THE GLOBAL SNAPSHOT OF PRE-PACKS
Pre-pack has lately become a buzzword in the restructuring and insolvency scene in Singapore. However, do you know that pre-pack can mean different things in different jurisdictions? To find out more, the Asian Business Law Institute (ABLI) spoke to Aurelio Gurrea-Martinez, Assistant Professor of Law and Head of the Singapore Global Restructuring Initiative (SGRI) at Singapore Management University for a global overview of this restructuring tool.
ABLI: You are currently conducting a research project on pre-packs. Could you tell us a bit more about that project?
Aurelio Gurrea-Martinez (AGM): As part of the research activities of the SGRI, we are analysing the rise of pre-packs as a restructuring tool. Namely, we are examining the advantages, risks, similarities and divergences of pre-packs around the world. We are also reviewing the empirical evidence on pre-packs so that we can gain a better understanding of the anatomy of pre-packs as well as the impact of this restructuring tool on the survival of businesses and the returns to creditors, among other aspects. The project will conclude by suggesting several recommendations to design or, if so, to improve the regulatory frameworks for pre-packs in different jurisdictions.
ABLI: Based on your research, what are some of the similarities and divergences you have found in the operation and the regulatory framework of pre-packs around the world?
AGM: Most pre-packs seek to achieve a similar goal: to reduce the costs and length of insolvency proceedings. Insolvency proceedings are very costly. In addition to direct costs (especially in terms of professional fees), a situation of financial distress may generate significant indirect costs, including loss of reputation, bargaining power, goodwill, employees, lenders and suppliers. These costs can end up destroying the going concern value of many viable companies that are merely facing financial trouble. By reducing the costs and length of insolvency proceedings, pre-packs can often facilitate the survival of viable businesses and the maximisation of returns to creditors.
However, the way by which pre-packs achieve this goal differs across jurisdictions. To understand these divergences, it is important to first distinguish three related concepts: pre-negotiated (or pre-arranged) reorganisations, pre-packaged reorganisations, and pre-packaged sales.
A pre-negotiated or pre-arranged reorganisation takes place when the debtor and its creditors negotiate a reorganisation plan prior to the commencement of a formal insolvency or restructuring procedure. The existence of prior negotiations naturally reduces the costs and length of formal reorganisation procedures, since the debtor and its creditors have already exchanged information and, if so, reached informal agreements. Due to the informal nature of these negotiations, a pre-arranged reorganisation can take place in any jurisdiction that has a reorganisation procedure. Therefore, it does not require any formal framework for pre-packs.
In a pre-packaged reorganisation, however, the debtor formally solicits acceptance for a reorganisation plan before the commencement of an insolvency or restructuring proceeding. Once the required creditor majorities are obtained, the debtor initiates the formal procedure asking the court to confirm the plan. Therefore, the insolvency proceeding can be concluded very quickly – even in a few days. This is the type of pre-packs traditionally found in the United States (US). The pre-pack introduced in Singapore was inspired by the US model.
Finally, a pre-packaged sale happens when a debtor negotiates the sale of all or part of its business or assets prior to the commencement of an insolvency proceeding. This type of sale is very common in the United Kingdom (UK). Namely, in a "pre-packaged administration" in the UK, the sale of a company's business (or assets) is arranged before the commencement of an administration procedure, after which the appointed administrator completes the sale, usually on day one of the administration, thereby rescuing the business in whole or in part.
Despite the similar terminology, we can see that the concept and structure of a pre-pack differs across jurisdictions. While some countries (e.g. the US and Singapore) use the term "pre-pack" to refer to a pre-packaged reorganisation (US) or scheme (Singapore), other jurisdictions (e.g. the UK) use this term for pre-arranged sales in insolvency proceedings.
The regulatory framework of pre-packs and the type of companies potentially eligible for this procedure also differ. For example, while some countries, such as India, have decided to reserve pre-packs for micro, small and medium-sized enterprises ("MSMEs"), other jurisdictions, including Singapore, the UK and the US, have no restriction on the type of companies that can pursue a pre-pack. There are also international divergences on the regulation of pre-packs. In countries such as the UK and the US, pre-packs are not regulated in the insolvency legislation. Instead, some courts in the US have enacted guidelines on pre-packs, while pre-packaged sales in the UK have traditionally been governed by a guideline enacted by insolvency practitioners (SIP 16) despite a new regulation dealing with the disposal of assets to connected persons in administration. On the other hand, pre-packs in India and Singapore are regulated in the Insolvency and Bankruptcy Code and the Insolvency, Restructuring and Dissolution Act, respectively.
ABLI: From the perspective of creditors, what are the primary risks involved in a pre-pack?
AGM: Empirical evidence on pre-packs, at least in the UK, shows that the counterparty in the majority of pre-pack sales is usually a connected party. Therefore, in the absence of proper safeguards, debtors may use pre-packs to siphon assets at the expense of creditors. Pre-packs can also be used to favor some creditors over others. Some studies have also shown that there is a higher rate of future business failure when the company's assets are sold to a connected party. If these problems are not addressed in a credible and transparent manner, the use of pre-packs may reduce the returns to creditors (especially unsecured creditors), and it can also destroy many viable but inefficiently managed businesses. Moreover, the higher risk of opportunism of debtors vis-à-vis creditors may discourage lenders from extending credit in the first place. Therefore, preventing the opportunistic use of pre-packs is also important to facilitate firms' access to finance.
ABLI: Overall, pre-pack appears to be a useful mechanism to save businesses and jobs. Should insolvency legislators therefore be encouraged to embrace pre-pack as a restructuring tool?
AGM: We must first emphasise that not all businesses should be saved. An insolvency system should make sure that only viable businesses are reorganised. Second, viable businesses may have many restructuring options at their disposal, such as workouts, hybrid procedures (including pre-insolvency proceedings and pre-packs) and formal reorganisation procedures. A pre-pack can indeed be useful in many cases. However, one size does not fit all. The most suitable restructuring option depends on a variety of factors, including the size of the company, the number and support of creditors, the debtor's financial situation, and the features and costs of reorganisation procedures, among other aspects. The particular market and institutional features of a country, including its restructuring ecosystem, may also play a significant role in deciding the most appropriate restructuring tool to use. These latter aspects will also be very relevant in assessing whether, and if so, how pre-packs should be regulated in a particular jurisdiction.
Assistant Professor Aurelio Gurrea-Martinez will be speaking at ABLI's webinar Rise of Pre-pack as Restructuring Tool – Global and Regional Perspectives on Thursday, 9 September 2021 at 7pm (SGT). He will share more of his research alongside his fellow speakers Debby Lim, Director, BlackOak LLC, Dan T. Moss, Partner, Jones Day and Dr Neeti Shikha, Head, Centre for Insolvency and Bankruptcy, Indian Institute of Corporate Affairs, during the live session. Secure your spot here. SAL members can sign up here to redeem SAL credit dollars for this session. Please contact Catherine Catherine_shen@abli.asia for any query.