Pre-packaged bankruptcy arrangements in the Indian context.
[Priyadarsini T P and Vishnu Suresh]
The authors are 3rd year students pursuing B.A.LLB(Hons.) from National University of Advanced Legal Studies, Kochi.
Introduction
The Insolvency and Bankruptcy Code, 2016 was enacted to overhaul the erstwhile haphazard legal framework to govern the matters of bankruptcy in India. It has been observed to be creditor-friendly. The corporate insolvency resolution process envisaged under the Code involves enormous participation of the adjudicating authority. It does not leave any scope for any out of court settlement of bankruptcy. Such an approach has been taken under the notion that the Indian market is not matured enough for an informal bankruptcy resolution. This is in stark contrast to countries such as U.S.A where bankruptcy resolution through out of court procedures is prevalent. Further, U.S.A and many other jurisdictions have also recognized a semi-informal arrangement known as pre-packaged bankruptcy or pre-pack.
Pre-packaged bankruptcy is a quasi-formal arrangement that combines the aspects of a private workout and legal bankruptcy. In a conventional bankruptcy case, the debtor files a bankruptcy petition, then negotiates a reorganization plan and solicits votes. In a pre-packaged plan, the applicant negotiates a plan and solicits votes before filing of a petition.[1] In U.S.A, the Bankruptcy Reform Act of 1978[2] provides that a debtor may file a plan for reorganization simultaneously with a petition for a voluntary bankruptcy case. The court’s role is limited to setting a date for approval of the reorganization plan. The creditors before entering into negotiations enter into agreements such as waiver or forbearance agreements to modify or waive their rights to collect debts. This is to avoid any creditor from initiating formal bankruptcy proceedings amidst the negotiations.In U.K, pre-packs have gained momentum as a result of the reforms introduced by Enterprise Act 2002and include a system of out-of-court entry into administration and simpler exit routes.[3]
Benefits of Pre-packaged arrangements
Pre-packs are a result of the promotion of rescue culture as opposed to debt collection during insolvency. Distressed companies may resort to pre-packs for the following reasons:
1.Decreased costs and increased speed: A pre-pack will minimize the time the company will have to spend in insolvency and thus increase the chance of rescuing its business.[4] They open up the scope for debt restructuring at a stage when the company’s business may still be viable.
2.Role of Existing Management:The Code entirely excludes the management of the corporate debtor once the insolvency resolution professional takes over. This may not be ideal in cases where the distress of the company cannot be attributed to the management and they may actually be able to play a role in the revival. Moreover, increased role of management would decrease the role played by insolvency professionals and thereby bring down the insolvency resolution process costs as well.
3.Prevents undue depreciation in value of assets:There is a stigma attached to insolvency which often plummets the value of whatever assets that may be remaining, especially of those businesses that are heavily dependent on reputation. This is not the case in pre-packs, as the plan of revival is drawn up in secrecy by way of negotiations between the management and creditors.
Indian Scenario
The interim bankruptcy law reforms committee, in its report debated on the viability of pre-packs in India. However, it was opined that the Indian market is currently not sufficiently developed to allow sales with zero intervention by the NCLT. Although, the report pointed out the possibility of allowing such arrangements after getting approved by NCLT within 30 days of filing. [5]
Further, the Supreme Court, in its decision in Lokhandwala Kataria Construction (P) Ltd. V. Nisus Finance and Investment Managers LLP allowed a settlement between the parties after the application was admitted even though the NCLT rules expressly prohibit the same.[6] Recently, the NCLT-Kolkata Bench suggested an out of court settlement in the matter of Binani Cements insolvency.[7] This incident sparked a debate on whether insolvency can be resolved through methods other than the formal Court-driven CIRP. The Supreme Court has allowed the out of court settlement bid to be considered by the committee of creditors along with other bids
Criticism
Though allowing such settlements may be desirable in the interests of corporate rescue, doing so in the absence of legal provisions to satisfy the claims of other creditors is dangerous in as much as it reminiscent of the time before the Code when the debtor was able to get away from not paying all the creditors, especially the unsecured ones.
Pre-packaged arrangements now in existence have received criticism on many grounds. One such ground is that there are increased chances of connected party sales to the existing management, their kin, promoters etc. with the sale grossly undervalued. Another drawback is that the market may not tested properly before the sale of assets leading them to be sold off at a lower value. Generally unsecured creditors who do not have access to information by way of contract are often left out of the negotiations nor are they given an opportunity to make representations. The business may be sold off without their claims being satisfactorily redressed.
The efficacy of pre-packs as an alternative informal insolvency arrangement is also questionable. There is no convincing evidence that pre-packs will always lead to maximum realization of value of assets. In cases where there are a large number of creditors with different interests, it will be difficult to reach an agreement to sell off the business to one or a few of the creditors. In those cases, formal bankruptcy procedure must be resorted to.
Conclusion
Nevertheless, the judicial trend and rise in resort to arbitration in India indicates the preference towards out of court/quasi-judicial insolvency resolution. Therefore, there is a need to amend the present insolvency regime so as to accommodate such pre-packs into the Indian insolvency regime. One existing method which could be utilized as a pre-pack is the scheme of arrangement under the Companies Act. A pre-pack pool, an independent body of professionals in existence in the U.K which offers opinion on the viability of the proposed sale of assets or any such arrangement, could be replicated in India to ensure transparency in the process. Giving the adjudicating authority power to sanction pre-packs would therefore be a right step towards a contractual approach to bankruptcy resolution while maintaining party autonomy in appropriate cases.
[1]In Re Pioneer Finance Corp., 246 B.R. 626 (Bankr. D. Nev. 2000).
[2] Bankruptcy Reform Act, 11 U.S.C. §§ 1101-1174 (1978).
[3]Gerard McCormack, Corporate Rescue, An Anglo-American Perspective 72 (2008).
[4]Bo Xie, Comparative Insolvency Law: The Pre-pack Approach in Corporate Rescue 323 (Edward Elgar Publishing, 2010).
[5] The Report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design 79( Bankruptcy Law Reforms Committee , Nov. 22 2015).
[6][2017] 140 CLA 215 (NCLAT).
[7]NCLT suggests out-of-court settlement between Binani Cement and Creditors Bloomberg Quint (27 March 2018 1:44 PM) www.bloombergquint.com/insolvency/2018/03/27/nclt-suggests-out-of-court-settlement-between-binani-cement-and-creditors (last visited on Apr. 8, 2018 7:27 GMT)