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What are pre-packs under the present insolvency regime?

Topics Covered: Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

What are pre-packs under the present insolvency regime?

Context:

The Ministry of Corporate Affairs (MCA) has set up a committee to look into the possibility of including what are called “pre-packs” under the current insolvency regime to offer faster insolvency resolution under the Insolvency and Bankruptcy Code (IBC).

So, what is a pre-pack?

Also called as a pre-packaged insolvency, It is an agreement for the resolution of the debt of a distressed company.

  • It is done through an agreement between secured creditors and investors instead of a public bidding process.
  • The process needs to be completed within 90 days so that all stakeholders retain faith in the system.

Benefits of a pre-pack:

  1. Faster: This process would likely be completed much faster than the traditional Corporate Insolvency Resolution Process (CIRP) which requires that the creditors of the distressed company allow for an open auction for qualified investors to bid for the distressed company.
  2. It would act as an important alternative resolution mechanism to the CIRP and would help lower the burden on the National Company Law Tribunal (NCLT).
  3. In the case of pre-packs, the incumbent management retains control of the company until a final agreement is reached. This is necessary because Transfer of control from the incumbent management to an insolvency professional as is the case in the CIRP leads to disruptions in the business and loss of some high-quality human resources and asset value.
  4. Also, a financially distressed company can continue its operations during the period leading to a formal default, and even thereafter, without the resultant reputational risks, business disruptions, or value erosion.

What are some of the drawbacks of pre-pack?

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.

  • 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.

Unlike in the case of a full-fledged CIRP which allows for price discovery, in the case of a pre-pack the NCLT would only be able to evaluate a resolution plan based on submissions by the creditors and the investor.

Do we need pre-packs?

Yes. It is because slow progress in the resolution of distressed companies has been one of the key issues raised by creditors regarding the CIRP under the IBC.

  • 738 of 2,170 ongoing insolvency resolution processes have already taken more than 270 days at the end of March.
  • Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings.

For IBC, please go through:

https://www.insightsonindia.com/2020/06/08/insolvency-and-bankruptcy-code/.

InstaLinks:

Prelims Link:

  1. What is insolvency and bankruptcy?
  2. Various institutions established under the IBC code.
  3. NCLT- composition and functions.
  4. What are debt recovery tribunals?
  5. Sections 7, 9 and 10 of IBC.
  6. Threshold for invoking insolvency under IBC.
  7. Composition of Insolvency and Bankruptcy Board.

Mains Link:

Discuss how suspension of initiation of fresh insolvency proceedings will help shield companies impacted by the outbreak of Covid-19.

Sources: Indian Express.