IBC: What Would It Take For Pre-Packs To Work?
(Photographer: Prashanth Vishwanathan/Bloomberg)

IBC: What Would It Take For Pre-Packs To Work?

After four years and five major amendments, the Insolvency and Bankruptcy Code is set for yet another change. With the proposed introduction of pre-pack insolvency, India joins the ranks of countries like the U.K., U.S., Singapore and France to have an informal, hybrid and debtor-driven pre-insolvency process that will operate under the Code.

International experience shows pre-packs have generally been successful in preserving enterprise value. For instance, a report by an insolvency panel points out that majority of pre-packs in the U.K. have been successful in preserving jobs. Research in the U.S. credits pre-packs for reducing the time taken by courts, in confirming a reorganisation plan, to half.

BloombergQuint spoke with experts to assess the utility of this feature and identify committee proposals that may require a rethink.

Stress Resolution: Prepack Vs Others

India’s debt resolution framework suffers from certain shortcomings.

Under most laws, resolution is initiated only when a borrower almost reaches a point of no return. Sometimes, obtaining requisite consent from creditors turns out to be a challenge. For instance, Reserve Bank of India’s prudential framework prescribes a 75% approval threshold, which is at times difficult to obtain in cases where creditors like mutual funds, insurance companies etc. are involved. Similarly, non-signatory lenders tend to prefer the IBC over the RBI framework.

Comparatively through pre-packs, a lender and borrower will agree in advance, either at the time of entering into a loan agreement or at a later stage, about what happens if a company hits a predefined event such as delinquency or default.

Banks would prefer pre-packs in almost every situation where there’s good enterprise value or a situation of good business in a bad balance sheet, Abizer Diwanji, partner and national leader for financial services at EY, said.

While IBC doesn’t allow division of business into smaller segments, this can be achieved through pre-packs and only specific parts which need restructuring can be addressed, he said.

Services companies would prefer a pre-pack as a lot of flexibility exists on how operations can be designed pre- and post-IBC. Power companies are viable businesses as long as they have a good power purchase agreements, but may be stuck in a bad balance sheet due to cost issues. This can be streamlined through pre-packs.
Abizer Diwanji, Partner & National Leader - Financial Services, Ernst & Young

Santanu Ray, insolvency professional at AAA Insolvency Professionals LLP, said pre-packs will be ideal between the period when there are early signs of stress and when an account actually becomes a non-performing asset.

The Question Of Section 29A

In the pre-pack proposal, the insolvency law committee has proposed a hybrid “debtor-in-possession” model with adequate oversight by the creditors. This would require co-operation and participation of the promoters or controlling shareholders.

But, majority of the committee members have warned against the dilution of section 29A for pre-packs. This section prohibits promoters of non-performing assets, willful defaulters and certain other class of persons from submitting a resolution plan for a corporate debtor.

Complete exclusion of promoters may not bode well for the pre-pack process, others said.

There is commercial justification for diluting the mandate of section 29A for pre-packs, Misha, partner at Shardul Amarchand Mangaldas & Co., pointed out. The insolvency process has become highly litigious because of direct confrontation between the promoters and creditors’ interests, she said.

Pre-packs are intended to be less formal and not a strict, statutory platform to resolve pre-insolvency stage stress for genuine businesses. Therefore, other than willful defaulters or disqualification on account of malfeasance related conduct, the NPA related disqualification may be considered for dilution.
Misha, Partner, Shardul Amarchand Mangaldas & Co.

Diwanji agreed. Some telecom companies became NPAs because of a collapse in the industry—mainly due to extrinsic factors like monopolisation or intrinsic factors like incompetence or inability of the management to sense a problem at the right time, he said.

If the applicability of section 29A is modified to only include established frauds, promoters will become eligible to enable the framework, he said, adding that depending on the capital structure that evolves through the pre-pack, there will be a minimal or majority stake.

But if promoters are entirely debarred, every pre-pack will become a situation of hostile M&A. Such methods have not worked under the RBI’s June 2019 circular or the Strategic Debt Restructuring framework. The only way it has worked is under the IBC, but even there, the chances of delay due to prolonged litigation and court process remain.
Abizer Diwanji, Partner & National Leader - Financial Services, Ernst & Young

Reconsidering Direct Liquidation

A pre-pack process may conclude when a resolution plan is approved by the National Company Law Tribunal. It may also end if no resolution plan is received or approved.

Failing these two outcomes, the creditors’ committee can pass a resolution to liquidate the corporate debtor. This can be done with a 75% approval of the committee of creditors, which will comprise of unrelated financial creditors, as per the committee’s proposal.

This suggestion needs a rethink for two reasons, experts told BloombergQuint.

First, pre-packs offer limited scope of restructuring as compared to the insolvency process. Second, it may be too premature to push a company into liquidation as another buyer can emerge during the IBC resolution process.

Failure of the pre-pack should restore the company to the pre-moratorium stage. This should be mandatory and not left to the discretion of the committee of creditors, Misha opined.

This will enable stakeholders to take legal recourse including enforcement or resorting to full fledged resolution process. A business should go to liquidation only after failure of the corporate insolvency process, with mandate of 66% absolute majority in value.
Misha, Partner, Shardul Amarchand Mangaldas & Co.

Tedious Trigger Thresholds

A company undergoing the insolvency process can attract good resolution plans if the process is timebound. As pre-packs involve even shorter timelines, the government may do away with overlapping approval processes, experts said.

The committee proposal says that the pre-pack process can be initiated on default by a company only after obtaining majority approval from both—shareholders and unrelated financial creditors.

The requirement of getting both lender and shareholder consent for initiating pre-packs may delay the entire process, Kumar Saurabh Singh, partner at Khaitan & Co., said.

Getting a 51% approval from creditors for triggering pre-packs may be a challenge in case of a conglomerate with a diverse pool of creditors. This can marginalise and delay the process.
Kumar Saurabh Singh, Partner, Khaitan & Co.

The approval for starting the pre-pack process may be subjected only to shareholders’ approval, as in any case, lenders have to approve a plan before it finally goes to the NCLT, he said.

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