The MCA has released the report of a sub-committee of the Insolvency Law Committee (ILC) tasked with preparing a detailed scheme for implementing a pre-packaged (pre-pack) and prearranged insolvency resolution process. The sub-committee, in its report, has designed a pre-pack framework within the basic structure of the Insolvency and Bankruptcy Code, 2016 (the “Code”) for the Indian market.  As its nomenclature suggests, pre-pack is a restructuring plan which is agreed to by the debtor and its creditors prior to the insolvency filing, and then sanctioned by the court on an expedited basis.

In drafting this framework, the sub-committee noted the various options presently available to a creditor for resolution of stress of its debtors, namely, the two court supervised statutory options of CIRP under the Code and scheme of compromise or arrangement (SoA) under the Companies Act, 2013, and the two out-of-court options, namely, RBI’s prudential framework for resolution of stressed assets and informal understanding between a debtor and creditor, with /without help of a mediator. It also examined pre-pack frameworks in select jurisdictions of UK, USA, Singapore, France, Canada and found that pre-pack is an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceeding.

The report recommends the simplest variant of a pre-pack, requiring the least preparation, which can be rolled out within the existing ecosystem as an additional option for resolution. This may be introduced in the Code by an Ordinance so as to constitute the formal part of the pre-pack, while the informal part could be left to market practice or guided by self-regulation, guidelines, best practices, etc. In any case, the new provisions would ensure that they do not impair rights of any party beyond what is provided in the Code and have adequate checks and balances to prevent any abuse.

The proposed legal framework of a Pre-pack is as under:

1. Pre-pack should be available for all Corporate Debtors (CDs),but could be implemented in phases. It should be initiated by the CD with the consent of simple majority of unrelated Financial Creditors (FCS)s (or unrelated Operational Creditors (OCs) where there are no FCs) and consent of simple majority of shareholders . The basis for initiation of pre-pack is Default, including Covid-19 defaults. Since pre-pack is a consensual process, unlike CIRP, the Government may consider a lower threshold of default for pre-pack as compared to that of CIRP. Later on, pre-default stress may be considered after having consent of a higher threshold of stakeholders, including OCs. Thus, it is recommended that pre-pack may be introduced in phases: (i) Default ranging from Rs.1 lakh to Rs. 1 crore and COVID-19 defaults, (ii) Default above Rs.1 crore, (iii) Default from Re.1 to Rs.1 lakh, and (iv) Pre-default stress. The phase (iv) should, however, require consent of higher threshold (say 75%) of creditors to avoid any potential misuse. However, both proceedings i.e. pre-pack and CIRP under the Code cannot run in parallel.

2. Before commencement of pre-pack, the following tasks may be carried out by the CD  – board meeting followed by general meeting of shareholders of the CD to approve the proposal to initiate pre-pack, engagement with creditors for approval by majority of unrelated FCs to the proposal, identification of an IP to act as RP, preparation and updating of records and information, preparation of resolution plan, etc. This process before the admission of the application should be flexible and not codified. After preparing itself for pre-pack and having complied with the specified requirements, the CD needs to file an application to the AA for initiation of pre-pack.

3. The pre-pack will be a hybrid model where the debtor will remain in possession and the creditor(s) in control, with clear demarcation of responsibilities of the CD, RP, and creditors. This will incentivise the CD to initiate pre-pack, as its management continues to run the business and has high possibility of retaining it through a resolution plan.

The CD should have access to interim finance subject to the approval of CoC, as is the current requirement under section 28 of the Code and it shall be included in the insolvency resolution process cost (IRPC). The IRPC for the purpose of pre-pack shall mean interim funding. The fees of RP will be fixed by the CD and borne by it and to the extent ratified by the CoC, shall form part of IRPC.

The CD shall make available to the RP an updated list of outstanding claims, including contingent and future claims. A draft IM (Information Memorandum) will be prepared by the CD  based on its books, duly certified by its Chairman/Managing Director/Managing Partner, along with an indemnification that if any claim is omitted by them, they will be personally liable to make such claim good. The IM shall be handed over to the RP on the pre-pack commencement date (PCD).Further, if the CD willfully provides any wrong information or omits to provide material information with respect to any claim, the same shall attract criminal liability.

4. Role of the Resolution Professional (RP)/Insolvency Professional (IP)  : The RP should ensure transparency and fairness of the process, safeguard the interests of stakeholders, business, and the public, and ensure compliances with the law as regards the process. IPs may play the role of RPs in pre-packs. IPs shall only conduct the process and not run the operations of the CD. The formal role of RP may begin with admission of the pre-pack, as it happens with CIRP. The choice of IP to act as RP and the terms of his appointment may have the consent of majority of unrelated FCs (unrelated OCs where the CD does not have any unrelated FC) and such IP may be appointed as RP by the AA. No specific provision for removal/replacement of RP is recommended except in case of death or incapacitation.

