Pre-Pack: Need of the Hour for Effective IBC


By CA Archit Gupta & Adv. Ajit Godara

Insolvency and Bankruptcy Code, 2016 (“IBC”) brought in a robust insolvency regime in India which is novice for the corporates. Lawmakers are actively bringing changes in law as per the need of the industries and economy, which is evident from the fact that IBC has been amended thrice[1]. Such changes, inter-alia, include the introduction of Section 29A to debar promoters and their relatives from participation in submission of resolution plan, inclusion of homebuyers within the definition of Financial Creditors, etc. IBC is an umbrella approach, which is not suited for asset light industries, as it is time-consuming and in most cases, it ends in destruction of wealth, instead of creation of wealth.

In his judgment on the landmark Swiss Ribbons case[2], Justice RF Nariman states “To stay experimentation in things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences to the nation.” Prepacks are an experiment worth considering facilitating swift and effective resolutions.

Pre-packed Insolvency refers to a special kind of bankruptcy procedure, wherein in an informal arrangement is entered between the corporate debtors and creditors as an alternative to initiate the insolvency proceeding. Many matured economies and markets like the USA (Chapter 11 of US Bankruptcy Code)and UK (since 2002) have the special provision of pre-packs as part of their respective insolvency regime. Even smaller economies like Croatia[3] and Other Eastern European countries prefer pre-packs over other procedures of insolvency.

On 10 August 2018, it was announced that Mike Ashley’s Sports Direct had bought House of Fraser, the 169-Year-Old Realtor of the United Kingdom out of administration for £90 million, hours after the store had announced its collapse and this was possible only because the deal was administered through the mechanism of pre-pack. The Prepacks have helped the management of the House of Fraser to preserve the value of the business that it has created in a period of 169 Years, without making a fuss in the market.

Prepacks are more sophisticated methods of dealing with insolvency as it allows the creditors as well as the company to enter a pre-negotiated plan to take timely action. Mechanism-based on US pre-pack model can be followed in India, under which Insolvency professional files the plan in the NCLT along with the statutory disclosures required under the law. IP should submit the claims collated and all other details of the process conducted until the filling date. NCLT, if satisfied with the process followed, should admit the Insolvency and appoint IP as IRP within 14 Days of filling. RP should invite the claims and form committee of creditors (CoC), as prescribed currently in IBC[4]. The pre-pack resolution plan should be put to vote in CoC if such plan is approved then such approval should be filled with NCLT. In case such plan is not approved, then creditors should continue with normal CIRP. If NCLT is satisfied with the process followed, should approve the plan within 14 days of filling.

Prepacks help in the effective use of resources and allow the management to streamline their capital structure and other business issues, including retention of its suppliers, customers, and employees. For those companies, whose capital structure is flawed and not the business model, a pre-pack is always a preferable option. This is evident from the latest pre-packed plan of reorganization filled by SunGard Availability Services Capital Inc[5] in the United States of America, wherein their plan got approved in a record time of nineteen (19) hours. Prepacks will provide benefits that include lower costs, faster approval, and implementation of a restructuring plan, protection for satisfaction and retention of employees, maximization of return to creditors, maximize value realized in sale, minimize risks associated with trading and preservation of value. Especially with keeping in view in relation to MSMEs, who are facing high CIRP Cost in relation to advantage attended from the said resolution, Pre-Pack can provide cheaper solution.

However, this kind of system is not new to Indian markets. There have been such schemes in the past as well, which include the Corporate Debt Restructuring Cell[6], informal restructuring arrangements between the borrower and lender, and but, these schemes were not very successful due to various reasons including lack of legal binding nature of such arrangements on the borrower as well as lenders. Such arrangements have also been used by the promoters and managements to defraud the lenders and to delay the insolvency proceedings.

Along with the said advantages, there are many issues that the countries which have implemented the said regime has faced. Such issues include matter related to cross class clamp down, valuable assets being sold before going for pre-packs etc.

However, pre-packs can give a new lease of life to such arrangements. If pre-packs can be introduced under the ambit and scope of the IBC and such scheme and arrangement will be approved under the supervision of the court-appointed expert by following considerably shorter Corporate Insolvency Resolution Process, with legal binding on both the parties, then such arrangement can result in a greater good for all the stakeholders.

A pre-pack is essentially a scheme between a corporate debtor and its financial lenders, which will require the expertise of various professionals, including those in negotiation and mediation, business valuation, Mergers and Amalgamations (M&A) and financial market advisory services. The regulations governing such pre-packs shall take into consideration the role of such professionals and a possible collision between a corporate debtor and its lender and shall provide for valuation standards and procedures.

For effective implementation of Pre-Packs, the intention of promoters matters the most as pre-packs follow debtor-in-possession models, and such model under the Sick Industrial Companies (Special Provisions) Act, 1985 (“SICA”) have miserably failed in the past. Therefore, before entering into such arrangements, creditors should be allowed to make reasonable due diligence regarding the will and intention of the management. At the time of pre-packs, if the creditors determine that the stress was due to bad business decisions or market factors and existing financial distress, then pre-packs may be preferred, however, if it was due to wrongful intentions of the management then pre-packs should be avoided and CIRP proceeding should be initiated under the IBC. A robust multilevel safeguard mechanism needs to be put, to ensure that such pre-packs are not used by the debtors as a mechanism to delay formal insolvency proceedings.

In our opinion, with many advantages of better financial value and timely action, pre-pack insolvency as a part of IBC can be implemented, with certain cautions and in an intended manner based on previous experiences.

[1] Insolvency & Bankruptcy Code, 2016 has been amended vide notifications in official gazette dated 19th January 2018, August 17,2018 and August 6th 2019
[2] Page No 148 in Decision by Supreme Court in matter of Swiss Ribbons Pvt. Ltd. & Anr. Versus Union of India & Ors Writ Petition (Civil) No 29 of 2018 pronounced on Jan 25,2019
[3] Croatian Financial Operations and Prebankruptcy Settlement Act which came into force on 1st October 2012.
[4] Committee of Creditors is constituted under Section 21 of the IBC, 2016 read along with Insolvency and Bankruptcy board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016
[5] Sungard Availability Services Successfully Completes Financial Restructuring and Emerges from "Prepackaged" Chapter 11 | Sungard AS - Resolution Bazaar
[6]Corporate Debt Restructuring (CDR) cell was created by notification number BP.BC. 15 /21.04.114/2000-01 dated August 23, 2001

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