What is Pre-pack?

In common parlance, pre-packaged insolvency resolution process (or pre-packs as popularly known) is essentially a negotiated agreement between the founders/management of the ailing entity and its secured creditors for the resolution of its debts. It is basically a restructuring plan where a debtor (company and its founders) and creditors of distressed entity agree upon a resolution plan before filing the insolvency application (unlike the CIRP process where application is filed immediately on default and well before any resolution or negotiation) and then sanction of the court is sought on the said resolution plan. The key difference between the regular CIRP and pre-pack is that in the pre-pack process, the existing founders/management retains control until the final agreement is agreed upon and the formal application is made to the court. Further, the process is entirely informal in the pre-packs in a sense (as opposite to CIRP process where things are advanced through a typical formal court process) with the sole aim of faster resolution of distressed entity. Thus, in nutshell, it is a mix of the court-oriented process under IBC (i.e. CIRP) and the erstwhile debt restructuring mechanism involving lender/banks such as OTS, SDR etc. with the twist of inviting PRA, when the proposal submitted by CD/existing stakeholders does not fulfill certain criteria.

Why Pre-Pack introduced now?

The purpose behind introducing pre-packs, as an alternative route (especially for MSME), is to lessen the burden on the Adjudicating Authority, faster resolution of the distressed assets, exploring quick revival with the involvement and support from the existing shareholders/management, avoiding unnecessary time and cost involved in the litigation and opening a window for MSME sector for reviving the ailing entity as the MSME is not likely to attract much interest from the investor/bidder due to very nature of their structure, size etc.

Thus, it involves the existing shareholders/management, giving them first chance to negotiate the deal with the secured creditors when there is default from their (i.e. company/management) side. The chances of success of pre-packs become high once all (creditors, founders etc.) are on board and negotiate the entire process internally between them. Most importantly, the cost of resolution under pre-pack is significantly lower as compared to regular CIRP as the substantial part of the process (in pre-packs) is informal in nature and this may be helpful in running the ailing entity for longer period of time due to quick decision and support from the existing management.

Does Pre-pack have any limitations?

Due to its very nature (i.e. negotiated arrangement between secured creditors and the stakeholders of the stressed entity), the pre-pack does not involve public bidding of the distressed entity and thus have less transparency as compared to the regular CIRP process. Here, financial creditors reach an agreement with a potential investor and/or stakeholders privately and not through an open bidding process.

Thus, pre-pack arrangements are, by its nature, very confidential and less transparent (as compared to regular CIRP) and due to this single fact, sometimes unsecured creditors may feel helpless or disinterested in the entire process due to high secrecy.

What does the Ordinance provide for Pre-pack?

• New Chapter Added : The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 has inserted Chapter III A titled Pre-packaged Insolvency Resolution Processcontaining Section 54A to 54P
• Eligibility: Section 54A lays down the eligibility conditions for initiation of pre-packaged insolvency resolution process (hereinafter referred to as “PPIRP”). Section 54A (1) clearly says that an application for initiating PPIRP may be made in respect of a CD classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.
• RP, Appointment & Duties: As already explained, the PPIRP involves the existing management and the secured creditors of the ailing entity, the name of the Resolution Professional (hereinafter referred to as “RP”) will be proposed (similar to CIRP) by financial creditors only. Section 54B and section 54F specifies the duties to be carried by the RP before initiation of PPIRP and after initiation of PPIRP respectively.
• Application & Time Limit: The CD shall file an application for initiation in accordance with section 54C of the Code and the Adjudicating Authority shall pass an order accepting or rejecting it within 14 days. The time limit for completion of PPIRP is 120 days from the pre-packaged insolvency commencement date.
• Claim, IM and Management of Affairs: Within 2 days of commencement, the CD shall publish a list of claims along with details and submit preliminary information memorandum to the RP. The management of affairs of CD shall continue to vest in Board of Directors, however, the CoC may resolve to vest it with the RP by vote of at least sixty six percent, upon which the RP shall make an application to the Adjudicating Authority (hereinafter referred to as “AA”) under section 54J.
• Resolution Plan& Approval/Termination of PPIRP: Sub-section 4(c) of Section 54A talks about submission of base resolution plan (which conform to Section 54K and other conditions as prescribed) by the CD to the FC. Section 54K lays down detailed provisions regarding the treatment of such base resolution plan (BRP), providing opportunity to CD for revision in BRP, circumstances leading to invitation of prospective resolution applicant (PRA) by the RP and competing the PRA/plan submitted by PRA with the BRP submitted by the CD. The provisions states that the CD shall submit BRP to the RP within 2 days of the commencement date, and the RP shall present it to the CoC. CoC may provide an opportunity to CD to revise the BRP. Further, where such BRP is not approved or impairs the claims of operational creditors (OC), PRA will be invited and then asked to compete with BRP submitted by the CD. If no resolution plan is approved, application for termination of PPIRP shall be filed by RP. In case a plan is approved, it shall be put forth AA and within 30 days of receipt, the AA shall pass an order approving or rejecting the plan under Section 54L. Appeal against such an order will lie under Section 54 M on the grounds laid down in section 61(3).
• Avoidance Application: The RP has to file an application for avoidance of transactions under Chapter III or fraudulent or wrongful trading under Chapter VI, if any, in accordance with 54F(h).
• Initiating CIRP: The CoC, at any time after the pre-packaged insolvency commencement date but before the approval of resolution plan, resolve to initiate CIRP as per Section 54 O, if such CD is eligible under Chapter II.

Will Pre-pack be successful?

This is the million-dollar question which only the time will tell whether pre-pack will be successful or not. Given the intent behind introducing such pre-packs, Government aims at providing relief to MSME sector and given the nature of business/structure MSME, such ailing MSME may not find much business interest from the PRA and therefore, the concept of BRP has been introduced. Second aim seems to be to lessen the burden of Adjudicating Authority and make the process flexible and faster, which of course, PPRIP may offer due to very nature of the entire process. Now the time will tell whether such MSME sector sees the same amount of litigation/court proceedings which we have seen in regular CIRP or this new concept will sail through and achieves its aim. However, as of now, in order to avoid large number of liquidations in the MSME sector and reduce the burden on the Adjudicating Authority, it seems the right step.

ADV SAUMYA MODI