‘Pre-packs’ for MSMEs
Source: By Karunjit Singh: The Indian Express
The Insolvency and Bankruptcy Code (Amendment) Bill, 2021, passed by Lok Sabha on 28 July 2021 has proposed ‘pre-packs’ as an insolvency resolution mechanism for Micro, Small and Medium Enterprises (MSMEs). The Bill will replace The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, which was promulgated on 4 April his year.
What is the Pre-packaged Insolvency Resolution Process (PIRP) in the Bill, and how does it differ from the existing Corporate Insolvency Resolution Process (CIRP)?
A pre-pack envisages the resolution of the debt of a distressed company through a direct agreement between secured creditors and the existing owners or outside investors, instead of a public bidding process.
This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the United Kingdom and Europe over the past decade. Under the pre-pack system, financial creditors will agree to terms with the promoters or a potential investor, and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
The approval of at least 66 per cent of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT. The NCLTs will be required to either accept or reject an application for a pre-pack insolvency proceeding before considering a petition for a CIRP.
One of the key criticisms of the CIRP has been the time it takes for resolution. At the end of March 2021, 79 per cent of the 1,723 ongoing insolvency resolution proceedings had crossed the 270-day threshold. A major reason for the delays is the prolonged litigation by erstwhile promoters and potential bidders.
The pre-pack in contrast, is limited to a maximum of 120 days with only 90 days available to stakeholders to bring a resolution plan for approval before the NCLT.
Another key difference between pre-packs and CIRP is that the existing management retains control in the case of pre-packs; in the case of CIRP, a resolution professional takes control of the debtor as a representative of financial creditors. Experts note that this ensures minimal disruption of operations relative to a CIRP.
According to sources aware of the developments, pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate while still providing adequate protections so that the system is not misused by firms to avoid making payments to creditors.
Currently, only corporate debtors themselves are permitted to initiate a PIRP after obtaining the approval of 66 per cent of their creditors.
The pre-pack mechanism does however, allow for a ‘Swiss challenge’ to any resolution plan that provides less than full recovery of dues for operational creditors.
Under the Swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company, and the original applicant would have to either match the improved resolution plan or forego the investment.
What challenges can pre-packs bring?
Experts say the timeline for the PIRP may be difficult to meet for lenders and distressed firms, and that forensic audits were particularly important in cases where the control of the firm remains with the same management.
Ordinarily where haircuts are involved, forensic/transaction audits become imperative, and a negative report becomes a roadblock in resolution involving the same management, Anoop Rawat, Partner, Insolvency & Bankruptcy at Shardul Amarchand Mangaldas & Co., said.
Rawat also said that if a firm restructures its outstanding debt through a PIRP with the existing management retaining control, the NPA status of the company’s account with lenders may not be automatically upgraded under RBI guidelines.
In order to motivate resolution under the PIRP, the RBI guidelines on account status may be aligned with the objective of IBC and the lenders may be given the benefit of account upgradation upon resolution. There is a need for the IBBI and RBI to find middle ground on these regulations to make the PIRP more attractive.
Experts also noted that the debtor-in-possession model may militate against the Swiss challenge option, as the existing management may create hurdles for an outside investor seeking information to potentially invest in the company.
Under CIRP, a resolution professional is in charge of running the company and providing information to potential investors.
So, what next?
Experts have noted that the pre-pack mechanism is effective in arriving at a quick resolution for distressed companies, and that the regime should be rolled out to all corporations over time as legal issues are settled through case law.
