Why pre-packs are introduced ?

• According to sources aware of developments, pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate while still providing adequate protections so that the system is not misused by firms to avoid making payments to creditors.
• Prepacks will help corporate debtors to enter into consensual restructuring with lenders and address the entire liability side of the company. The government should consider setting up specific benches of the NCLT to deal with pre-pack resolution plans to ensure that they are implemented in a time-bound manner.
• One of the key criticisms of the CIRP has been the time taken for resolution.  At the end of December 2020, over 86 per cent of the 1717 ongoing insolvency resolution proceedings had crossed the 270-day threshold. One of the key reasons behind delays in the CIRPs are prolonged litigations by erstwhile promoters and potential bidders.
• The pre-pack in contrast is limited to a maximum of 120 days with only 90 days available to the stakeholders to bring the resolution plan to the NCLT.
• Another key difference between pre-packs and CIRP is that the existing management retains control in the case of pre-packs while a resolution professional takes control of the debtor as a representative of financial creditors in the case of CIRP. Experts note that this allows for minimal disruption of operations relative to a CIRP.
• The key drawback of a pre-packaged insolvency resolution is the reduced transparency compared to the CIRP as financial creditors would reach an agreement with a potential investor privately and not through an open bidding process. Experts said this could lead to stakeholders such as operational creditors raising issues of fair treatment when financial creditors reach agreements to reduce the liabilities of the distressed company.

When Pre-Pack was first introduced?
The practice of pre-packs was first developed in the US, following the enactment of the Bankruptcy Reform Act of 1978. This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade. It provides for a time-bound process to resolve insolvency.  When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency within a 180-day period.  To ensure an uninterrupted resolution process, the Code also provides immunity to debtors from resolution claims of creditors during this period. The Code also consolidates provisions of the current legislative framework to form a common forum for debtors and creditors of all classes to resolve insolvency.The insolvency resolution in India took 4.3 years on an average.  This is higher when compared to other countries such as United Kingdom (1 year) and United States of America (1.5 years).

Where Swiss Challenge can be used ?
A Swiss Challenge is a method of bidding, often used in public projects, in which an interested party initiates a proposal for a contract or the bid for a project. The government then puts the details of the project out in the public and invites proposals from others interested in executing it. On the receipt of these bids, the original contractor gets an opportunity to match the best bid.
Applied to the ongoing bankruptcy cases, a Swiss Challenge may entail two rounds of bidding for a distressed company or its assets. Assume that Company A wins the first round of bidding by a quoting a price of ₹5,000 crore for a power plant. This will be made public and a second set of bids invited. If Company B quotes ₹5,500 crore, Company A will be offered a second opportunity to match it. If it refuses, Company B would be declared the winning bidder. If Company A steps up, then it will bag the power plant at ₹5,500 crore.

Who facilitates the insolvency resolution under the Insolvency and bankruptcy Code?

The Code creates various institutions to facilitate resolution of insolvency.  These are as follows:

• Insolvency Professionals: A specialised cadre of licensed professionals is proposed to be created. These professionals will administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.
• Insolvency Professional Agencies: The insolvency professionals will be registered with insolvency professional agencies. The agencies conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
• Information Utilities: Creditors will report financial information of the debt owed to them by the debtor. Such information will include records of debt, liabilities and defaults.
• Adjudicating authorities: The proceedings of the resolution process will be adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The duties of the authorities will include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
• Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.  The Board will consist of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.

How are creditors protected from misuse by promoters to simply reduce liabilities and retain control?
Experts noted that the pre-pack provisions introduced by the central government also provided for adequate protection to ensure the provisions were not misused by errant promoters. The pre-pack mechanism allows for a swiss challenge for any resolution plans which proved less than full recovery of dues for operational creditors. Under the swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company and the original applicant would have to either match the improved resolution plan or forego the investment.
Adopting plan evaluation process akin to Swiss Challenge, it (the pre-pack mechanism) retains competitive tension such that promoters propose plans with least impairment to rights and claims of creditors. The option available to creditors to require the promoters dilute their shareholding in case the resolution plan provides for impairment of claims by creditors would also be a significant deterrent against “unreasonable terms” in resolution plans. Creditors are also permitted to seek resolution plans from any third party if they are not satisfied with the resolution plan put forth by the promoter.