Some Open Questions under the IBC: Debt Restructuring Schemes and Prepacks

[The following is a guest post contributed by Aparna Ravi, who is Counsel at Samvad Partners. The views expressed here are personal and comments are welcome.]

In the high-profile insolvency case of Essar Steels Ltd., that was admitted by the Ahmedabad Bench of the National Company Law Tribunal (“NCLT”) last week, two objections raised by Essar against admission of the insolvency application were (a) that restructuring discussions with its lenders were already underway and (b) that the insolvency resolution process and, in particular, appointment of a resolution professional under the Insolvency and Bankruptcy Code, 2016 (the “IBC”) would have disastrous consequences on Essar’s business.  While the NCLT correctly rejected both these arguments (the NCLT’s order is discussed in detail on this blog here), they raise broader questions on the inter-play between proceedings under the IBC and the debt restructuring mechanisms driven by the Reserve Bank of India (“RBI”), and on how the IBC can be used for coming up with effective resolution plans. 

Relationship of IBC with Non-Statutory Debt Restructuring Schemes

One of the arguments made by Essar’s counsel was that the insolvency application filed against Essar should not be admitted because the company was already involved in restructuring discussions with its lenders. In response to this objection, the NCLT pointed out that Essar had begun restructuring discussions with its lenders in 2014 and to date no plan had been finalised. The NCLT further stated that commencement of the insolvency resolution process did not mean that ongoing restructuring discussions with lenders had to be abandoned as they could form the basis of a resolution plan under the IBC if 75% of financial creditors approved. As such, the existence of these restructuring discussions was not a reason to reject the application for insolvency resolution.

The IBC is silent on the relationship between proceedings under the IBC and RBI-driven debt restructuring mechanisms, such as strategic debt restructuring (“SDR”) or the Sustainable Structuring of Stressed Assets Scheme (“S4A”).  There is clearly no prohibition under the IBC on admitting an insolvency resolution application for a debtor who is undergoing a debt restructuring process, and the NCLT has on other occasions as well clarified that an application could be admitted under the IBC even if restructuring discussions were ongoing at the Joint Lenders’ Forum.[1] At the same time, the NCLT’s order in the Essar case made it clear that the use of the word “may” in section 7 of the IBC gave the NCLT discretion on whether to admit an application filed by a financial creditor even if the conditions under the IBC (the existence of a payment default and the absence of disciplinary proceedings against the resolution professional) were met.  Section 7(5) of the IBC states:

“Where the adjudicating authority is satisfied that –

(a)        a default has occurred and the application under sub-section (2) is complete, and there is no disciplinary proceedings pending against the proposed resolution professional, it may, by order admit such application.”

[Emphasis added]

The NCLT, thus, stated that the IBC required the adjudicating authority to exercise its discretion in admitting or rejecting the application, taking into consideration the facts and circumstances surrounding the default, including, in this case, the ongoing restructuring discussions. In this instance, the NCLT considered the circumstances of the restructuring discussions and determined that circumstances did not warrant a rejection of the application for insolvency resolution.

The NCLT’s decision in relation to the Essar restructuring appears logical and was perhaps an easy decision given the stage of the restructuring discussions and the fact that one of the applications for insolvency resolution was filed by the State Bank of India, which was also a party to the restructuring discussions.  However, the answer may be less clear cut if one were to alter the facts slightly. What if the application for insolvency resolution was filed by an operational creditor, while debt restructuring discussions between the debtor and financial creditors were ongoing and almost completed?  Would the NCLT be required to admit the insolvency application filed by the operational creditor if there was a default of an undisputed debt, much smaller than the amounts at stake for financial creditors?

Section 9 of the IBC, which applies to applications filed by operational creditors, uses the word “shall” instead of the discretionary “may” in section 7.  Thus, from a literal reading of the IBC, the NCLT would have to admit an application made by an operational creditor if the debtor has defaulted on an operational debt, which has not been disputed.  While to date the NCLT has not specifically had to deal with such a situation (and in practice the debtor may well seek to settle with the operational creditor prior to admission, rather than risk derailing the restructuring discussions with financial creditors), it would be worth considering the implications of the NCLT admitting an application in this situation.   

Under the IBC, while operational creditors can trigger the commencement of an insolvency resolution process, they do not have much say in the proceeding once it is underway as it is only financial creditors who get to vote on a resolution plan.  In this sense, upon admission of an application for insolvency resolution filed by an operational creditor, the financial creditors could simply bring the ongoing debt restructuring discussions within the four corners of the IBC and have the NCLT approve the resolution plan.

