CAA’s Articulate – 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.

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.

Deference between Pre- pack insolvency resolution process and Corporate insolvency resolution Process (CIRP)

Pre- pack insolvency resolution process

  • Byepasses open auction: This process would likely be completed much faster than the traditional CIRP.
  • NCLT approval: The proposed pre-packaged resolution would likely be subject to approval by the NCLT.
  • 90 days timeline: The process needs to be completed within 90 days so that all stakeholders retain faith in the system.
  • It gives a fair deal to the operational creditors.
  • 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.
  • 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.

Corporate insolvency resolution Process (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.
  • 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.
  • Cases that take more than this time should be taken through the normal CIRP.
  • Operational creditors tend to get worse recoveries in cases where the company is no longer operational.
  • 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.
  • 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.