PRE-PACKAGED INSOLVENCY FOR MSMES: IS IT THE RIGHT TIME?

This article has been authored by Vaishnavi Patel, a third year student at GNLU, Gandhinagar.

Introduction

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, was issued by the President of India on April 4, 2021, to implement a Pre-Packaged Insolvency Resolution Process (“PIRP”) under the Insolvency and Bankruptcy Code (“IBC”), 2016. This law was enacted to give corporations designated as micro, small, and medium enterprises (“MSME”) with an “efficient alternative insolvency resolution process.” Formal insolvency processes, such as the Code's corporate insolvency resolution procedure ("CIRP"), can take a long time and cost a lot of money considering the direct and indirect costs. On the other hand, while informal workouts give a flexible and cost-effective alternative for resolving insolvency, the outcomes reached through such methods lack the legal sanctity of a court-approved resolution plan due to a lack of statutory underpinning and legal certainty. Pre-packs are a one-of-a-kind method that tries to combine the advantages of informal workouts with the legal certainty of official insolvency proceedings. Pre-packs are hybrid methods that allow out-of-court remedies to be recognized under insolvency law while also providing sufficient safeguards for all parties involved.

Overview of The Process

The MSME, as the corporate debtor (“CD”), can start a PIRP by submitting an application in the required form within 90 days of the default date. The adjudicating authority (“AA”) having 14 days from the date of receipt of the application, can choose to accept or reject it. Within 120 days from the date of its acceptance, the PIRP is required to be completed. Following receipt of resolution plans from possible bidders, the Committee of Creditors (“CoC”) would analyse the resolution plans and select one that meets the requirements and is superior to the base resolution plan.

Moratorium as prescribed under the Section 14 of IBC shall mutatis mutandis apply to the Pre-Pack insolvency Process for MSME. It would be available from the pre-pack commencement date until the process is closed. Unlike the traditional CIRP, the current promoters and management of the CD would continue to retain control and possession during the Pre-Pack process. The CoC must approve the resolution plan with at least 66 percent of the voting share and propose it to the AA for approval within 90 days of the commencement date. If the National Company Law Tribunal (“NCLT”) is satisfied that the resolution plan approved by the CoC meets the requirements of Section 30 of the IBC, the NCLT shall adopt the resolution plan by order within 30 days of receipt of the resolution plan.

Critical Analysis

A popular criticism faced by the CIRP has been the duration of time it takes to resolve cases. It has been stated by reports that over 86 percent of the 1717 ongoing bankruptcy resolution processes had reached the 270-day mark by the end of December 2020. Prolonged litigation by former promoters and possible bidders is one of the main causes of CIRP delays. The pre-pack, on the other hand, is limited to a maximum of 120 days, giving stakeholders only 90 days to submit a resolution plan to the NCLT. As per the scheme, a CD will be able to start a pre-pack before starting any IBC proceedings under the current structure. A CD's action plan will be to draft a pre-package before entering into insolvency, and once completed, the debtor will be able to submit a CIRP. As a result, pre-packs will not function independently, but rather as part of the CIRP. The advantage would be to forgo the official procedure and save time.

The debtor-in-possession model, which allows the MSME's existing management to continue to govern, manage, and focus on the turnaround, is a significant benefit of PIRPs. To some extent, this guards against business disruptions and loss of goodwill. Of course, management powers are subject to safeguards to ensure that the process is employed by MSMEs who are legitimately afflicted by unavoidable circumstances, rather than those who are deliberately in financial problems. The resolution professional, for example, is obligated to keep an eye on management and report any violations to the COC. By a 66 percent vote, the COC can also replace management by electing a resolution expert to oversee the corporate debtor during the PIRP process.

The pre-pack rules also included necessary safeguards to guarantee that the measures were not abused by rogue promoters. A crucial aspect is that there would be no dilution of provisions under Section 29A of the IBC which provides for the eligibility of resolution applicant. It allows for a Swiss challenge for any resolution proposals that result in less than full payment of operating creditors' dues. Any third party might propose a resolution plan for the distressed company under the Swiss challenge procedure, and the original application would have to either match the improved resolution plan or forego the investment.

Prior to activating the PIRP, a speedier recourse to a resolution plan in cooperation with stakeholders would allow for asset maximization. Furthermore, the option for PIRP proceedings to begin on the first occurrence of default would limit the scope of liquidation and the continuance of the firm would be made easier. The recent Supreme Court ruling in Ramesh Kymal v. M/s Siemens Gamesa Renewable Power Pvt Ltd., clarified that the IBC suspension due to Covid-19 would have retrospective operation. As a result of the retrospective application, there is naturally going to be a hike in the number of case with the moratorium being lifted. Therefore, the plan might have the potential to shine and assist the Adjudicating Authority in reducing its workload.

However, it can’t be ignored that the success of Pre-Packs would be determined in large part by the transparency with which current management operates, and the role played by the Resolution Professional. The mind-set of both the creditor and the debtor to operate in the best interests of the company must be ingrained in the operations of all stakeholders. Another important consideration is that even with the approval of 66 percent of the Financial Creditors, the Resolution Plan does not become final until it is approved by the NCLT. Such approvals are not only time demanding, but they also add a level of uncertainty to the entire pre-pack scheme's procedure. The success of a resolution is severely hampered by this element of uncertainty. Since there is a limited possibility for restructuring with financial creditors, which mostly involve banks and financial institutions, the strategy fails to strategize the true financial suffering. The Resolution Plan is obliged to take no action against Operational Creditors, such as suppliers of goods and services, and the MSME is obligated to pay these creditors' debts in any distressed circumstances.

Lastly, the system assumes cooperation among different types of creditors and debtors in order to work more efficiently. Unlike insolvency proceedings under the IBC, the promoters will retain control of the business during the pre-pack discussion, and if they fail to provide necessary information to the creditors about the scheme and asset valuation, the pre-packs scheme will be haphazard and useless to the creditors, especially to operational creditors. Because this arrangement is frequently made with the company's management's input, it prioritizes the interests of debtors and secured creditors over operational creditors. As a result, the effectiveness of Pre Packs is directly related to the roles played by the process participants, which include Management, Financial Creditors, Resolution Professionals, and Adjudicating Authorities. In order to achieve the system’s goal, the Company's and creditors' entire economic business cultures must be unified. Such a unification can prove to be a challenge for the timely completion of the entire process. Additionally, the rules for dilution of stock represent a risk of creditors gaining control of existing management, which is not a particularly remarkable characteristic of the system.

Concluding Remarks

It's worth noting that the corporate debtor's affairs will continue to be managed by the Board of Directors or the partners of the corporate debtor during the PPIRP. With CIRP's flaws, such as its length, and the rising popularity of out-of-court settlements and arbitrations, pre-packaged insolvency resolution could be a more efficient alternative for stressed corporate MSMEs in India. It is a positive start towards establishing a flexible, quick, and collaborative procedure for MSME financial stress resolution. The method is potentially significantly faster and more cost-effective than a CIRP procedure, especially if the base resolution plan is accepted. While the benefits are obvious, the key to the PIRP's success as a fast and efficient method is the strict compliance of the specified timelines and insightful engagement by the various stakeholders.