The Challenges and Opportunities of Pre-Packs as a Restructuring Tool

In recent years, many countries have adopted some form of pre-packaged reorganizations (“pre-packs”), inspired largely by pre-packs popularized in the United Kingdom and the United States. By shortening insolvency proceedings, pre-packs can reduce the costs of financial distress and especially the loss of reputation, employees, suppliers, and goodwill. As a result, pre-packs can also help maximize the value of an insolvent firm for the benefit of debtors, creditors, and society. However, conflicts of interest, a lack of transparency, and various forms of opportunistic behavior in some pre-packs have raised concerns about their desirability. In a new article, I examine the types of pre-packs around the world and their risks and advantages. I also review the empirical evidence on pre-packs and conclude with various policy recommendations for countries considering the adoption of this restructuring tool.

My article starts by distinguishing between pre-negotiated reorganizations (where parties only share information prior to the commencement of an insolvency proceeding) and actual pre-packs. It then identifies four types of pre-packs: (i) pre-packaged administrations leading to a going concern sale, popularized in the United Kingdom and recently adopted in other jurisdictions such as Spain (“pre-packaged going concern sales”); (ii) pre-packaged reorganizations leading to a debt restructuring, which is the type of pre-pack that became popular in the United States and has been partially replicated in countries like Singapore and the Philippines (“pre-packaged debt restructuring”); (iii) fast-track reorganization procedures, such as those in South Korea and Japan; and (iv) some forms of workouts that, if approved by certain majorities and sanctioned by a court, can be binding on dissenting (or some dissenting) creditors,  found in several Latin American countries such as Argentina, Brazil, Chile, Uruguay and popularized in various European countries in the aftermath of the 2008 financial crisis.

Even though fast-track procedures and workouts approved by courts are often classified as pre-packs, they are different from the pre-packs seen in the United States and the United Kingdom. For instance, in the fast-track reorganization procedure in jurisdictions such as South Korea and Japan, the procedure can still be lengthy given that the debtor is subject to most of the formalities and procedural requirements of ordinary reorganizations. Similarly, the workouts approved by courts in various countries are also different from the U.S. and UK-style pre-packs. Even though such workouts can be functionally similar to a U.S.-style pre-pack, they do  not generally require the initiation of a formal insolvency proceeding. By contrast, in the United States, companies need to file for Chapter 11 even if they can exit the procedure quickly – in some cases, even in less than 24 hours.

Pre-packs are also regulated differently around the world. For instance, the U.S. Bankruptcy Code does not have a formal regulatory framework for pre-packs. Yet, some courts have issued guidelines to deal with pre-packs. In the United Kingdom, while the disposal of assets to connected parties has been recently regulated, pre-packaged sales have traditionally been governed by a guideline enacted by insolvency practitioners. By contrast, in countries like Singapore, India, Spain, and the Philippines, pre-packs are formally regulated in  insolvency legislation. Finally, while some countries, such as India, have adopted a pre-pack that is exclusively available for certain types of debtors (small companies), most jurisdictions allow pre-packs for any type of firm.

Evidence on the use of pre-packs seems to show that they can indeed reduce the length and costs of insolvency proceedings. It also shows that, on average, pre-packs can be beneficial for creditors, the survival of businesses and the preservation of jobs. Yet, some empirical studies have also highlighted certain risks associated with pre-packs, such as sales to connected parties, at least in the context of UK-style pre-packs (Frisby, 2007; Walton et al, 2014), and lower post-bankruptcy earnings for debtors reorganized through pre-packs rather than  through an ordinary reorganization (Lopucki and Doherti, 2003).

While pre-packs can create several advantages, especially in emerging economies and more generally in countries with inefficient insolvency systems, the need for and optimal implementation of a system of pre-packs depends on a variety of country-specific factors. For example, in jurisdictions with an attractive environment for workouts and hybrid procedures, a pre-pack can have benefits, but it would not be needed as much as in countries with a costly one-size-fits-all insolvency process. Another aspect to consider is that, in the absence of a developed restructuring system and sophisticated and predictable courts, a formal regulatory framework for pre-packs would probably be more desirable than would allowing a pre-pack to evolve informally.

More important, while pre-packaged debt restructurings generally involve lower risks for creditors (given that the debtor needs to show support from the relevant majority of creditors), pre-packaged sales of assets can be riskier for two primary reasons. First, the experience of the United Kingdom shows these transactions are often entered into with related parties. Therefore, there is a higher risk of opportunism of debtors in relation to creditors. Second, in some jurisdictions with this type of pre-pack, creditor approval is not always required. Instead, the pre-packaged sale of assets just needs to be approved by a court or by an insolvency practitioner usually appointed by the debtor. As a result, my article argues that creditors should play a greater role in the approval of pre-packaged sales of assets, especially in countries without competent and independent courts and insolvency practitioners.

This post comes to us from Aurelio Gurrea-Martínez, an associate professor of law and head of the Singapore Global Restructuring Initiative at Singapore Management University.  It is based on his recent article, “The Rise of Pre-Packs as a Restructuring Tool: Theory, Evidence and Policy,” available here. A version of this post appeared on the SGRI blog.

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