Debt Restructuring in India (2/2): Issues with Pre-Packs as a Solution
By Ganesh Gopalakrishnan (Research Fellow, National Institute of Public Finance and Policy, New Delhi) and Urmika Tripathi (Legal Consultant, REDD Intelligence)
Introduction
In a previous post dealing with the challenges and framework of debt restructuring in India, especially in times of COVID-19, we mentioned that the market was advocating for a hybrid solution having characteristics of both a court-monitored insolvency framework as well as an out-of-court restructuring process. Given the recognized issues with the RBI-issued ‘Prudential Framework for Resolution of Stressed Assets’ (the “Prudential Framework”), the (Indian) Ministry of Corporate Affairs set up a sub-committee under the Insolvency Law Committee to study and recommend a regulatory framework for pre-pack insolvency resolution process in June (for the purposes of this article, the term pre-pack has been used to mean and include references to pre-packaged insolvency processes and pre-arranged insolvency processes). The mandate for the sub-committee requires that the framework must set out the pre-requisites for an insolvency resolution process in terms of default and threshold, role and responsibilities of the committee of creditors, and timelines for completion of the process. The sub-committee has submitted its report in the first week of November, as per a local report.
While the findings of the sub-committee are still unknown, what we do know based on media reports so far is that the pre-packs framework is likely to come into effect once the suspension on the initiation of new corporate insolvency resolution processes is lifted. The framework is likely to complement the corporate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016 (“IBC”) by providing another channel for out-of-court settlements. The Chairperson of the IBBI visualises it as a ‘hybrid between the court supervised insolvency framework and out-of-court restructuring schemes that harnesses the best of both the worlds sans their demerits and provides a formal framework for resolutions that are happening today in the shadow or on account of the Code [IBC]’. While the intent behind a framework for pre-packs is noble, in the totality of circumstances, the chances of its success being greater relative to the Prudential Framework or debt restructuring schemes are uncertain. We discuss certain reasons for our apprehensions.
Reaching intercreditor consensus is difficult
The success and efficiency of the pre-packs framework for resolution of stressed assets is likely to depend on getting different creditors on board with the resolution plan. However, there has been a demonstrated inability in getting diverse groups of creditors to agree to a consensus-based restructuring process. This has led to the undoing of many processes under the existing resolution frameworks in India. For example, as part of Project Sashakt, more than 85 financial institutions including public sector banks, private banks, and foreign banks came together in 2018 to sign a master intercreditor agreement to address resolution of stressed assets. The master intercreditor agreement envisages that the lead lender would take the initiative to arrive at the terms of the resolution plan, oversee the resolution process and its implementation. After the Prudential Framework came into effect in 2019, the master intercreditor agreement was amended to incorporate the new terms. Based on the master intercreditor agreement, an ICA that is tailored for a specific transaction could be separately executed for different distressed accounts.
The master intercreditor agreement sought to contractually address three key problems that were persisting in the then-framework: first, there was an intent to transition intercreditor interactions from a largely ad-hoc system to one where there was a pre-fabricated intercreditor agreement; second, there was a need to lend operational certainty to the enforcement of the provisions of the intercreditor agreement, at least indirectly, by reducing the number of instances of ‘rogue’ creditors who could independently pursue insolvency proceedings; and third, there was a need for a stand-still arrangement or moratorium to take effect that at least reasonably binds a majority of creditors. Amongst these, the effectiveness of the latter two directly rely on the number of creditors that sign the intercreditor agreement, as fewer excluded creditors means lesser chances of the resolution process being derailed by insolvency or enforcement proceedings by individual creditors.
Despite the solutions offered, creditors appear to have misgivings about entering into intercreditor agreements. A survey suggested that there have been delays in entering into the intercreditor agreement in a significant number of cases. Although this is not wholly unexpected, given that different creditors may prioritise different courses of action depending on their security interest and independent perceptions about value maximization and efficient recovery, there must be reasons for why intercreditor action remains coordinated at a macro-level but inconsistent in its application at a micro-level. This experience suggests that a presupposition of coordination between different creditors comes at great risk in India. Delays in achieving such consensus in various instances of restructuring under the Prudential Framework suggest that even if a consensus amongst different creditors is achieved eventually, the process is likely to be time consuming and will likely remain subject to delays on account of litigation by dissenting creditors.
Evidently, one of the primary goals of introducing the pre-packs framework is to provide a quicker alternative to the resolution process under the Prudential Framework or IBC. Unless the proposed pre-packs framework specifically addresses the problem of reaching a consensus amongst diverse creditors on an expedited basis, it remains to be seen how its goal of speeding up resolution process can be achieved.
