[By Pranav Karwa and Gaurav Karwa]

Pranav is a student at the National Law University, Jodhpur and Gaurav is a student at the West Bengal National University of Juridical Sciences.

 

Pre-pack insolvency process involves an arrangement between the debtor and the creditor to negotiate the sale of assets before initiating the insolvency proceedings via the court or any other appropriate forum so as to enable resolution and debt recovery at a faster pace than the regular insolvency resolution process. This practice was prevalent in countries like the USA and UK since 1978, however, recently, the Insolvency and Bankruptcy Board of India notified the Insolvency and Bankruptcy Board of India (Pre-Packaged Insolvency Resolution Process) Regulations, 2021 ( “Pre-Pack Regulations”) for MSMEs, which are squarely based on the Report of the Sub Committee of the Insolvency Law Committee, chaired by Dr. M.S. Sahoo. One of the most striking recommendations made by the sub-committee was the “debtor in possession model.” As per this model, during the pre-pack insolvency process, the promoters are permitted to remain in the Management of the affairs of the Corporate Debtors except for the matters covered under § 28 of the Insolvency and Bankruptcy Code, 2016 (“the Code”), which require mandatory approval of Committee of Creditors (‘CoC’).

This recommendation of the sub-committee has been retained under Chapter X, Rule 50 of the Pre-pack Regulations, with minor changes. The authors believe that the “debtor in possession model” is in stark contrast to the existing insolvency regime in India and is marred with various inconsistencies and difficulties.

Critical Analysis of Debtor in Possession Model proposed under the Pre-Pack Regulations

The authors believe that ‘debtor in possession of the management model’ is fundamentally contrary to the well-established principles of insolvency jurisprudence in India. It seeks to place the same set of promoters back in the helm of affairs who are ultimately responsible for dragging the company to insolvency.

• 29A of the Code lays down the eligibility criteria of resolution applicants and bars certain classes of persons from submitting a resolution plan. Therein, promoters of the Corporate Debtor are barred from submitting a resolution plan. The rationale behind this rule is to keep the persons responsible for the default of the Corporate Debtor out of its Management. Moreover, as observed by Supreme Court in Chitra Sharma v Union of India, the primary intention of inserting § 29A in the Code is to prevent people responsible for the insolvency of the Corporate Debtor from getting a backdoor entry in the Management of Corporate Debtor. This practice further ensures effective corporate governance and the maintenance of public interest. It, thus, becomes clear that the legislature and judiciary have been highly concerned about the involvement of promoters in the Management of Corporate Debtor, and this apprehension justifies the rationale behind the insertion of § 29A.

The ‘debtor in possession model’ under the Report of the Sub-Committee and Rule 50 of the Pre-Pack Regulations goes squarely against the very spirit of § 29A as even after the initiation of the Pre-Packaged Insolvency Process, the promoters remain at the helm of affairs.

Moreover, recently, in Arun Kumar Jagatramka v. Jindal Steel and Power Limited, the Apex Court decided whether the promoters, who are ineligible u/s 29A of the Code, can propose any scheme of arrangement u/s 230 of the Companies Act, 2013. The Court observed that § 29A of the Code ensures a sustainable revival of the Corporate Debtor and is grounded on the fact that the person responsible for the problem cannot participate in resolving the problem. Finally, the Court disallowed such promoters, ineligible u/s 29A of the Code, from submitting a compromise or arrangement u/s 230 of the Companies Act, 2013 as it would be manifestly arbitrary. Therefore, a corollary to bar u/s 29A of the Code is a bar from proposing any scheme u/s 230 of the Companies Act, 2013.

