Comments on Proposed Framework for Prepacks

-Sikha Bansal & Megha Mittal

(resolution@vinodkothari.com)

While there had been murmurs of a prepack insolvency resolution framework, the Report of the Sub-Committee of the Insolvency Law Committee, on Pre-packaged Insolvency Resolution Process[1] issued on 8th January, 2021 (“Sub-Committee Report”/ “Report”) comes as the first concrete step in bringing prepacks to India. In an earlier write-up, we have discussed possible framework for bringing pre-packs in India; see here- Bringing Pre-Packs to India

Below we discuss the various facets of the Report in terms of application and feasibility, both legal and practical.

Proposal with references in the ReportRecommended- Yes/ NoOur Comments
Extent of involvement of AA

[Annexure C; Para Nos. 3.34, 3.39, 3.42, 3.43, 3.54, 3.57, 3.60 and 3.75]

 

 

NoIt seems that the concerned parties will have to approach the AA twice – first, at the pre-admission stage wherein AA will order moratorium and appoint RP, and second, for approval of the pre-pack plan.

 

§  It is felt (which is also in consonance with globally adopted framework and practices; e.g. see, UK), pre-packs are seen as high-speed and prominently informal remedies with a tinge of formal procedures.

§  The whole idea of a ‘pre’ pack is that the parties go with a pre-packaged deal before the AA, which, unless there is a material irregularity in the process, ratifies the acts done and approves the plan which has the same effect as a plan otherwise formed under the premises of AA.

§  The proposal takes us back to CIRP – AA will have to step-in twice. It will be time-consuming. While, “The key attraction to the use of pre-packs is the speed with which the administration proceeds” [Insolvency Service Report, UK]

§  Possible concerns behind the proposal are – initiation of moratorium and appointment of RP (who is supposed to be an officer of court being appointed by AA) – these are addressed in subsequent comments.

§  Hence, it is recommended that the involvement of AA should be required only at the time of approval of the pre-pack plan and at the time of initiation of pre-pack process.

 

Applicability/Availability [Para 3.16, para 3.28]

The Report has suggested a phase-wise implementation which may be introduced in the following manner[2]

(i)     Default ranging from Rs.1 lakh to Rs. 1 crore and COVID-19 defaults,

(ii)   Default above Rs.1 crore,

(iii) Default from Re.1 to Rs.1 lakh, and

(iv) Pre-default stress, which would require consent of higher threshold (say 75%) of creditors to avoid any potential misuse.

 

Partially Yes§  The range of minimum default which the CG can vary is Rs. 1 lakh to Rs. 1 crore.

§  Section 10A was introduced w.r.t COVID defaults only (that is, default arising on or after 25th March, 2020). Hence, there is a presumption under law that default which arises after 25th March, 2020 is a COVID default.

§  Pre-pack is a benevolent remedy, which can only be initiated at the stance of the CD. Hence, there can be no fear of a creditor pushing the CD into the process (unlike CIRP). Further, pre-packs are proposed to come with all checks and balances including that of section 29A.

§  There seems to be no reason for withholding the benefit of pre-packs for non-COVID defaults where the default is from Rs. 1 lakh to Rs. 1 crore. The proposed framework for pre-packs must not be made subject to COVID related defaults only, and instead be a more general process.

§  Hence, pre-packs can be allowed for the entire range of debtors (default range from Rs. 1 lakh to Rs. 1 crore) to which the Code can apply, and which the CG can notify under the Code, whether or not the default qualifies as a COVID default.

§  As to categories (iii) and (iv), the default range and pre-default category are not presently covered under the Code. Hence, this might require dilution in the present structure of the Code which may not be warranted currently.

 

CIRP vs. SIRP vs. PPIRP

[Para 3.16]

 §  PPIRP is suggested to be available to all CDs – MSMEs as well; which is recommended.

§  However, with PPIRP in place, one may question the relevance of a separate process of SIRP for MSME debtors.

§  With PPIRP also coming into picture, it has now become like a buffet of options available to the CD, vis-à-vis only CIRP available to the creditors- this may also create confusion amongst the CD as to which route should be opted for.

Cooling off Period

[Para 3.31]

The Report provides for a cooling period of three years within two simultaneous prepacks.

NoIt is suggested that the cooling period should be left to the discretion of debtor and CoC. The need for a company to opt for a pre-pack would depend on various factors, including business cycles, general economic conditions. Instead, the pre-pack plan should include a viability review (see, para 9.14 of Graham Review) stating how the new company would survive for a certain minimum period of time, detailing how things would be ‘different.’