However, financial creditors and the corporate debtor may be against this for two reasons. First, going through the tribunal process and the appointment of a resolution professional may disrupt the debtor’s normal course of operations.  Second, while the IBC is very flexible (through its silence) on the type of resolution plan that the financial creditors can approve, it does include two stipulations – the plan must make provision for the costs of the resolution process and ensure that operational creditors obtain at least their liquidation preference.  Including these stipulations would likely cause the financial creditors to take a further hair cut than they might have otherwise intended in the out-of-court restructuring.

On the other hand, the resolution process under the IBC may have certain advantages for the corporate debtor.  Such a plan would be binding on all creditors, including foreign banks, who would not be part of the RBI-designed restructuring mechanisms. Standard Chartered Bank, for example, which also filed an insolvency application against Essar, was not part of the restructuring discussions at the Joint Lenders’ Forum.  Thus, if financial creditors are able to take a resolution plan that was negotiated out-of-court and have it approved with minor modifications to comply with the IBC’s requirements, this would relieve the debtor from all claims and liabilities.      

The bigger issue is, of course, whether operational creditors should be able to force the hand of financial creditors to enter into insolvency resolution under the IBC if they are in the process of reaching an out-of-court arrangement with the debtor. It remains to be seen how the NCLT will react when faced with this situation.

Arriving at Effective Resolution Plans under the IBC – Are Prepacks Permitted?

A second objection made by Essar’s counsel was that appointment of a resolution professional would have disastrous consequences on its business as a single individual could not possibly manage such a complex business.  While this argument did not have merit from a legal standpoint as the statute mandates a resolution professional to take control of the debtor’s business upon admission of the insolvency application, it raises broader questions on how creditors and debtors can use the IBC to arrive at more effective resolution plans that cause minimal disruption to the debtor’s business.

To date, a lot of attention has focused on the admission of an application and the parties are often found floundering once an application for insolvency resolution is admitted.  Some of the early cases filed under the IBC, including Innoventive Industries and Nico Corporation, were forced to request a 90-day extension of time to arrive at a resolution plan and it was only last week that the Hyderabad Bench of the NCLT approved the first resolution plan under the IBC for Synergies-Dooray Automotive Ltd.  There have also been cases of alleged fraud and misconduct by resolution professionals as in the case of Synergies-Dooray.

These teething problems are understandable given how new the IBC is and that it is dealing with defaults that have been in existence for several years. However, the IBC’s success would depend on the willingness of potential buyers of distressed assets to use the IBC to purchase assets and businesses from distressed debtors, which in turn would depend on the competence of resolution professionals and the level of consensus and coordination among financial creditors to achieve a resolution plan quickly.  There is also the melting ice cube problem that once an insolvency application is admitted, the company may not have sufficient working capital to maintain the business as a going concern while a resolution plan is being chalked out.

In many jurisdictions, pre-packaged bankruptcies or “prepacks” are the way to deal with these problems.  Unlike in conventional bankruptcies, where a resolution plan is arrived at after the filing has been made, in prepacks negotiations between creditors and debtor have already taken place prior to the filing and the formal insolvency resolution process is only used to give effect to the out-of-court restructuring that has been agreed between the parties.

Are prepacks permitted under the IBC? While not explicitlyy provided for, there is nothing in the IBC that would a prevent a prepack, particularly as the statute says very little on the contents or manner of arriving at a resolution plan. Rather than filing an application for insolvency resolution and then waiting to see what happens, financial creditors and debtor could have a resolution plan on the table before filing an application.  In this way, a resolution plan could obtain the requisite 75% consent of financial creditors soon after a resolution professional is admitted and the statutory compliances regarding notices and giving creditors an opportunity to make claims are completed. Such prepacks would help provide greater deal certainty to buyers of distressed assets and also minimise the disruption to the debtor’s business by limiting the time period during which the resolution professional controls the business. Now that banks have come forward to begin to use the IBC in high profile cases, the next step may be to take advantage of the inherent flexibility in the IBC regarding resolution plans by using prepacks.

– Aparna Ravi

[1] In Innoventive Industries v. ICICI Bank (NCLAT on May 15, 2017), the National Company Law Appellate Tribunal (“NCLAT”) opined that consent of the joint lenders’ forum (“JLF”) was not required for a financial creditor to commence an insolvency resolution process.

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  • So By the route of Pre-Packs , can we eliminate Insolvency Resolution Professionals from the picture altogether ?

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