Debut of Pre-Packaged Insolvency for MSMEs amid COVID-19 Pandemic
Author: Archita Tiwari & Kriti Agarwal
Designation: Students, National Law Institute University, Bhopal
Contact: 81********, 78********
The Insolvency and Bankruptcy Code (“IBC”)', has been amended in April 2021 after the recommendations of the Insolvency Law Committee to incorporate a Pre-packaged Insolvency Resolution Process (“PIRP”) for corporate persons classified as Micro, Small and Medium Enterprises ("MSMEs"). It was promulgated two weeks after the uplift of the ban on the initiation of the Corporate Insolvency Resolution Process “CIRP” amid the COVID-19 pandemic keeping in mind the heightened possibility of initiation of CIRP for bad loans, especially for MSMEs. Moreover, MSMEs contribute considerably to the Gross Domestic Product of the country and employ a large chunk of the population. The Ordinance is promulgated expediently for the continuity of the business in the least disruptive manner and for the jobs to be preserved to check escalating unemployment all over the country.
Pre-packed bankruptcy is a quasi-formal procedure that puts together the pros of a formal bankruptcy procedure along with an out-of-court debt restructuring. Pre-packs, perceived as a subset of corporate rescue, are typically employed to preserve the business of the debtor with its enterprise value intact.
LAW BEFORE AND AFTER
Under the typical IBC process, a financially stressed borrower is presented before the bankruptcy tribunal i.e. the National Company Law Tribunal “NCLT” by the corporate persons to initiate a time-bound resolution in which the company is auctioned to an investor through a competitive bidding process wherein the inventive promoter cannot participate. This method obtains plenty of time and money from a party that is already financially stressed. It takes from about six months to 270 days for the process to complete in some cases.
Whereas in Pre-pack the plan has to be proposed in the tribunal in less than 90 days only then the NCLT will take another 30 days to approve or disapprove the plan. This makes the entire process much faster than the usual CIRP.
PIRP allows original promoter to run the MSMEs, while CIRP allots a resolution professional to control functions of the company with the guidance of the financial creditors.
Furthermore, the legislature increased the minimum threshold to initiate the PIRP from rupees 1 lakh to 10 lakh by amending section 4 of the IBC, 2016 vide section 2 of the Ordinance, 2021. Since the private restructuring takes place out of the Court, the corporate persons are not under any statutory procedure. It reduces the cost to a great extent, and can be custom made. This helps the MSMEs that are struggling to survive in the Covid-19 pandemic and the market crises.
The MSME debtor must get the plan approved by at least 66% of the unrelated financial creditors to file for pre-pack insolvency for the dues. Original promoters will be bound to submit a base plan which would be up for competitive bidding through the Swiss challenge method. As this process requires a 66% approved limit by the unrelated financial creditor, only limited companies will be able to initiate the PIRP, making the amounts of disputes minimal and making the whole process much more efficient than CIRP.
Here, the debtor can either make the company profitable again with the help of the creditors suggest a plan to regain control of the company, or the borrower can introduce an investor to help with the resolution or sale.
LEARNING FROM THE WEST
The USA has envisaged the process of a pre-packaged resolution plan under Chapter 11 of the United States Bankruptcy Code. In the USA, PIRP is not for companies that need a comprehensive overall debt restructuring but for corporate persons' companies whose primary reason for financial distress is excessive debt levels. It has an insolvency-oriented approach as the corporate debtor sells his assets either in parts or complete based upon sufficient business justification.
As per UK laws, an insolvency practitioner (IP) is appointed as an administrator to help in administration and to negotiate a deal before the formal insolvency proceedings begin. The administrator should disclose all the activities and transactions undertaken with adequate reasons for such negotiation. The laws and requirements in the UK are somewhat similar to the Corporate Insolvency Resolution Process provided under the IBC.
Pre finalized resolution plan implemented as the “concept of cram down” is available against minority dissenting creditors after settling the pre-pack resolution plan. This concept has been explained and applied by the Supreme Court of India in the judgment of Essar steel. The Court can approve a resolution plan even after disapproval of a minor group of creditors. In other words, majority stakeholders can cram down on minority stakeholders to prevent the company from going into liquidation.
It is assumed that the enactment of PIRP with the needed changes can change the whole idea of insolvency resolution in India.
Pre-packs are referred to as “the best of both worlds” because they bring to the table speedy resolutions, cost-effectiveness, and value maximization with business continuity and nominal disruption to debtor’s company operations.
However, out-of-court settlements in most cases yield no desired results. Private negotiations before the formal process begins, which is one of the advantages of pre-pack, often lead to distress, and the need to maintain transparency for the whole process without losing the confidence of creditors proves to be a challenge. This process also gives rise to “serial pre-packing” wherein the help is misused to get away from loan repayment and continue the unviable business.
The authors conclude that pre-packs will be convenient as liquidation of borrowers is not a feasible option to curtail the financial market crises. This process will bring about a successful change only after a proper implementation.
The IBC Amendment Ordinance, 2021, https://www.mca.gov.in/Ministry/pdf/IBCAmedOrdinanceBill_06042021.pdf
Kridhan Infrastructure Pvt. Ltd. vs Venkatesan Sankaranarayan, Civil Appeal No.3299/2020
Chapter 11: United States Bankruptcy Code, https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics
Committee of Creditors of Essar Steel India Limited (through authorized signatory) v. Satish Kumar Gupta and Others, (2020) 8 SCC 531