Debtor-in-Possession Model under Pre-PACKS: – A False Reality

*Aryan Sharma and Yashita Bhardwaj

Introduction

The insolvency regime in India before the introduction of the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (“Ordinance”) was completely governed by Corporate Insolvency Resolution Process (“CIRP”). The model envisaged the spirit of Creditor-in-Control and was considered as an effective insolvency resolution procedure for a Corporate Debtor (“CD”). However, the model was time-consuming and vests major powers to the Committee of Creditors (“COC”), whereas the CD was just a bystander in the whole process. Pre-Packaged Insolvency Resolution Process (“PIRP”), introduced specifically for the Micro, Small and Medium Enterprises(MSME), is a pre-arranged negotiation process between a debtor and creditor for the sale of assets before starting an insolvency procedure in any court or by any other means. The Insolvency Law Commission had an ultimate aim that PIRP should be accepted as a major resolution process and very few should go for CIRP.

The idea behind this Ordinance is to make the whole resolution process time-efficient and more beneficial for the CD. The portrayed Debtor-in-Possession (“DIP”) model in the PIRP lacks the objective in the essence as it provides unbridled powers to the COC in relation to the whole process.

The authors strongly believe that rather than providing debtors with the possession, it seems like debtors are under the possession of the creditor’s undue control. This article aims to shed light on the intricacies of the new PIRP model and will try to provide some possible solutions to overcome the hurdles in the application.

Debtor in possession vs. Creditor in control: A global perspective

The sub-committee of the Insolvency Law Commission recommended to follow the DIP model for pre-package insolvency resolution process. The ultimate aim behind introducing this model is to let the CD control the management of the company even during the PIRP. However, when it comes to practical application the concept in India is completely opposite. Before analyzing the situation in India, the article will elaborate on the universal application of DIP.

The concept of DIP was introduced in the USA under chapter 11 of the US bankruptcy code where the CD is allowed to restructure their company while remaining in possession of its assets. The PIRP model in the USA takes the interest of debtors into account and incentives the debtors to opt for this process. The primary advantage of the DIP model in the USA over other countries is that the debtors are allowed to take the loan even under the moratorium period and use their personal belongings to pay off the creditors in full. On the other hand, introducing pre-packs in the UK was UK’s response to the pandemic to revive the financially distressed companies. Pre-packs in the UK is not only a new insolvency process but it is the shift from receivership to administration. Unlike the USA, in the UK the management of the debtor’s company is in the hands of the court’s appointed administrator and usually, it’s the insolvency professional who evaluates the financial position of the company.

In both UK and India, resolution professionals are appointed to supervise the negotiation process and the sale of assets, whereas in the USA appointment of such professionals are rare and the corporate debtor exercises the sole power to negotiate with the creditors and make a plan for sale of assets. Moreover, during the process of the Swiss challenge in the USA, the sole power is given to debtors to choose a bidder and negotiate the deal.

The proposed debtor in possession model: Sheep in the lion’s skin

The introduction of the PIRP model has brought in many splendid changes to the Insolvency and Bankruptcy regime of India, however, the far-reaching repercussions of the model can’t be overlooked. The newly proposed DIP model by the Insolvency Law Commission at the outset gives a new light of hope to the CD to remain in the management of the company even during the PIRP by the introduction of the Base Resolution Plan (“BRP”). However, it gives a wide array of overriding powers to the COC during the whole PIRP process. A detailed analysis of the Ordinance(and the “IBBI Regulation on Pre-Packaged Insolvency Process”) shows that there exist many inconsistencies between the proposed idea of the DIP model and the way of its implementation. In this regard, Section 54A(2)e of the ordinance read with Regulation 14 gives power to unrelated financial creditors in the appointment of the Resolution Professional, wherein the Resolution Professional is to be approved by those unrelated financial creditor to whom 66% of the debt is owed. Furthermore, without such approval, the CD is barred to file an application for the initiation of the PIRP. The major objective of the PIRP model is to incentivize the CD to roll into the process himself by filing an application, but Section 54A(3) of the code destroys the very objective by introducing the provision of mandatory approval from the financial creditors in order to file such an application. The shift from CIRP to PIRP model renders a simultaneous shift of the powers from Resolution professional to the CD, as now in the PIRP the CD could run the company as a going concern. In this regard Section 54J of the Code puts a “hanging sword” over the CD, as the section gives the power to the COC to transfer the management of the CD to the Resolution Professional with the approval of 66% of the voting share. The application for such transfer has to be made to the Adjudicating Authority, which can then transfer the management if it finds that the affairs of the CD have been conducted in a fraudulent manner or if there is gross mismanagement during the PIRP process. The provision gives unbridled power to the COC which can be misused on its whims and fancies whenever the CD does not function on its terms.  

Swiss challenge under pirp

Swiss challenge is a formal bidding process wherein the best proposal is selected among the different proposals. The PIRP model of Insolvency and Bankruptcy regime proposes to incorporate the same by the way of Section 54K of the Ordinance. Under the Ordinance, Section 54K(4) accommodates the DIP model wherein the CD is given the first opportunity to present the BRP. However, when BRP does not pay the operational creditors in full then the base plan will be opened to Swiss challenge. Unlike CIRP where the COC aids in restructuring the company, PIRP gives this opportunity primarily to the CD (directors and promoters of the company) to present the BRP. The basic objective of the introduction of the Swiss challenge in PIRP is to ensure that the operational creditors are paid in full. However Swiss challenge has posed a serious concern in the mind of the CD as this could be a way for a CD to lose control over the management of his company. The COC’s decision is dependent on two situations: First, when the BPR suffices all the claims of the operational debtor, the COC may accept the BRP. Second, when the BPR does not satisfy the claims of the operational creditors then the COC has to mandatorily open the BPR for the Swiss challenge. The whole process of Swiss challenge where extraordinary powers are given to COC poses a fear in the mind of the CD that even if their BPR pays all the operational creditors in full then also COC can open the plan for the Swiss challenge, which could result in them losing their company. The PIRP is a consensual process and the primary objective is to make the process fast and friendly for the CD, but the fear of losing the management and control of the company will de-incentivize the CD to roll in for the PIRP. This will ultimately fail the key objective of the introduction of the PIRP, as the CD can prefer other debt restructuring methods over PIRP where they can possess proper control over the management of the company.

Concluding remarks

The PIRP model ensures the maximum benefits to the operational creditor, as the CD has to make sure that the BRP pays them in full. The major difficulty lies in regards to the position of the CD as the model proposes to give rights to the CD but at the same time snatches those very rights by giving overriding powers to the COC. The transparency stands as a critical issue in the process as the conduction of the Swiss challenge wholly depends on the discretion of the COC which makes the CD prone to discriminatory treatment. Hence, proper supervision of the Adjudicating Authority should be there in order to ensure that the process favours the CD as well. Furthermore, the authors agree that a proper balance needs to be maintained between the creditors and the debtor during the process, however, rights of the CD have to be given equal importance. The introduced BRP and Swiss challenge are no doubt theoretically well-balanced provisions however in order to cater to the practical needs the provisions would have to be tuned in accordingly.

*The authors are third-year students at the Institute of Law, Nirma University,  Ahmedabad.