Pre-pack incorporates the benefits of both informal and formal insolvency proceedings. In many jurisdictions, there exists a codified framework for pre-packs
By Bibek Debroy & Aditya Sinha,
A few days ago, a woman in Bhopal moved a court because her father allegedly cheated in a Ludo game. The court asked them to resolve the family matter amicably. This may be unusual. But a lot of civil litigation can be resolved through mediation and conciliation, without approaching the court. The end-result, after going through adjudication and incurring costs, is no different from what an amicable solution would have found.
Today, insolvency and bankruptcy resolution in India also needs an informal dispute resolution mechanism that can be triggered much before any crisis precipitates into formal action. The Insolvency and Bankruptcy Code (IBC) has been instrumental in resolving a large proportion of non-performing assets. It has also acted as a deterrent, given creditors have used IBC proceedings as a tool to nudge debtors to restructure and fulfil their obligations to creditors. About 83% of cases, with a realisation value of Rs 5,15,170 crore, were resolved without going through the full process.
However, the Corporate Insolvency Resolution Process (CIRP) under IBC is often not completed within the stipulated time. The Bankruptcy Law Reforms Committee, which proposed the IBC, noted that “the most important objective in designing a legal framework for dealing with firm failure is the need for speed”. However, the adjudicating and appellate authorities, i.e., National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT), that deal with IBC-related matters have been bogged down by a lot of cases. Apart from dealing with IBC-related cases, these tribunals also handle cases related to Competition Act and Companies Act. Sections 7, 9 and 10 of IBC provide 14 days for the NCLT to admit or reject any application for initiating insolvency proceedings.
Unfortunately, there are more than 9,000 applications that are pending admission before various NCLT benches. Out of this, 5,485 have been pending for more than 180 days. Similarly, the CIRP should be normally completed within 180 days, or within 330 days including “any extension of the period of corporate insolvency resolution process granted and the time taken in legal proceedings in relation to such resolution process of the corporate debtor”. However, this rarely happens. In JK Jute Mills Company Vs Surendra Trading Company, the NCLAT ruled that timelines mentioned in the Code are “procedural in nature, a tool of aid in the expeditious dispensation of justice and is directory”, i.e., they aren’t mandatory. Moreover, the date of receipt of application isn’t treated as the date of filing of the application. The date on which the application is listed for hearing in the registry of NCLT is treated as the date of filing the application. The countdown won’t start even if the application is pending to get admitted for 180 days.
No doubt, a more efficient mechanism to deal with the pending caseload before NCLT benches is needed. However, till that is done, an informal mechanism is needed to ensure that resolution occurs without resorting to formal action, maybe before a debtor defaults. For this, a pre-pack insolvency framework may be useful. Unlike conventional CIRP, a pre-pack is a debtor-driven agreement for the resolution of the debt between financial creditors and a distressed company. This out-of-court restructuring gives the flexibility to arrive at a plan best suited for consenting financial creditors and corporate debtors. Once all stakeholders agree on a resolution plan informally, they can seek a nod from the courts—in India’s case, the NCLT. Pre-pack is an innovative corporate-rescue tool that incorporates the benefits of both informal and formal insolvency proceedings. In many jurisdictions, including the US and the UK, there exists a codified framework for pre-packs. Several empirical studies have found that, compared to conventional insolvency proceedings, they create more value for all stakeholders.
There are several benefits of pre-packs: (1) they ease the burden on the NCLT and the NCLAT; (2) drastically reduce the time for the resolution process; (3) there is minimal disruption of the debtor’s business, as the debtor is in possession throughout the process; (4) there is also higher employee retention in pre-pack insolvency as compared to the conventional CIRP; and (5) transaction and administrative costs are relatively low as compared to the traditional CIRP.
The problems in devising a pre-pack insolvency framework are apparent, but not intractable. The pre-pack insolvency framework should balance the interests of both the financial and operational creditors. The framework shouldn’t be heavily biased in favour of financial creditors. The framework should also ensure a transparent insolvency resolution process. Unless there is a provision of moratorium if the majority of financial creditors are in talks of pre-pack insolvency with the debtor, pre-packs will not be an attractive insolvency resolution tool.
Logically, financial creditors and corporate debtors should have got into an informal arrangement akin to pre-pack insolvency, as a standard market practice. However, this doesn’t happen. The absence of a codified framework deters the stakeholders from trying this tool that is relatively alien to an evolving Indian insolvency regime. As per reports in the media, the government is weighing proposals to introduce a pre-pack insolvency framework in India. This is a welcome move.
Debroy is chairman, and Sinha is assistant consultant, EAC-PM