Insolvency & BankruptcyChallenges and Drawbacks  of IBC Pre-Pack Scheme

May 9, 20200

What is Pre-packed IBC Scheme?

A pre-packaged scheme is an arrangement under which stressed company and the purchaser negotiate the sale of all or part of a company’s business or assets prior to the appointment of an insolvency professional as administrator. The completion of such a transaction is conditional on the scrutiny of details by the Insolvency professional appointed and until he gives a nod for the sale to be effected, the consideration by the purchaser is held in an escrow account.
The main objective of bringing in this concept is to aid the insolvency framework, avoid spending time and money in court proceedings & legal battles and directly move to getting a fair resolution for the company, which was the very objective of the IBC in the first place.
It is suggested that the proposed plan should have an assent from at least two-third of the creditors before it is being put before the NCLT for its approval. Since the plan would already be endorsed by the lenders, it will effectively bypass various requirements and interventions by the NCLT at different stages under the usual IBC process and would help unburden the already over-burdened NCLTs.
Such a pre-pack process can also be considered as a process preceding the usual course of insolvency under Section 7, 9 and 10. A pre-pack process is carried out by the debtors who try to keep their entity afloat and try to negotiate with the creditors for a resolution of the debt. Therefore, if such a process fails, it can always lead to a creditor filing an application under Section 7 or 9 of the IBC and triggering insolvency.
Challenges and Drawbacks 
Though pre-packaged IBC Schemes have their own share of supporters, it brings with itself many a challenges and drawbacks that cannot be just ignored. Some of them are listed herein below:
1.The biggest issue that pre-pack schemes will face initially is that while the options are being evaluated by the company, they would not have capital lenders lending money to them. This is because there is obviously a risk involved in the recovery of the money and while lenders already know that the company is stressed, they would not want to take the financial risk. If the company doesn’t have enough cushion to go on for weeks/months while the scheme is put in place, the idea may fail altogether.
2.Another major concern that may arise during the pre-pack scheme implementation is that it would not have the shield of moratorium like it is there when a case is admitted under Section 7 or 9 of IBC.
Therefore, creditors may enforce their rights and remedies while the company is negotiating for a pre-pack scheme. This would be a huge hurdle that the scheme would face in its implementation.
3.One major criticism of pre-pack schemes is that it is more in the favour of secured creditors and neither do the operational creditors have much say in the negotiation nor they are given a fair share. This challenge has to be overcome if pre-pack schemes are to be implemented in India.
4.Transparency would also be big hurdle since the existing management would be in-charge of alienating the assets to keep the company afloat and therefore, there would always be apprehensions regarding the correctness of the entire process. This may lead to creditors, especially unsecured, to approach the NCLT and filing cases against the corporate debtor.
5.It is even argued that since the company is pushed into insolvency by its own management (be it operational mismanagement or bad business decisions), it is not sensible to allow the same management to alienate the assets of the company and this insolvency framework could turn out to be prejudicial to certain stakeholders.
6.The role of IRP would be another grey area where the implementation of pre-pack scheme would face challenges in as much as in the normal CIRP process, the IRP is appointed as soon as the application is admitted. However, in a pre-pack scheme, the IRP is appointed when the scheme is already finalized and presented before the NCLT and the NCLT gives a nod to it.
Therefore, the role of the IRP limits down to only administrative stuff and he has no say in how the proceeds are being distributed to the creditors or how the company was being managed through the structuring of the scheme.
7.Section 29A would act as a major hurdle in the introduction of pre-pack schemes in India as in a pre-pack scheme, the debtor would be in-charge of the process and not the IRP and this would go against the basic essence of Section 29A.
Since the legislature has already introduced Section 29A with so much emphasis and importance and the same has also been analyzed & reiterated in the Supreme Court decision of Essar Steel, it would be difficult to move away from the provision or create an exception for pre-pack schemes. It would stand as one of the biggest obstacles for pre-pack schemes.
8.It is also being contended against the introduction of the pre-pack scheme is that it is too soon to bring such a drastic change as the Insolvency law in India is still in its nascent change. There are also apprehensions that it may contribute to burdening the NCLTs even more as the schemes can be challenged at any stage and there would be big scope of increasing litigation. Additionally, the outgoing management may not be very cooperative with the incoming management and this also may create disputes.
With the current Pandemic creating havoc in almost every industry, it is almost certain that a lot of companies would be pushed into insolvency in the coming times and there this scheme of pre-packaged deals, if introduced, may act as a catalyst in helping those companies survive.
However, the system comes with its own set of challenges and disadvantages which cannot be shrugged off. The Indian system is very different from the USA and the UK and a comprehensive study should be conducted in order to ensure that the problems are eliminated and a better mechanism is put in place. Therefore, it is important to strike a balance between the existing and the new system.
It is expected and emphasized that if the pre-pack system is implemented well, it would lead to smoother implementation of resolution plans, would promote growth and keep the company as a going concern while retaining jobs and ensuring creditors receive the funds due to them. Especially during these difficult financial times, it is imperative that such a system would only yield fruitful results and would have more pros than cons.

Leave a Reply

Your email address will not be published. Required fields are marked *

Current day month ye@r *

© 2020-21 AMLEGALS Law Firm in Ahmedabad, Mumbai, Kolkata, New Delhi, Bengaluru for IBC, GST, Arbitration, Contract, Due Diligence, Corporate Laws, IPR, White Collar Crime, Litigation & Startup Advisory, Legal Advisory.


Disclaimer & Confirmation As per the rules of the Bar Council of India, law firms are not permitted to solicit work and advertise. By clicking on the “I AGREE” button below, user acknowledges the following:
    • there has been no advertisements, personal communication, solicitation, invitation or inducement of any sort whatsoever from us or any of our members to solicit any work through this website;
    • user wishes to gain more information about AMLEGALS and its attorneys for his/her own information and use;
  • the information about us is provided to the user on his/her specific request and any information obtained or materials downloaded from this website is completely at their own volition and any transmission, receipt or use of this site does not create any lawyer-client relationship; and that
  • We are not responsible for any reliance that a user places on such information and shall not be liable for any loss or damage caused due to any inaccuracy in or exclusion of any information, or its interpretation thereof.
However, the user is advised to confirm the veracity of the same from independent and expert sources.