Furthermore, there is a power and responsibility mismatch for Resolution Professionals under the Pre-Pack Regulations. Minimal powers have been given to the Resolution Professional to visit Corporate Debtor’s premises, inspect assets and prepare a monthly report with the Corporate Debtor for CoC, among others under Rule 50 of the Pre-Pack Regulations. Ultimately, the Management of the Corporate Debtor does not transfer to the Resolution Professional on initiation of the Pre-Pack Insolvency Resolution Process. Therefore, it may become practically difficult for the Resolution Professionals to discharge their statutory obligations. For instance, a Resolution Professional has to undertake multiple responsibilities like overseeing an independent asset valuation and also conducting an eligibility test under § 29A as to proposing resolution plan. However, it may become difficult for Resolution Professional to complete all these duties in a ninety-day timeline when the Resolution Professional is not in Management or responsible for preserving the value of assets.

The way forward: Suggestions

The authors believe that Pre-Pack Insolvency Resolution Process has remained unexplored and can reduce the pendency of insolvency matters if implemented in the proper form. The Pre-Packs can wholly revolutionise how insolvency resolution takes place, which is necessary, considering the Indian economy is gripped with the challenge of mounting Non-Performing Assets at present. Further, it is feared that soon after the ban on insolvency application is lifted on 25^th March, 2021, an upsurge in insolvency applications under the Code may temporarily derail the insolvency resolution process. Thus, the Sub-Committee of Insolvency Law Committee has rightly observed that the real test of Pre-Pack Insolvency will be how it pans out once implemented during the COVID-19 Pandemic and even post-pandemic.

Also, the Scheme, as introduced by Pre-Pack Regulations, is only in its nascent stage and will require requisite revisions to suit the Indian Insolvency Regime. For instance, presently, the Promoter has been given a very significant role in the Management during the Pre-Pack Insolvency Resolution Process. Thus, Rule 50 of the Pre-pack Regulations must be revised to completely exclude the Corporate Debtor/Promoter role in the Management once the resolution process starts.

Moreover, instead of opting for a single option Pre-Pack Insolvency Scheme in India, the legislature could have considered importing the pre-packaged resolution process of the USA, which allows for three types of pre-packaged processes, which are Pre-Packaged Insolvency resolution process (“PPIRP”), Pre-Arranged Insolvency Resolution Process (“PAIRP”) and Pre-Arranged Sale (“PAS”). The bifurcation into multiple processes gives more options to all the stakeholders. To illustrate, PPIRP can be considered when CoC consists of a small group of homogenous financial creditors. There, the threshold required for approval of the resolution plan can indeed be reached very quickly.  Further, PAIRP can be prioritised for those scenarios where the CoC’s approval of the resolution plan cannot be obtained easily, as CoC consists of multiple heterogeneous members.  At last, apart from the above two methods, PAS (wherein sale of all the assets of the Corporate Debtor is envisaged without the prior consent of the CoC) must be considered in those cases where the following of any other method would result in the depletion in the value of the assets as a necessary consequence.

Further, despite the apparent mismatch of power and responsibilities in the Pre-Pack Regulations, it must be ensured that the Resolution Professionals face no practical difficulties in carrying out his statutory duties. A more pro-active role in the Management of the Corporate Debtor must be assigned to the Resolution Professionals in the Pre-Pack Insolvency Resolution process. To this end, a higher degree of professional standards may also be prescribed for Resolution Professional engaged in Pre-Packaged Insolvency Process for better accountability.

Concluding Remarks

To conclude, from the critique of the ‘debtor in possession model’, it becomes clear that as per settled jurisprudence, promoters accountable for insolvency of a Corporate Debtor must not be allowed backdoor entry in the Management of the Corporate Debtor during the initiation or pendency of Corporate Insolvency Resolution Process. The same fundamental principles must be followed even in the Pre-Pack Insolvency Resolution Process case as any other practice may severely affect the interests of creditors and may jeopardise the credibility and efficacy of the entire insolvency resolution process. Therefore, the proposed “Debtor in Possession Model” in the Pre-Pack Regulations violates the letter and spirit of the Code and must be removed by the legislature at the earliest opportunity.