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Pushing ‘pre-packed’ insolvency resolution

The Hindu Business Line |
Sanjeev Jalan, Partner
Business Restructuring Services

24 May 2021

In these troubled times, a consensus-based approach can be effective in saving viable MSMEs in a time-bound manner

The Insolvency and Bankruptcy Code, 2016 (IBC) was notified four years ago and since then the law has witnessed various notifications and amendments by the Centre. Currently, the changes brought about by the Covid pandemic have forced governments across the world to introduce measures to protect their economy and, more particularly, small businesses.

Keeping in view, the current scenario, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 was promulgated on April 4, 2021 (’Ordinance’), introducing Pre-Packaged Insolvency (PPIRP) for the relief of the stressed entities in the MSME sector. The main aim behind the introduction of the Pre-pack was to provide an alternative insolvency resolution process to the bankrupt MSMEs. It provides them with the opportunity to restore their liabilities and start afresh while safeguarding the rights of the stakeholders; it provides enough protection to prevent any potential misuse by the firms to avoid making payments to the creditors.

Pre-packaged insolvency, or Pre-pack, as known globally, is an informal arrangement through which the promoters of a stressed company propose a resolution plan to the creditors before the company goes for bankruptcy proceedings.

The time factor

The purpose is not only to have a timely and quick resolution mechanism but also to give legal sanction to a plan agreed upon between financial creditors, corporate debtors, and buyers. This system of insolvency resolution has become an increasingly popular mechanism in the UK and other Western countries and can have immense potential for India as well, given that it seeks to provide quicker, cost-effective, and value maximising outcomes for all stakeholders in a manner that is least disruptive to the continuity of their businesses.

As notified, an MSME Corporate Debtor (CD) (as per Section 7(1) of the Micro, Small and Medium Enterprises Development Act, 2006) having defaulted for an amount more than ₹10 lakh is eligible to make an application to initiate a Pre-pack process, provided that such the CD is also eligible to submit a resolution plan under Section 29A of the Code.

The PPIRP functions as a hybrid framework blending both formal and informal processes within the overall mechanism of the IBC, wherein the CD in default, with the approval of not less than 66 per cent financial creditors (other than a related party), will proceed with filing an application before the National Company Law Tribunal (NCLT).

Once the process starts, the CD needs to submit its resolution plan before the Committee of Creditors for approval. The CoC may approve/reject the plan or seek changes to it; an important point is that the CoC can approve the plan as submitted by the CD only if it does not impair any claim of operational creditors. Otherwise, the RP will have to invite a resolution plan from prospective investors/applicants.

In such a scenario, the base plan submitted by the CD would be subject to a Swiss Challenge kind of methodology. The resolution plan which is best viable in the opinion of the CoC will be approved by not less than 66 per cent of the CoC and subsequently filed with the NCLT by the RP for approval.

On the commencement date of the PPIRP, the Adjudicating Authority (AA) will be required to declare a moratorium as under the CIRP, appoint the proposed RP, and publicly announce the initiation of the PPIRP. Thereafter, the RP is to implement the PPIRP and is vested with several powers and obligations for the same.

It is worthwhile to note that during the PPIRP, the management of the affairs of the CD shall continue to vest with its board of directors, the PPIRP working on the ‘Debtors in possession’ model as against the existing Corporate Insolvency Resolution Process (CIRP) that follows the ‘Creditors in control’ model and as such would enable the MSME to resolve its stress as going concern.

Compared to the CIRP, which requires a threshold period of 270/330 days, the PPIRP is required to be completed within 120 days from the commencement of the process, out of which 90 days are given to the RP to file the resolution plan with the AA and 30 days stipulated for the AA to approve the resolution plan. If no resolution plan is approved by the CoC, then the RP shall apply to the AA to terminate the PPIRP.

The advantages

Business continuity, shorter timeline, efficiency, and cost-effectiveness are some key USPs of PPIRP. Moreover, this entire process remains outside the restructuring framework of the RBI and encompasses all financial creditors; as opposed to the RBI’s restructuring schemes that deal only with banks, this considers concerns of other financial creditors as well.

Further, a judicial seal of approval also addresses questions raised by investigative/other agencies in the future. One of the major concerns of the CIRP is the delay due to litigation, etc., while the Pre-pack framework provides a timeline; given the burden of the NCLT, it looks very unlikely that things will improve under the new regime.

The need of the hour would be to gradually reduce dependence on the NCLT and simultaneously have sufficient numbers of Insolvency Benches to adhere to the envisaged timelines. Excess legislation and restrictions may dilute the intent of the Pre-pack, which requires that those involved in the process be sensitive towards consensus-building mechanisms between debtors and creditors.

While the PPIRP is a timely effort to protect viable MSMEs, it is likely that operationalising it only for MSMEs now may just be the first step towards a sound Pre-pack and will lead to a much wider coverage in the future which, like the IBC, is expected to evolve with time and jurisprudence.

The writer is Partner - Business Restructuring Services, BDO India