Financial & Insolvency Law

Pre-packaged Insolvency: Time for India to Accept?

The Insolvency and Bankruptcy Code (“IBC”) was enacted to provide a legal framework for the effective resolution of insolvency and bankruptcy of corporate persons, individuals and partnership firms. It was welcomed because it worked for the benefit of the creditor as well as debtor. With the increasing challenges and pendency in adjudication and the consistent failures in meeting the 180-day deadline, parties have started figuring out means outside of the IBC to reorganise/appropriate their assets and come out of insolvency or effect an efficacious liquidation.

[Shiphali Patel is a student of 4th year BA LL.B (Hons.) at Dr Ram Manohar Lohiya National Law University, Lucknow]

 

Background

In the case of Lokhandwala Kataria Construction Pvt. Ltd. v. Nisus Finance and Investment Managers LLPthe parties had entered into an out of court settlement. When applied, NCLAT rejected the application to quash NCLT Mumbai’s order admitting the CIRP application looking to Rule 8 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016 (“AA Regulations”) which only provides for the withdrawal of the CIRP Application before its admission. A conflict arose between the enshrined word of the AA Regulations and the pragmatic approach of the settlement for the benefit of the stakeholders. The matter had to be taken to the Supreme Court (“SC”). The Apex Court used its power under Article 142 of the Constitution to accept the settlement and allow the withdrawal of the application for the benefit of all the stakeholders and for meeting the ends of justice.

With the increasing use of the settlement process, cases had started to be dumped on SC since only the Apex Court could provide a temporary judicial solution to this problem. In the case of Uttara Food and Feeds Pvt. LtdSC observed that to avert unnecessary appeals, amendments should be made to the relevant Rules to allow withdrawal of petition after its admission in case the parties settle outside the court. Eventually, the Insolvency Law Committee (Committee) was formed on 16thNov 2018 which, inter-alia, recommended that the withdrawal of application after its admission must be allowed only if it is approved by 90% of the Committee of Creditors (“CoC”). This was materialised as Section 12A of the IBC.

 

Comment

If we see the cases where the parties reach a settlement before a CIRP is applied for or accepted, the settlement never gets to reach the court for its input. Is only notified to the Court, to be allowed if the relevant conditions of consensus are met. Without the court’s approval, a pre-arrangement scheme is nothing but a commercial contract. Outside bankruptcy such agreements need a unanimous written agreement of the creditors. Difficulty can arise in the enforcement of such agreements if even one party backs out. Such holdouts or non-responsive parties can frustrate the agreements and make their enforcement and implementation tricky.

While in the case of a pre-admission settlement, mere withdrawal of the Application by the Applying Creditor is required, a post-admission withdrawal requires a near-unanimous consensus of the CoC to this effect. Such exceedingly stringent criteria can thwart a settlement which could be beneficial for all the stakeholders, including the creditors. Non-responsive parties and holdouts can easily defeat the settlement and create hindrance in both situations, against the greater good. Now with the proliferation of the settlement scheme, there is an express need of a provisional backing to these out-of-court settlements where they can get the security of a court’s approval and a corporate debtor can work in sync with the CoC and implement changes with a more relaxed criteria put in place in order to effect a settlement.

The Government of India has mooted the idea of introducing the concept of pre-packaged insolvency (“pre-pack”), a prevalent practice in the USA and UK. In pre-pack, a company prepares a reorganisation plan with its shareholders and creditors that will come into effect immediately after the company enters into CIRP. An 11-member working committee has been formed, headed by Mr Injeti Srinivas to examine this idea. The pre-pack scheme will typically allow a stressed company to prepare a reorganisation plan with its at-least two-third of creditors and shareholders before anyone could file an application in NCLT. Then afterwards the plan so prepared would be produced before the NCLT, once approved it could be immediately implemented. Since the plan has already been approved by the creditors, it would pass various stages required under the usual process of IBC. This would reduce the time and litigation cost of the entire resolution process and would also help release the clogged NCLTs.

 

Conclusion

In this article, the author aims to present pre-packaged insolvency as a solution to the problems faced by Indian companies and NCLTs. The only question is, what flavour of pre-pack would the Indian authorities choose? By pre-pack insolvency resolution coming in India, stressed companies would be able to come out of their insolvent position in a more efficacious manner whereas in the case of pre-pack liquidation, various problems relating to value destruction, going concern sales, time factor of liquidation, etc. can be effectively dealt with. Companies like marketing firms or law firms, whose business depends upon their reputation will be protected from the adverse publicity, which is likely to happen in the procedure mentioned under IBC. Since the companies would reach the court with a pre-negotiated resolution plan, the litigation cost and the cost of Resolution would reduce considerably making the resolution process cheaper. The value erosion caused by a disruption in the Board of Directors/promoters exiting and Interim Resolution Professional (IRP) taking over will be prevented. Most importantly, the sanctity and security of approval by the Adjudicating Authority would be provided. A pre-pack scheme would enable alternative capital providers to participate and would provide the time to focus completely on the resolution process. While IBC endorses lengthy procedures, a pre-pack gives a shortcut of out-of-court settlement of insolvency/bankruptcy to the proactive debtors and with the increasing use of settlement scheme, its time India embraces pre-packaged insolvency.


 

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