Getting prepacks to work well: The framework must refrain from stipulating a Swiss Challenge method

By L Viswanathan & Richa Roy

Prepacks are indispensable in insolvency legal infrastructure, especially given the imminent Covid-19-induced deluge of distress—the IMF recently advised policymakers regarding ‘pent-up bankruptcies’. The World Bank, in May 2020, recommended raising barriers to creditor filings (which India undertook through the IBC Ordinance precluding filings), and establishing hybrid workout frameworks. The IBBI’s draft prepack framework for public consultation is, therefore, apposite, supplementing Budget announcements on ARC-AMC and NCLT capacity augmentation. India joins jurisdictions, including the UK and Singapore, in introducing (or reworking) a prepack framework.

Indian insolvency law reforms have been ahead of the curve, but the prepack framework needs overhaul for effective impact. It envisages initiation of prepacks by debtors only; upon authorisation by a simple majority of financial creditors & shareholders; on default—each needs a rethink. While permitting debtors to initiate prepacks is useful—they are best informed about company affairs and incentivised to file since they can propose plans; rightly acknowledged by the framework—the vital financial creditor’s right to trigger prepacks must not be curtailed. The framework notes that the IBC’s ‘basic structure’ includes the inviolable principle of creditor control—critical to this is triggering the process.

Shareholder approval should be obviated for initiation and all corporate actions during prepack. Also, prepacks will invariably pare down creditor payouts—a justifiable basis to limit shareholder participation. Prepacks are consensual resolutions, and possible trigger may be prior to default—incipient stress, defaults in financial covenants, as contemplated in RBI regulations (while the CIRP trigger could continue to be default). Safeguards against abuse include authorisation by financial creditors and existing IBC penalties.

Financial services providers (FSPs) are excluded from prepacks, given that only debtors can initiate resolution, and under IBC FSP rules RBI initiates FSP insolvency. Recent events underscore the imperative for a swift, predictable resolution framework for FSPs. Prepacks are ideal for FSPs, enabling resolution with minimal disruption to financial system and depositors. In the US, under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Section 165d) systemically-important banks & financial institutions must periodically submit prepacked plans (living wills) to the Federal Reserve and the Federal Deposit Insurance Corporation, describing their strategy for rapid, orderly resolution upon financial distress or failure. Recent fragilities in India’s financial sector demand FSPs’ eligibility for prepacks, and subsequently becoming a periodic regulatory requirement.

Towards maintaining the hybrid model of ‘debtor-in-possession’ and ‘creditor-in-control’, prepacks—while allowing existing management to continue—must require the appointed RP acts to protect financial creditors, preventing any management ‘poison-pill’ actions when management apprehends financial creditors choosing a resolution plan other than the debtor’s. But a further tempering of Section 29A, at least with regard to clause(c)—i.e. legacy distress (could be addressed through the prepack itself)—is critical.

Rightly noting that prepack subordinate legislation should not be over-prescriptive and meet the proportionality principle, the prepack framework must refrain from stipulating a Swiss Challenge method. Simply providing for certification by the RP that the prepack outcome is better than liquidation, has approval of financial creditors, and incorporates safeguards for ‘cramdown’ of creditors (including cross-class cramdown as in the IBC, recently also adopted by the UK and court-approved in the DeepOcean case) will ensure effective completion within 90 days.

The IBBI’s statistics reveal delays with resolutions taking on average 443 days—exceeding the 330-day prescription, and high-value cases over two years. The framework’s intention for completion of all CIRP and other actions in 90 days is inconceivable. Instead, prepacks should rely on RP certification with creditor supervision. Gita Gopinath in ‘Foreign Policy’ urged governments to tailor resolution mechanisms for the current crisis. With these amendments, the prepack framework will be a timely intervention for the present but also a timeless tool in our insolvency law cache. Absent such amendments, there is a grave danger of losing the hard-fought progress made on insolvency resolution.

Authors are partners at Cyril Amarchand Mangaldas