Participation by borrowers and third-party security providers
Pre-packs may require an alignment of the terms of the resolution plan between not only the creditors, but the borrower as well. The possibility of the borrower agreeing to the terms of the resolution has been claimed as potentially incentivizing creditors to negotiate and finalise resolution plans, as it reduces the possibility of adversarial legal filings by the borrower against the resolution plan. A pre-pack resolution process is additionally differentiated from the Prudential Framework by likely requiring a stamp of regulatory approval from the NCLT. This may, in theory at least, lend more teeth to its enforcement.
However, given that the master intercreditor agreement has been signed by almost all major banks and financial institutions, and has been modified to incorporate the terms under the Prudential Framework by the RBI, enforceability of resolution plans does not appear to be a significantly worrisome issue under the existing framework in the first place. As a result, the relatively greater certainty offered by a regulatory approval by the pre-packs framework is unlikely to solve any immediate concerns in the short-term.
On the other hand, there are more serious concerns about the chances of reaching a mutually agreeable resolution plan under a pre-packs framework where the transaction involves third party security providers or guarantors, as there are more counterparties to be brought on board, whose objectives may differ from the borrower’s and the creditors’. The participation of the borrower may not necessarily improve the time taken to finalize/approve a resolution plan, the quality of resolution plan, or increase the chances of a successful resolution. The initial challenge of achieving consensus among all creditors in short timelines remains both under the Prudential Framework as well as the pre-packs process.
Position of minority and unsecured creditors
The positions of operational creditors (as defined under the IBC) and unsecured creditors are likely to remain the same under the Prudential Framework and the pre-packs framework. None of these frameworks incentivizes nor places these creditors at a position of sufficient power for their participation in intercreditor forums. Past evidence indicates that many insolvency resolution processes under the IBC have faced delays on account of litigation by operational creditors on the ground of unfair treatment under the resolution plan. Again, it is difficult to imagine why a pre-pack mechanism would be quicker, when it is also likely to face delays on account of litigation and challenges by operational creditors.
As mentioned above, a common concern that plagues the Prudential Framework is that non-signatories to the intercreditor agreement cannot be stopped from independently initiating insolvency or enforcement proceedings. It will be interesting to see if the proposed framework for pre-packs provides for imposition of a stand-still period or a moratorium similar to the one available for insolvency processes under the IBC. This might help in ensuring that the pre-pack resolution process is protected until its implementation is completed, and its application on non-signatory creditors could be made subject to a certain percentage of creditors of the borrower electing to proceed with the resolution plan.
Inclusion of ‘29A entities’
Under section 29A of the IBC, certain persons – such as convicted offenders, entities holding non-performing accounts (“NPAs”) (where interest or the principal has been due for more than 90 days) for a period of at least one year prior to initiation of the relevant insolvency proceedings, wilful defaulters, or promoters of the corporate borrower (under specific circumstances) – are prohibited from submitting resolution plans for a corporate borrower. As per a report, these persons – the ‘29A entities’ may be excluded from participating in a pre-pack resolution process. The report further states that the proposed pre-pack framework will not be available to promoters who are ineligible under s.29A as per the report. While the details of the proposed pre-pack framework are not yet available, if the intention is to restrict promoters who are disqualified under s.29A from bidding in the pre-pack process, then such a restriction is likely to cover many promoters. As mentioned above, one of the disqualifications under s.29A relates to holding NPAs. Promoters of a distressed company are likely to be disqualified on this ground, unless the sub-committee has suggested some relaxations in this regard.
Given the possibility of reduced interest by third party bidders in the current COVID-19-induced slowdown, expansion of eligible bidders to promoters (other than those who are disqualified on grounds of being a wilful defaulter or committing fraud) may be crucial for any alternative framework to succeed. To address concerns with allowing promoters to bid, a trade-off in terms of extensive reporting and/or disclosure requirements may be considered. It will also be interesting to see the modalities and processes set out for participation of promoters in the proposed pre-pack resolution process, especially if the resolution plan involves sale of assets to third parties.
Conclusion
Given the similarities in approach and defects, the pre-packs framework may not present a clear alternative to the existing mechanisms for resolution and restructuring in India. One of the end goals of introducing a pre-packs framework is to lessen the caseload on the NCLT, but in the absence of any obvious advantage over existing restructuring mechanisms, one remains sceptical on its fulfilment.
Apart from the issues highlighted above, establishing adequate thresholds for approval of plans, laying down mechanisms to cram down dissenting creditors, binding dissenting creditors to the pre-pack process, incentivizing participation by creditors and creating necessary checks to prevent litigation by non-participating creditors, and binding offshore enforcement processes by creditors to Indian law are other key objectives for the pre-packs framework. The fulfilment of these objectives is critical for the pre-packs framework to be considered as a viable alternative.
In this regulatory environment, there are more pressing short-term concerns for the IBBI and the Central Government to solve – looking into the ‘rogue’ creditor problem, and the regulatory and legal vacuum over foreign creditors and foreign-law governed documents, for instance. These issues must be solved as priority, or at least in parallel to a pre-packs framework, which may offer little to no advantage if not carefully considered.