[By Damini Chouhan and Vinisha Jain]
The authors are fourth-year students at the Institute of Law, Nirma University, Ahmedabad.
Introduction
The Indian Insolvency Law Committee (hereinafter “ILC”) believes that pre-pack models must be introduced as an alternative to Corporate Insolvency Resolution Process (hereinafter “CIRP”) to ease the insolvency process. ILC formed the Sub-Committee of the Insolvency Law Committee on Pre-packaged Insolvency Resolution Process (hereinafter “sub-committee”). This sub-committee proposed a pre-pack model to the government in October 2020. A pre-packaged insolvency resolution process can be encapsulated as follows. First, it will be available for insolvency resolution as a supplementary method along with CIRP but it shall not run parallel to it. Second, the process commences when the promoters submit a base plan after completion of other formalities. In order to upgrade the value of the Corporate Debtor (hereinafter “CD”), a model of Swiss Challenge has been introduced wherein the base plan submitted by the promoters may or may not be opened to a bid. To begin with, the base plan will have to be necessarily opened to Swiss Challenge if it does not propose to pay the Operational Creditors (hereinafter “OCs”) of the CD in full. On the contrary, if the base plan proposes to pay the OCs in full, the Committee of Creditors (hereinafter “CoC”) is free to decide according to its commercial wisdom whether or not this base plan shall be opened to a Swiss Challenge. Evidently, the optional approaches of the Swiss Challenge are the deciding factors for the outcome of the entire process. These approaches in turn are dependent on the payment proposed to be made to the OCs. Though protection has been imparted to OCs, the protection is hinged upon certain assumptions. This article, therefore, analyzes this provision in light of its probable fallouts and the importance of OCs.
The Proposed Swiss-Challenge Model
Swiss Challenge is a bidding process where each applicant makes a better offer than the existing one, to secure the contract. It would now be introduced to the insolvency resolution process as well. As mentioned above, the proposed provision which is based on the payment to the OCs presents a binary approach with respect to the Swiss Challenge. The CoC has been made responsible to act in this respect according to the following two situations: first where the base plan proposes to pay the OCs in full and second where the base plan does not propose to make good the entire claim of the OCs.
In the first scenario, the CoC has the choice to decide whether or not the base plan will be opened to Swiss Challenge and if CoC feels that it suffices in terms of value, CoC may accept the base plan and not open it to Swiss Challenge. On the other hand, if it feels that the base plan does not give the best value, the CoC applying its commercial wisdom may open it to the Swiss Challenge. Hence, in either case, the entire claim of OCs is protected irrespective of whether the base plan is opened to Swiss Challenge or not.
In the second scenario, where the base plan does not propose to make good the entire debt owed to the OCs, the CoC has to mandatorily open the base plan to Swiss Challenge. A single round of bidding would take place and the plan that offers the best value shall proceed further in the process. The promoters shall be given a chance to match their base plan to such a competing plan. It is not necessary that the value escalation in the plan that is finally accepted reaches a stage where the entire claim of OCs is covered. Nevertheless, the OCs have to be paid the minimum liquidation value or no plan will be accepted and the pre-pack would close without consequence.
Scope of Improvement
In both scenarios, payment of at least the liquidation value to OCs is guaranteed incongruity with the existing CIRP Regulations.[i] Sadly, the liquidation value is generally way too less than what is owed to the OCs. The case of Maharashtra Seamless Limited v. Padmanabhan Venkatesh & Ors is an illustration of such situations where the liquidation value is not even close to the claimed amount. ILC acknowledged this issue in its 2018 Report, but it did not suggest any amendments due to the following reasons. First, even though the liquidation value is the mandate, it was observed that what the OCs actually receive is way above the liquidation value in most cases. Second, when the OCs receive a very less amount, it is in cases where the stress on the CD is extremely high. Third, no representations or evidence that suggest otherwise could be found.
Hence, it decided to continue with the status quo, despite the fact that current law provides an inherent scope to the CoC and Resolution Applicants to lawfully leave the OCs with only a meager payout. It seems like ILC is turning a blind eye to a bomb just because it has not exploded. Similarly, just because there is no prima facie evidence of inequitable treatment, does not mean that such treatment is not there. Therefore, even if the faith of ILC in the maturity of CIRP is to be relied upon, the same cannot be said for pre-packs. It would be unwise to continue with the same position of law for the pre-packs regime as well, presuming that pre-packs would work out the same way as CIRP. Moreover, given the role of OCs as suppliers of working capital, in order for a CD to continue as a ‘going concern’, the aim should not just be to protect the OCs but also to incentivize them.
Conclusion & Suggestions
In both the scenarios of the Swiss Challenge model, the position of the OCs can be further strengthened or they will remain aloof from the value escalation or additional benefits that pre-packs offer. An express provision mandating equitable payouts to all the creditors in cases of abnormal profits or distribution of all additional gains on a pro-rata basis can be added. Likewise, since pre-pack is a hybrid and informal process which is likely to yield higher value for the CD, it would also be conducive to set fair value as the floor payment to OCs and dissenting Financial Creditors as opposed to liquidation value which is prone to discriminatory implementation. Since, the OCs often have very high stakes in the business of the CD, the prioritization and protection provided to them under the Code shall no longer suffice. If the goal is to hike credit availability, the current times render it necessary that OCs along with other creditors are lured with value-addition and not just value protection. With the introduction of pre-packs in the insolvency structure of India, the need for a more subjective treatment of creditors is called for and therefore the provision of the Swiss Challenge must be tuned accordingly.
[i] Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, reg. 38(1), Gazette of India, Extraordinary, pt. III, Sec.4 (November 30, 2016).