 

Even if there is a stated cooling period, the same should be less than 3 years.

Management of CD

[Para 3.35 to 3.37]

Yes, with additional suggestions

 

§  As DIP Model is envisaged, certain checks and balances become important.

 

§  Already proposed –

–          Approval of CoC for certain acts [section 28]

–          Liquidation of CD may be resolved by CoC.

 

§  Besides, it is suggested that the CD be subjected to continual reporting requirements. For instance, in jurisdictions like US, debtors are subject to Operating Guidelines and Reporting Requirements, whereby they are required to ensure inter-alia monthly operating requirement, proof of insurance, updates w.r.t. physical inventory etc.

 

§  The reporting requirement would serve multiple purposes –

–          Assist in regulating the conduct of CD

–          RP and CoC would be aware of happenings

–          CD can be held responsible for false reporting/misrepresentation

–          The reports would serve as a reference before AA, which can be used by RP to show how the affairs of the CD has been managed and how he has monitored the activities of CD

–          The reports would need to be preserved for future references.

Appointment of RP

[Para 3.42]

The Report provides that the choice of IP to act as RP, and the terms of his appointment may have consent of majority of unrelated FCs (unrelated OCs where the CD  does not have any unrelated FC) and such IP may be appointed as RP by the AA

 

No

 

§  While we concur to the fact that the RP shall be selected by the CD and approved by unrelated FCs, the suggestion that the appointment may be confirmed by the AA does not seem tenable.

 

§  The role of the RP is most crucial during the pre-NCLT stage- hence appointment is warranted. However, if the appointment is to be approved by the AA, it would mean that the AA is involved at two stages– at the time of appointment and then for approval of the resolution plan.

 

§  This would be counter-intuitive to the basic essence of the prepack process- minimal role of the AA.

 

§  Hence, rather than approval of the RP by the AA, it is suggested that the RP may be selected by the CD with the consent of requisite unrelated FCs; appointed by the CoC and later (at the time of application for approval of the plan), the appointment of the RP, and acts done thereto may be ratified by the AA. Once the RP is appointed by AA formally, the pre-pack plan will be implemented.

 

§  The above suggestion would ensure that the RP is held answerable for all acts done in such capacity[3] and that the involvement and role of AA can be limited to a single application for approval of the resolution plan.

 

§  The RP would anyway remain under obligation to act independently, in the best interest of all stakeholders.

 

Public Announcement

[Para 3.49]

No§  PPIRP is an out-of-court process, at least, to begin with. And, it would have far-reaching effects on various stakeholders.

 

§  Hence, it would be important to disseminate there is a restructuring taking place and provide a right to potential claimants to put their claims/objections forward.

 

§  There can be 2 possible alternatives

–          First, public announcement may be made as usual, including in newspapers, as soon as pre-pack is initiated out-of-court. However, this would take away required confidentiality imbibed in a pre-pack process.

 

–          Second alternative is, a public announcement is made at the instructions of NCLT, before the pre-pack plan is approved; inviting creditor objections, if any. This would ensure that the pre-pack plan is safeguarded against future litigation.

 

§  Only electronic dissemination may not suffice; given that the proposal is to cover small debtors as well. In any case, small creditors may not have access to electronic platforms or may not be tech savvy (as has been practically experienced in many cases).

 

Avoidance Transactions

[Para 3.54]

Yes, with additional comments§  While we agree that normal provisions relating to avoidance transactions shall apply to PPIRP; however, prominently in view of the fact that the Report envisages DIP model, accessibility to relevant records and costs involved might be practical considerations. Such issues are to be seen gradually in light of experiences gained.

 

Moratorium

[Para 3.57]

Moratorium under section 14 should be available from the PCD till closure of process, whether by approval of resolution plan or otherwise, to be ordered by AA.

No§  At the outset, it must be noted that the Report has referred to section 14 of the Code, for providing moratorium in the prepack process also. Here, the primary lacuna would be that moratorium under section 14 of the Code is effective by way of an order of the AA on the CIRP Commencement date. Would it mean that for bringing moratorium to effect, an order of the AA would be warranted? If so be the case, the essence of prepacks would be frustrated- repeated involvement of AA would negate the speedier and cost-effective pros of the prepack process. Hence, while it is suggested that moratorium should be available, the same should be automatically brought to effect upon approval by the FCs and the shareholders, that is, the order of AA should not be required. Alternatively, moratorium can kick-in at the time of constitution of CoC by the RP.

 

§  Alternatively, moratorium can begin from the time the pre-pack plan is approved by the AA. This would facilitate easy implementation of the plan. However, this would deprive the CD of a calm period at the time of negotiations.

