Resolving Insolvency Faster by Recognising Out-of-Court Workouts under the IBC

Reports by Corporate & Financial Law · February 29, 2020
Author(s): Oitihjya Sen, Shreya Prakash and Debanshu Mukherjee

Introduction

The Insolvency and Bankruptcy Code, 2016 (‘Code’) provides for strict time-lines for conclusion of insolvency proceedings. However, it is observed that in practice, it takes much longer to resolve insolvency cases than what was envisaged under the Code – a maximum of 330 days. The current average of successful resolutions is 394 days and this delay impacts all stakeholders negatively. 

In order to effectuate quick resolutions under the Code, a Report published by Vidhi Centre for Legal Policy, titled Designing a Framework for Pre-Packaged Insolvency Resolution in India: Some Ideas for Reform, builds a case for introduction of pre-packs in India.

What are pre-packs?

Largely, there are two approaches to rescuing a financially distressed company: private restructurings and formal insolvency proceedings. The former is an informal arrangement wherein a distressed debtor and its creditors negotiate and reach an agreement to restructure the debtor’s debts in order to revive it. The latter involves statutory proceedings where the process of restructuring takes place under judicial supervision.

Pre-packaged insolvency resolution, or pre-packs, combines the above approaches to corporate rescue, by providing statutory recognition and protection to workouts that are agreed between parties.

Advantages of pre-packs

Speed: A pre-pack process is generally significantly less time-consuming and expensive than formal proceedings. The speedy disposal of a pre-packaged case reduces the total cost involved in the process and preserves the value of the business, which can be crucial for the survival of small businesses.

Confidentiality: As a large part of the process takes place outside the statutory process, the publicity attached to formal proceedings can be avoided to a great extent. The element of confidentiality prevents value destruction that takes place on the commencement of formal insolvency proceedings, which can maximise the returns for all stakeholders.

Statutory Sanction: Unlike a purely private restructuring process, pre-packs operate within the fold of the statutory scheme. As a result, the final outcome of a pre-pack is binding on all stakeholders and is not under the threat of subsequent challenges. This certainty increases investor confidence and prevents the threat of non-compliance.

Context for introduction of pre-packs

Costs associated with formal proceedings: One of the key objectives behind the enactment of the Code was to provide a timely and efficient mechanism for resolving insolvency in India. Towards this end, the Code provides for strict-timelines: if creditors fail to resolve a debtor within the stipulated time-frame, the debtor needs to be compulsorily liquidated.

However, by way of judicial interpretation, certain time-periods, including time spent during judicial proceedings, have been exempted from this time-line. As a result, in practice, it takes on an average 394 days to successfully resolve a debtor under the Code, which is significantly greater than the 330-day timeline currently prescribed under the Code. Apart from delays, formal proceedings come with other significant costs – both direct (such as court fees, engagement with third party advisors such as lawyers, accountants etc.) and indirect (such as loss of reputation and goodwill, disruption of business, etc.)

Failure of out-of-court workouts in India: Unlike formal proceedings, out-of-court workouts are generally considered to be more efficient, as they provide a more flexible platform for parties to engage, that is not bound by formal procedures and strict time-lines. However, private restructuring mechanisms have not been very successful in India because of the lack of statutory sanction. For example, when the Corporate Debt Restructuring (CDR) Mechanism was rolled back by the Reserve Bank of India in 2018, only debts worth Rs 84,677 crores were resolved successfully while debts worth nearly Rs 1.84 trillion exited the CDR process without meeting any success.  

Impact of the Code on out-of-court workouts: Interestingly, the enactment of the Code, which is a creditor-centric statute, has boosted out-of-court workouts and has encouraged debtors to voluntarily resolve their debts at the pre-commencement stage itself. However, despite this, the Code does not formally recognise the outcome of private workouts, which makes them susceptible to future challenges by a dissenting creditor or the debtor itself. Further, the advantages available under the Code to the creditors cannot be availed during out-of-court workouts. For example, unlike a resolution plan approved under the Code, there is no threat of initiation of liquidation proceedings if the debtor fails to fulfil its obligations under the restructured debt agreement.

Hybrid system: Therefore, with a view to marry out-of-court workouts with formal proceedings, the Report proposes a framework for pre-packs, which is essentially a hybrid mechanism that can provide statutory recognition to out-of-court resolutions that are concluded between a debtor and its creditors.

