP is that of liquidation, but the statistics reveal that debtors that stay long at CIRP are more prone to end in liquidation. Liquidation is a consequence of failed resolution and a non-desirable situation for the debtor, the creditors, the employees, etc. With prepack invoking informal methods, the chances of resolution increase with intent to move with commercial wisdom, which the debtor can assist and resolve.

Less reliance on courts: The report of the sub-committee of the Insolvency Law Committee on prepacked Insolvency Resolution process mentions withdrawal of applications filed for initiation of CIRP in respect of 14,510 Corporate Debtors at pre-admission stage, closure of CIRPs of 218 CDs u/s 12A of the Code, 27 terminations of CIRPs by the Adjudicating Authority (AA), closure of CIRPs on taking note of settlement recorded by the mediator, and even settlements at the level of the Apex Court. The volume of cases is testimony to the success of out-of-court settlements which if nurtured and guided can enable courts to decide and resolve.

CONCERNS IN PREPACK
Transparency: In the existing CIRP, section 29A of the IBC, 2016 imbibes the importance of transparency and concern of involvement of the related party in the process. Over the concerns of serial prepacking or phoenix companies hangs the fear of failure of prepack. This may also necessitate the Government to work the whole process in a controlled environment to ensure that any unscrupulous elements do not fail the process.

Defaulting debtor in decision-making: The process of CIRP shifts the decision-making power from the CD to professionals who are independent and work for the common commercial good of all. This ensures that the CD is not in control of but only a part of the decision-making process. The RP and the COC decide the course of action which is further supervised by the Courts. Prepack in contract empowers the defaulting corporate to decide on the course of resolution, whereas administrator / RP / IP have a limited role in the resolution process, that of overseeing and approval. This ensures that the CD does not hijack the resolution in his favour if left unchecked.

Framework on prepackaged Insolvency Resolution Process as suggested by the sub-committee
Different jurisdictions have legislated prepack under insolvency with various options; but it is necessary to make a law which is country-specific because one size may not fit all. The three principles that the sub-committee suggested to guide the design of the prepack framework are,
(i)    the basic structure of the Code should be retained;
(ii)  there should be no compromise of the rights of any party; and
(iii) the framework should have adequate checks and balances to prevent any abuse.

The report mentions the following as the main features of prepack:

•  Prepack as an option must be part of the same law which governs IBC and also part of the same legislation.

•  Prepack as an option must be available to all CDs for any stress, pre-default and post-default.

•  The CD shall initiate prepack with consent of simple majority of (a) unrelated FCs and (b) its shareholders. No two proceedings – prepack and CIRP – shall run in parallel.

•  Promoters and management of the CD to be in control of the decision-making process, except for decisions on matters enumerated u/s 28 of the Code, including interim finance, which shall be taken by the CD with the approval of the CoC.

•  List of documents and reports like outstanding claims, including contingent and future claims, and a draft Information Memorandum, etc., shall be prepared by the CD and certified by the MD.

•  The moratorium u/s 14 shall be available from the Prepack Commencement Date (PCD) till closure or termination of the process.

•  IP shall be appointed by unrelated FC’s who shall not run the business like in CIRP but only administer / conduct the process of prepack.

•  Similar to CIRP, RP shall make public announcements but on electronic platform, he shall verify the claim, constitute CoC (Committee of Creditors), get valuation report, conduct due diligence, make application to AA (Adjudication Authority) in case of avoidance transaction, etc.

•  As in CIRP, the CoC shall take decisions with regard to approval by majority of votes except that of liquidation which requires 75% vote.

• ? Section 29A related to persons not eligible to be resolution applicants to remain sacrosanct even in the prepack process.

•  Prepack to have the Swiss challenge method to counter the first offer to ensure better proposals. Two-option approach: (i) without Swiss challenge but no impairment to Operational Creditors (OCs), and (ii) with Swiss challenge with rights of OCs and dissenting FCs subject to minimum provided u/s 30(2)(b). Prepack should allow 90 days for market participants to submit the resolution plan to the AA and 30 days thereafter for the AA to approve or reject it.

BRIEF ABOUT THE PREPACK INSOLVENCY RESOLUTION PROCESS (PIRP) PASSED BY ORDINANCE DATED 4TH APRIL, 2021

•  An application for initiating a PIRP may be made in respect of a CD classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.

•  Restrictions have been placed on the CDs who have recently concluded CIRP / PIRP within three years or are undergoing CIRP, or those against whom liquidation order is passed u/s 33.

