CO-AUTHOR - DOLLY CHOUHAN
Pre-pack is a viable insolvency tool wherein a new company comes into existence and buys the shares of an old, existing company which is then liquidated. The sale is made before a liquidator/administrator is assigned to make the sale, it is not the same as conventional company administration because in this method pre-negotiation of assets is done before the appointment of the administrator whereas in conventional administration it is the administrator who makes an attempt to sell the assets. This helps in speeding up the insolvency procedure and also reduces the burden on NCT national company law tribunals. It can turn out to be a very useful tool as it can save jobs, rescue businesses and preserve value. This becomes highly important during times of pandemic which is wreaking havoc on the governments and crashing economies. Taking this into account the government of India decided to make some amendments to the insolvency and bankruptcy code. Certain suggestions were also made in relation to pre-pack theory and how it should be regulated deriving its base from the core principles on which the IBC work that is:
Financial creditors are given the authority and control to decide the distressed company’s fate during resolution.
A moratorium is imposed during the resolution period on the corporate debtor.
The outcome of the following resolution is binding and each person concerned.
Different countries have different names for pre-pack theory as it is a more generic term. It is termed as “expedited reorganization proceedings” by (UNCITRAL) UN Commission on International Trade Law. And is called “pre-packaged insolvency resolution” in the U.S, “pre-pack sale” in the U.K and “scheme of arrangement” in Singapore. Its primary objective in the Indian legal field is the rehabilitation of the corporate debtor and shifting the focus on the resolution of debt rather than the conventional sale of assets or business. This is done in the scenario when the creditors' committee disapproves of a resolution plan the pre-pack process comes to the aid of the corporate debtor and it can initiate the corporate insolvency resolution process (CIRP).
The integrity of this process is often questioned especially in the cases where the owner of the ‘newco’ that is the new company formed in order to buy the shares of the old existing company is a relative or known person of one of the directors of the old company. The creditors can question the authenticity of the agreement because they are usually in the inhibition that they were not consulted before the sale was made or that the value obtained is not valid because of collusion between the two parties. But this can sometimes be the best option for the profit of the credit debtor and the stakeholders of the company because it can help in deriving the best value for the company because the creditor will not take advantage of the deteriorating condition of the liquidating company because once the news of liquidation becomes public the goodwill, brand value and other tangible and intangible assets will depreciate and these conditions make the debtor collection problematic and this was a major reason that the pre-pack administration was introduced to facilitate continuation in trading and preserve the brand value. This will also help preserve the cost of trading the business to preserve asset value prior to finding a buyer by the administrator in case a pre-pack deal is made.
There are certain pros and cons of pre-pack:
The pros include:
Saving jobs- the process of liquidation includes cost-cutting and reduces trading operations which costs a lot of people their jobs but pre-pack allows continuing the trade and minimal cost-cutting which helps a company in the long run. It helps in running the company efficiently and reduces the number and value of preferential and unsecured claims in insolvency.
Reduced costs- liquidation and trading after insolvency is rather expensive, but the cost of pre-pack is low and offers a great return to the creditors because shortly after the appointment the business- control and risks and costs of it are transferred to the purchaser.
Continuing business- declaring insolvency and liquidating the company takes a lot of time which requires a break in trading and has detrimental negative effects on the company because there is no funding and complying with regulatory requirements is not possible but it is not the case with pre-pack, in pre-pack the transfer of business is smooth and fast and therefore the trading can continue.
But with the benefits, there also exists some cons of pre-pack:
The dearth of transparency- pre-pack only requires informing secured creditors in advance and therefore unsecured creditors may feel disenfranchised and suspicious of the procedure.
Insufficient marketing- it can be believed by the creditors that the maximum value is not achieved through the transaction due to the nature of pre-pack and also due to lack of timing which limits the marketing options. When going for the conventional sale option they have time to put the product/company on market and evaluate different vendors and price options for the same which is not the option with pre-pack where you have to make decisions relying only on independent valuations.
Conflict of interest- this usually occurs when the new company’s owner is a known person of one of the directors then the question of biased valuation in these cases the IP needs to be satisfied that they can comply with the presented set of statutory duties and that a pre-pack sale in this scenario is the most appropriate course of action with the given conditions.
In the case of pre-pack deals, the pros seem to outweigh the cons and it is termed as a valid insolvency tool that can provide the best results in certain circumstances.
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