Recommendations of the Report

Drawing on the international experience on pre-packs in the USA and UK, the unique features of the Code and the nature of the Indian financial ecosystem, the Report proposes three modes of pre-packs: a pre-packaged insolvency resolution process, a pre-arranged insolvency resolution process and a pre-arranged sale.

However, since there is no prevailing market practice or regulatory experience with respect to pre-packs in India, the Report proposes that any new framework for pre-packs should be implemented in a phased manner, starting with small debtors or others with no complications in their debt structure.

Pre-packaged insolvency resolution process will entail an insolvency professional being appointed at the pre-commencement stage, who will conduct a marketing exercise and invite resolution plans from prospective resolution applicants. Subsequently, the committee of creditors of the debtor will vote upon and approve the most viable plan. Thereafter, formal proceedings will be initiated by the insolvency professional for the plan to be approved by the Adjudicating Authority.

Pre-arranged insolvency resolution process is proposed for cases where it may not be feasible for creditors to vote during the pre-commencement stage. In a pre-arranged insolvency resolution process, the insolvency professional will invite and finalise a plan at the pre-commencement stage and then initiate formal proceedings for the plan to be approved by the committee of creditors and the Adjudicating Authority.

Pre-arranged sales are proposed for time-sensitive cases, which cannot withstand a prolonged insolvency proceeding. In a pre-arranged sale, the insolvency professional will be permitted to conduct a swift ‘going concern sale’ (i.e., sale of all assets) of the corporate debtor during the pre-commencement stage itself, without requiring the prior approval of creditors. However, as the insolvency professional will play a central role in a pre-arranged sale and as the profession of insolvency professionals is still at its nascent stage, it is proposed that pre-arranged sales should be enabled only after the profession has sufficiently developed.

Download the full report – Designing a Framework for Pre-Packaged Insolvency Resolution in India: Some Ideas for Reform


About Oitihjya Sen:

Oitihjya is a Research Fellow with the Vidhi Bankruptcy Studies Programme and the Corporate Law and Financial Regulation vertical. He is currently conducting research on insolvency law and policy in India. Oitihjya graduated with a B.A.LL.B. (Hons.) from Hidayatullah National Law University, Raipur in 2018. Prior to joining Vidhi, he has worked with the Corporate Legal Group of ICICI Bank, where he assisted in drafting security documents and in researching on rights of creditors under the Insolvency and Bankruptcy Code, 2016. Link to full bio


About Shreya Prakash:

Shreya is the Coordinator of the Vidhi Bankruptcy Research Programme & a Research Fellow with the Corporate Law and Financial Regulation vertical. Her research is focussed on insolvency law, corporate governance and financial regulation. At Vidhi, she has worked extensively with the Insolvency and Bankruptcy Board of India and the Ministry of Corporate Affairs, advising them on the implementation of the Insolvency and Bankruptcy Code, 2016 and the design of second-generation reforms, such as group insolvency, in the field. She is a member of the Joint Steering Committee of the Insolvency Research Foundation and the Taskforce on Insolvency Best Practices set up by the Society of Insolvency Practitioners of India. She has also worked on law and policy issues pertaining to companies law, debt markets, public finance, commercial remedies and regulatory architecture. Shreya is an alumna of the University of Oxford where she read for the BCL as the Zaiwalla scholar at the Oxford India Centre for Sustainable Development, and the National Law School of India University, Bangalore from where she graduated as a gold-medallist. She has previously written for publications such as Financial Express, Hindu BusinessLine & IndiaCorpLaw and served as an editor of the National Law School of India Review. Link to full bio


About Debanshu Mukherjee:

Debanshu is part of the founding team at Vidhi and leads its Corporate Law and Financial Regulation vertical. He graduated from the Hidayatullah National Law University and completed his graduate studies at Harvard University and the University of Oxford. He attended Harvard Law School as a Fulbright- Nehru Fellow where he was awarded the Irving Oberman Memorial Writing Prize in Bankruptcy and the Dean's Scholar Prize in Corporations. He has advised the Ministry of Finance, the Ministry of Corporate Affairs, the RBI and the IBBI on projects relating to bankruptcy, corporate law, and financial regulation. He was previously a lawyer with AZB & Partners. Link to full bio