Background and purpose of the proposals
On 8th January proposals for a new ‘Prepackaged Insolvency Resolution Process’ ("PIRP") were issued by the Indian Ministry of Corporate Affairs for public consultation, and we have considered them from a foreign perspective.
The proposals are continuing evidence of the Indian Government’s admirable ongoing commitment to swift further development and improvement of the insolvency framework that was introduced five years ago in the Insolvency and Bankruptcy Code (“IBC”).
The IBC, itself a game changer, has been amended several times already, but these proposals if implemented would be a very radical change. The thrust of the PIRP is to encourage Corporate Debtors (“CDS”)– who likely are those most interested in doing so - to put forward their own restructuring proposals. It does so by following a debtor in possession model.
The existing shareholders and management continue to run the business while proposing their own Resolution Plan - which is then used as a stalking horse against which other bids are solicited. In contrast, under a Corporate Insolvency Resolution Process ("CIRP”) under the IBC control of the business passes to an Insolvency Practitioner. When the IBC was introduced, that change of control was perceived to be critically important.
The proposals are clearly designed to encourage CDs to recognise and address financial distress at an early stage. This is good, and absolutely in tune with responsible management. The PIRP will nonetheless be considered to be Insolvency Proceedings and carry that stigma, since they follow so closely the framework in the IBC – for example being triggered by financial default, protected by a moratorium on enforcement, monitored by an Insolvency Practitioner in a formal role and so on.
Contrast with other markets
It is important to note that the proposals do not amount to a ‘Prepack’ as often understood by other markets. The emphasis remains very much on preserving the CD as an entity rather than focussing on maximising value by swiftly recycling its viable businesses and other assets. Another point of difference from what we would refer to as a ‘Prepack’ is formal involvement of financial creditors. Although the debtor remains in possession and control of the business the proposals are somewhat hybrid because financial creditor consent is required to kick start the PIRP and to approve the Base Resolution Plan, as well as for the same key business decisions which are reserved to the Committee of Creditors (“CoC”) in a CIRP.
The Indian proposals are seeking to strike a balance between the informal processes that operate – admittedly with regulatory and other checks and balances - in markets such as the US and UK and the CIRP as it has developed to date. They represent a quite strict legally codified approach, and it is clearly contemplated that they will require fine tuning as time goes on (as indeed has been the case with the IBC) with the benefit of experience and operation in practice.
It is easy to spot potential pitfalls.
Involvement of financial creditors
The constructive role of creditors will be key; experience to date has been that the dominance of public sector banks on CoCs has not facilitated swift and commercial decision making. To be fair, they have responded when constrained by the time bound formal process of the CIRP. But without the sword of Damocles – insolvency – hanging over their heads their inertia may prove difficult to overcome. It is after all the financial creditors who must decide whether or not to allow the PIRP to begin by deciding whether to support the Base Resolution Plan proposed by the Corporate Debtor.
Will the CD manipulate the process?
Just as critical, the new proposals have a steep hill to climb in ensuring that the CD does not successfully retain control of the business on unduly favourable terms. Much will depend on whether third parties are prepared to come forward with stronger bids than the CD has initiated in the Base Resolution Plan.
The process proposed seems modelled on a stalking horse process under s.363 of the US Bankruptcy Code. The US process aims to maximise sale prices for assets by creating an auction, with the stalking horse bidder setting the minimum price (and being paid a break fee if it Is sold to someone else). The proposed Indian PIRP is seeking to achieve a resolution plan instead, using this approach.
In essence the idea is that the CD (with a simple majority of financial creditor support) puts forward the Base Resolution Plan – which will presumably force promoters to put some money up in order to improve creditor returns above valuation levels. The process may then be opened up (the creditors do this) and the Base Resolution Plan is tested by alternative bidders to see if they can improve on it. Improvement will only be achieved if a third party is willing to incur cost in bidding against a promotor/CD who (with better knowledge of the business) can simply decide to improve its terms whilst forcing a haircut on existing creditors. The existence of the Corporate Debtor’s ability to match or improve on a third party bid could easily dampen the interest of potential competing bidders.
While the Corporate Debtor retains control of the business, the preparation of the Information Memorandum and the information on which valuations depend, it is easy for a cynic to see how true value will be difficult to establish. It is of course the case that the proposals seek to address this by requiring full disclosure, personal liability for sign off of the Information Memorandum and so on, but in jurisdictions such as the US that has only lead to copious disclosure which reduces perceived value in the eyes of a prospective competing bidder. And without the RP taking control of the CD as it does under CIRP it may never be clear whether or not full disclosure and accurate valuation has in fact happened.
Other safeguards against manipulation of the PIRP by the Corporate Debtor may well prove essential – if not now, then over time. For example, there will be an inevitable temptation to arbitrage the PIRP against the CIRP – since the one postpones the other. The ‘debtor in possession’ does not sit easily with other features of the process such as investigating antecedent transactions (which as the Committee report drily notes ‘are not rare’). The fact that the RP has that within his scope of work while monitoring the PIRP may in itself be a disincentive for CD to use the process since they and their promoters will thereby be opening themselves to scrutiny.
The Committee sensibly suggests a phased introduction of the PIRP, and highlights the need to achieve a very significant strengthening of the NCLT; the professions (Insolvency Professionals and Valuers) will also need to be beefed up. The Insolvency Professional’s role is not to run the PIRP quite as the RP does in the CIRP, and he or she is certainly not such a driver of the Prepack process as in other jurisdictions such as the UK, but nonetheless the IP has a critical role in monitoring and lending credibility and objectivity to the PIRP. The PIRP will depend upon the Insolvency Profession operating efficiently and to the highest standard.
A unique feature of India is the disqualification of a significant number of Promoters from bidding for their own assets through proposing a Resolution Plan under the IBC; this new process is designed to facilitate proposals initiated by the Corporate Debtor itself, but the same disqualification would apply to the PIRP as it would to the CIRP. Whether or not to apply that disqualification to the PIRP was hotly debated by the Committee, as recorded in their report. In other markets – of course subject to suitable checks and balances – promoters and incumbent management groups have been a substantial user of prepackaged solutions to distressed situations. Their understanding of the business and stake in its successful turnaround has been key to a number of success stories. Time will tell how great a hurdle to the widespread use of PIRP such disqualification in India will be.
How will foreign investors who may wish to participate in the restructuring scene in India react to the new process?
It is probably safe to say they will be positive but cautious, as they have been to date, and that they will look for case by case opportunities rather than piling into the market. It is also likely they would like to see still speedier, more flexible means to quickly assess and acquire assets (of course accepting the need for checks and balances like those that have evolved in other markets) out of distress rather than such a strictly codified yet still in some senses uncertain process which remains focussed on the survival of the Corporate Debtor rather than on the swift recycling of viable businesses out of insolvent entities.
In fact they may prefer greater clarity to bid processes under the existing system, so as to reduce the risk of challenge, litigation and consequent delay and uncertainty that has to be priced into a bid, rather than yet a further process which will have inevitable teething troubles and need to bed in before its usage becomes widespread and its merits apparent. The big hurdle of ensuring bid processes and auctions are predictable open and properly run is probably the biggest concern that they will have. The prevalence of challenge, litigation and revised bid processes with the attendant cost of delay and uncertainty has to date been at the forefront of many potential investors’ thinking.
We are positive about the new proposals, and as we have done to date continue enthusiastically to support and encourage the development of the restructuring market in India. So much has been achieved so quickly since the IBC was introduced in 2015/2016 that the obvious and salutary commitment to further reform can only be for the good.
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© Herbert Smith Freehills 2021