 

§  Another important point of consideration would be the commencement of moratorium. The Report provides that the moratorium shall commence from Prepack Commencement Date (PCD). However, the term “Prepack Commencement Date” is not defined. It appears from the Report though, that AA orders moratorium and that date be considered as PCD. However, our consistent view has been that there should be no requirement of approval of AA for initiation of pre-pack.

 

§  This raises a question as to what date shall be considered as PCD – date on which CD initiates the proposal; date of approval by the unrelated FCs; or the date of approval by the shareholders.

 

§  It is suggested that drawing inspiration from section 59 of the Code (for commencement of voluntary liquidation), the PCD may be considered as the date of approval by the shareholders or unrelated FCs, whichever is later. Moratorium may, accordingly, begin from that date, without the need of an order of AA.

 

§  Further, in view of the fact that a moratorium is highly susceptible to misuse, it would also be important to impose penal provisions for fraudulent initiation to prepacks similar to sec 65 of the Code, in case of a CIRP.

 

Timeline

[Para 3.60]

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.

 

Yes with additional suggestionsConsidering that the idea behind prepacks was to provide a cost-effective and speedier resolution, we concur with the suggestion that extensions may not be provided.

 

However, the effectiveness and practical feasibility of the 90-day timelines is majorly subject to the time subsumed in litigation. CIRP cases till date, have been enough evidence of the fact that once the matter is drawn to litigation, completion of acts within the prescribed timelines becomes a vague objective. Hence, the period of litigation may be considered before stipulating the timeline for completion of pre-packs.

 

Swiss-challenge mechanism

[Para 3.73]

The Report recommends that the pre-pack should offer two optional approaches, namely, (i) without swiss challenge but no impairment to OCs, and (ii) with swiss challenge with rights of OCs and dissenting FCs subject to minimum provided  under section 30(2)(b).

 

Partially Yes§  A swiss challenge mechanism enables value maximization, and hence is advisable. However, the Report has provided for a swiss challenge mechanism in case of resolution plans only where rights of OCs are impaired.

 

§  While it is understandable that the basis for such a suggestion could be that OCs do not get a say in the acceptance/ rejection of a plan, it is suggested that swiss-challenge may be allowed irrespective of impairment to OCs. It may also be made subject to the decision of CoCs- given that along with the financial aspects of a plan, evaluation is also required at the commercial front, it may so happen that the CoC decides, on the basis of the base plan and/ or other plans received, whether a swiss-challenge mechanism is desirable.

 

Closure Process

[Para 3.75]

 

(b) Liquidation-

 

The CoC may, with 75% votes decide to liquidate the company, if they are of the view that the company ought to liquidate and/ or the CD does not cooperate. However, the liquidation cannot be done for cases of pre-default stress or where default is lower than Rs. 1 crore.

Yes, with additional suggestions§  The threshold may coincide with the present threshold under law – that is, 66%. Given that, there is no automatic liquidation (as against CIRP), the threshold of 66% for explicitly passing a resolution for liquidation is safe in our view.

 

§  In any case, as suggested in the Report [Para 3.48], the threshold of 75% (or 66%, as suggested by us) should be determined as a percentage of all FCs of the CD, rather than those present and voting.

 

 

Other Comments

A bird’s eye view of the Sub-Committee Report gives an idea that proposed pre-pack framework for the Indian insolvency scenario, is similar to a creeper plant, finding its support from the already established provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”/ “Code”). As per the Report, several provisions in the prepack framework with respect to constitution of CoC, voting etc shall be drawn from the Code itself. Further, reference has also been made to the proposed Special Insolvency Resolution Framework (“SIRP”) for MSMEs[4], wherein the proposed framework had very close resemblance to prepack.

Furthermore, while the Report also fairly focuses on COVID-related defaults, it is essential to assess and acknowledge the relevance of pre-packs with or without COVID. Hence, it is strongly suggested that the proposed framework for pre-packs must not be made subject to COVID related defaults only, and instead be a more general process.

In addition to the above, the framework should be carried out with minimal changes in the Code.


[1] https://www.ibbi.gov.in/uploads/whatsnew/34f5c5b6fb00a97dc4ab752a798d9ce3.pdf

[2] Para 3.28

[3] Similar principle is also followed in the UK- The RPs are held responsible for all acts done during the prepack process- the SIP 16 lays down guidelines for the RPs to be followed by the IPs during prepacks.

[4] Issued by the Insolvency and Bankruptcy Board of India on 20th June, 2020- however, not notified as on 16th January, 2021.

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