•  An FC, not being a related party of more than 66% in value, has to propose an IP to be appointed as the Resolution Professional (RP). The CD shall also obtain approval for filing the PIRP from its FC not being its related parties representing not less than 66% in value of the financial debt due to such creditors.

•  The majority of directors / partners have to declare that the CD shall file an application for PIRP within the timeframe not exceeding 90 days along with other declarations as required u/s 54A(2)(f).

•   The special resolution in case of companies should have three-fourths of the total number of partners approving for filing the PIRP.

•  The IP to be appointed as RP in PIRP is duty-bound to confirm whether the CD confirms the eligibility requirement for application under PIRP.

•  Fees paid to the IP to perform his duties shall form part of the PIRP costs.

•  The AA shall, within a period of 14 days of the receipt of the application under PIRP, either accept or reject it after providing seven days’ time to rectify the defects, if any.

•  The PIRP shall commence from the date of admission of the application by the AA. The PIRP shall be completed within 120 days from its commencement and the RP shall submit the resolution plan within 90 days from the prepackaged insolvency commencement date. If the resolution plan is not approved by the CoC within the stipulated time, then the RP shall file for termination of the PIRP.

•  Moratorium as provided in sub-section (1) read with sub-section (3) of section 14 shall be applicable and shall cease to exist upon termination of PIRP.

•  CD shall submit within two days of commencement of PIRP a list of claims and preliminary information memorandum relevant to formulate the Resolution Plan.

•  Unlike in CIRP, the management of affairs shall vest with the Board of Directors. However, the management may be handed over to the RP if the Committee by a vote of not less than 66% of the voting share in value decides to do so, or the AA is of the opinion that the affairs had been conducted in a fraudulent manner or there has been gross mismanagement.

•  The CoC shall be constituted within seven days of the prepackaged insolvency commencement date and its first meeting shall be held within seven days of its constitution.

•  The CD shall submit the base resolution plan, referred to in clause (c) of sub-section (4) of section 54A, to the RP within two days of the prepackaged insolvency commencement date and the RP shall present it to the CoC.

•  The CoC may approve the base resolution plan for submission to the AA if it does not impair any claims owed by the CD to the operational creditors.

•  The RP shall invite prospective resolution applicants to submit a resolution plan or plans, to compete with the base resolution plan, in such manner as may be specified.

•  Sub-section (2) section 14, sub-section 2A of 14, section 14(3(c), section 17, section 19(3), section 18 clause g to e, section 19(2), section 21, section 25(1), clauses (a) to (c) and clause (k) of sub-section (2) of section 25, section 28, section 29, sub-sections (1), (2) and (5) of section 30, sub-sections (1), (3) and (4) of section 31, sections 24, 25A, 26, 27, 28, 29A, 32A, 43 to 51, provisions of Chapters VI and VII of Part II have been applied mutatis mutandis to the PIRP.

•  If the AA is satisfied that the resolution plan as approved by the CoC under sub-section (4) or sub-section (12) of section 54K, as the case may be, subject to the conditions provided therein, meets the requirements as referred to in sub-section (2) of section 30, it shall, within 30 days of the receipt of such resolution plan, by order approve the resolution plan.

Prepack is a great way if India can take a leaf out of the book of countries which have legislated, administered and have learnt from experience. It may also be necessary to implement the law in a controlled environment but with the caution of not excessively restricting the eco-system which the law would promulgate. This law would stretch to the fullest strength when it is allowed to resolve the stress, provided that it is allowed to be experimented with within the framework, with little interference from courts. Excess legislation and restrictions may dilute the intent of faster resolution; this requires that those involved in the process of prepack are sensitive to the consensus-building mechanism of debtors and creditors. This also means that creditor-debtor must also act maturely during this process as they must realise that the success of this process depends on its negotiation and approval of the same. On the point of restriction, such as the one in section 29A, views are divided on transparency and genuine related-party buyer.

References
1 Bo Xie (2016), Comparative Insolvency Law: The Prepack Approach in Corporate Rescue, Edward Elgar Publishing
2 Vanessa Finch, Corporate Insolvency Law Perspectives and Principles (2nd ed., Cambridge University Press, 2009) 454
3 John D. Ayer et al, ‘Out-of-court Workouts Prepacks and Pre-arranged Cases, a Primer’, (April, 2005), ABI Journal <https://www.abi.org/abijournal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer> [2] (2020) 8 Supreme Court Cases 531