what-are-pre-packs-under-ibc

Context: The Ministry of Corporate Affairs (MCA) has set up a committee to look into the possibility of including “pre-packs” under the current insolvency regime to offer faster insolvency resolution under the Insolvency and Bankruptcy Code (IBC), while maintaining business continuity and thereby preserving asset value and jobs.

Background:

  • Slow progress in the resolution of distressed companies has been one of the key issues raised by creditors regarding the Corporate Insolvency Resolution Process (CIRP) under the IBC. 
    • 738 of 2,170 ongoing insolvency resolution processes have already taken more than 270 days at the end of March. 
  • Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

Salient Features of IBC

  • It applies to both individuals and companies.
  • Earlier it provided for a 180-270 days period to resolve insolvency but now the deadline of 330 days has been set for completion of corporate insolvency resolution process (CIRP), including litigation and other judicial processes.
  • It provides immunity to the debtors from claims of resolution by creditors during this period of resolution.
  • It provides for a common platform of debtors and creditors of all classes to resolve insolvency.
  • The Code gives the highest priority to those who have brought interim finance to meet the costs of resolution or liquidation, followed by dues to workers for the past two years and dues to secured creditors in equal priority. 
    • Employees other than workmen, and unsecured creditors and operational creditors are further down the line in the priority of receiving resolution or liquidation proceeds.

About pre-pack insolvency proceedings

  • A pre-pack is an agreement for the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process
    • This system is a popular mechanism for insolvency resolution in the UK and Europe.
  • In India, it would likely require that financial creditors agree on terms with potential investors and seek approval of the resolution plan from the National Company Law Tribunal (NCLT). 
  • The pre-pack would act as an important alternative resolution mechanism to the CIRP and would help lower the burden on the NCLTs.
  • Protect unsecured operational creditors like suppliers of goods and services: You can’t run a business without operational creditors. If you have to continue to buy from raw material providers and service providers, you have to give them a fair deal which can be offered through a pre-pack.

Pre- pack insolvency resolution process 

Corporate insolvency resolution Process (CIRP)

Byepasses open auction: This process would likely be completed much faster than the traditional CIRP. 

Open auction: It requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company which is time consuming.

NCLT approval: The proposed pre-packaged resolution would likely be subject to approval by the NCLT. 

Committee's approval: Even under the CIRP financial creditors make up the committee of creditors which votes to decide the distribution of the proceeds of any resolution plan.

90 days timeline: The process needs to be completed within 90 days so that all stakeholders retain faith in the system.

Cases that take more than this time should be taken through the normal CIRP.

It gives a fair deal to the operational creditors.

Operational creditors tend to get worse recoveries in cases where the company is no longer operational.

Business continues: The incumbent management retains control of the company until a final agreement is reached. Pre-packs would mostly be used for businesses that are running. 

Disruption in business: Transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.

The main drawback is the reduced transparency compared to the CIRP as financial creditors would reach an agreement with a potential investor privately and not through an open bidding process. 

  • This could lead to stakeholders such as operational creditors raising issues of fair treatment when financial creditors reach agreements to reduce the liabilities of the distressed company.
  • Bankers themselves may hesitate to restructure liabilities outside of an open bidding process for fear of their decisions leading to investigations by agencies.

More transparency due to open bidding:Unlike in the case of a full-fledged CIRP which allows for price discovery, in the case of a pre-pack the NCLT would only be able to evaluate a resolution plan based on submissions by the creditors and the investor.

Image Source: Economic Times