With IBC suspended, now pave the way for pre-packaged insolvency : 12-05-2020

The Union Cabinet has decided to put the Insolvency and Bankruptcy Code, 2016 (IBC) in abeyance by suspending the admission of new cases into insolvency for the next six months to address the hardship of businesses which risk being dragged into bankruptcy due to pandemic-fuelled distress. This move has resonated well with the banks, who are, in fact, suggesting a two-year suspension in light of what they estimate is going to be the time it would take for the markets to normalise and provide reasonable recovery.

While IBC in its current avatar would remain suspended for fresh cases, it becomes pertinent that alternative solutions to address the stress in the system be explored. Pre-packaged insolvency or more colloquially, “Pre-Pack” is one such promising solution.

Essentially, a pre-pack is a mix of an out-of-court restructuring scheme and formal insolvency process where the terms of sale are pre-negotiated and finalised with approvals of creditors prior to filing for insolvency with the court. After obtaining the approval of the court, the plan gets implemented through the mechanism of the IBC and is binding on all the stakeholders. Pre-Pack has been in existence in developed countries like the US and the UK for many years and has enjoyed a fair bit of success.

Why India needs Pre-Pack

Pre-Pack is strongly built around the tenets of value preservation and timely resolution, which form the lifeblood of any insolvency law.

The current insolvency regime, although a great improvement over its predecessors, leaves a lot to be desired with respect to recovery rate, swiftness, and ease of resolution. Asset stripping and value deterioration are few of the major concerns, as the current Section 29A bar, which disallows an exhaustive list of people from acquiring companies under insolvency, also bars erstwhile promoters. This leaves little incentive to the promoter to contribute positively towards the process, risking asset stripping while business-as-usual comes to a standstill. A pre-pack, on the other hand, would check perverse behaviour and give incentive to the existing management to revive the company while ensuring business continuity, which would help preserve value and maximise recovery for the lenders. This is all the more relevant in certain industries, such as trading and services, which are traditionally asset-light.

Undue delays and litigation also remain a persistent issue in the current scenario. As per the latest statistics, it takes approximately 394 days for resolution, which far surpasses the stipulated timelines. Pre-pack will cut these timelines significantly, while also cutting down costs of litigation and administration, and will decongest the overburdened NCLTs. It is noteworthy that in May 2019, a company in the US, called Sungard Availability Services, had its pre-pack confirmed within 19 hours, setting a record as the fastest ever bankruptcy case in the US.

Introduction of pre-pack would, however, be a fundamental shift from the current “creditor in control” model, and brings with it its own set of challenges, which would necessitate significant changes to the framework. Legislation would have to be brought in to address the risk of lack of transparency and cramdown on the unsecured creditors or operational creditors as they would not be parties to the dialogue preluding the submission of plan. Principles of equity and transparency would also have to be built into the Code, taking care not to shackle it to the point of inefficiency. Regulatory framework around the insolvency professionals would also need to be strengthened further to check the exercise of what could be significantly more power in the hands of insolvency professionals in a pre-pack.

The insolvency law has undergone several amendments since its inception in 2016 to keep pace with the changing landscape and pre-pack will be a major step in the direction of continuous evolution. Recently, the insolvency law committee was reconstituted to deliberate on the functioning and implementation of the Code, and in this regard, in April 2019, the ministry of corporate affairs had invited comments on implementation of pre-pack in India. It was also recently reported that a panel headed by former SEBI chairman UK Sinha is deliberating on the framework and it is expected that legislation may soon follow. In unprecedented and distressed times like these, when insolvencies are bound to increase, the introduction of pre-pack becomes more necessary than ever.

Source : Financial Express