The RP should constitute the CoC comprising of unrelated FCs (unrelated OCs where the CD does not have any unrelated FC) within seven days of the prepack commencement date (PCD), based on the list of claimants provided by the CD and verified by the RP. The RP shall appoint two registered valuers to determine the ‘fair value’ and ‘liquidation value’ of the CD. He will also conduct the usual due diligence and make applications to the Adjudicating Authority (AA) in respect of avoidance transactions.

5. The CoC should approve or reject a resolution plan, like it does in a CIRP. It shall also approve decisions relating to (a) termination of process, (b) liquidation of the CD, and (c) matters under section 28. The requirement under the Code of approval by 66% voting shares for matters under section 28, replacement of RP and approval of resolution plan may continue under Pre-pack. However, since the pre-pack aims to reduce the possibility of liquidation, the decision to liquidate a CD should require approval by a higher threshold of creditors of 75% of voting power. The CoC should take decisions with votes of the required majority of those present and voting, except in case of decision to liquidate a CD.

6. Considering the shorter timeline available for pre-pack, and the simplified claim collation and verification process, the publication of public announcement on the website of CD and on the website designated by IBBI may suffice. The outreach of information utility (IU) should be leveraged to disseminate information about the commencement of pre-pack to the creditors of the CD.

7. Moratorium under section 14 of the Code should be available from the PCD till closure of process, whether by approval of resolution plan or otherwise. It shall not, however, cover essential and critical services.

8. Pre-pack resolution plan: The provisions of section 29A, which prohibits persons with specified disabilities to submit resolution plan in a CIRP, would not be diluted in respect of Resolution Applicants (RAs) for submission of resolution plans. The pre-pack should start with a base resolution plan, which will face Swiss Challenge. Under the ‘Swiss Challenge’ method, the highest bid (H1) in the first round of bidding becomes the base price for bidders including the H1 bidder, to place counter-bids in the second round of bidding. The stressed asset will go to the highest bidder in the second round. If no other bidder is able to better the H1 bid, the top bidder in the first round is declared the successful bidder. This challenge should come from the promoters if they are eligible and interested. Otherwise, the CoC may arrange a base plan. The design of the Swiss Challenge needs to balance the incentives and disincentives of the promoters and the swiss challenger so as to drive value maximisation. Details of such design should be specified through Regulations.

The pre-pack should offer two options : (i) without Swiss Challenge but no impairment to rights of OCs and (ii) with Swiss Challenge, with rights of OCs and dissenting FCs subject to the minimum provided under section 30(2)(b) (i.e the amount paid to such creditors in the event of liquidation of the CD under section 53 of the Code). The resolution value does not necessarily have to be higher than the realisable value. There should be no requirement of validation of the resolution value by an experienced person.

The pre-pack shall not end up with liquidation, except when the CoC decides to liquidate the CD with 75% voting share. However, where pre-pack is initiated for pre-default stress or default below the threshold for initiation of CIRP and COVID-19 defaults, there will be no liquidation.

The pre-pack should allow 90 days for submission of the resolution plan to the AA and 30 days thereafter for the AA to approve or reject it. The resolution plan approved by the AA shall be binding on everyone. The successful resolution applicant shall start on a clean slate. The regulatory benefits, as are available for CIRP, shall be available for pre-pack as well.

9. Closure of Process : A pre-pack process may conclude by an order of the AA, based on an application by the RP, under any of the following circumstances:
   • Approval of Resolution Plan: Where the process yields a resolution plan which is approved by the CoC, the RP shall file the same with the AA in the manner provided under section 30(6) for its approval. Upon approval of the plan by the AA, it shall be binding on the CD and other stakeholders, as provided under section 31 for CIRP.
   • No resolution received or approved: The process will close where no resolution plan is received, or where no resolution plan is approved by the CoC, or where resolution plan is not approved by the AA, whichever is the earliest. On closure, a stakeholder may use CIRP to resolve stress of the CD.
   • Expiry of Timeline: The pre-pack process shall close on the expiry of 90th day, except where the application for approval of resolution plan has been submitted to the AA for approval.
   • Termination by CoC: The conduct of the CD is critical. For example, it needs to fully co-operate with the RP and the CoC to complete the process. The CoC may close the process with 66% of creditors, present and voting, if the CD does not conduct itself well. Since the process is initiated on an application of the CD, it may not be closed by withdrawal of application after admission.
   • Liquidation: The CoC may decide anytime, including in its first meeting, to liquidate the CD for any reason, including commercial considerations, conduct of the CD, with 75% of voting share. There will, however, be no liquidation where pre-pack was initiated for pre-default stress, default below the threshold for initiation of CIRP (which is Rs. 1 crore at present) or COVID-19 defaults.

Public comments to the Report and legal framework of pre-pack have been invited by 22 January 2021. To refer to the Report of the sub-committee dated 31 October 2020 and the MCA notice inviting public comments, dated 8 January 2021, click here.