Pre-Packed Insolvency Mechanism for MSMEs: Can There be More?

*Amay Kapil Bahri

Introduction

The discussion around the pre-pack mechanism has been sparked again with the introduction of the pre-pack insolvency mechanism for MSMEs. Pre-packed insolvency is an arrangement reached between the corporate debtor and its purchaser, before instituting a formal insolvency proceeding against the Corporate Debtor (“CD”). Since the introduction of the Insolvency Bankruptcy Code 2016 (“IBC” or “the Code”), there has been a lot of debate regarding the introduction of a pre-packed insolvency mechanism to ensure faster, out-of-court resolutions. The Code has been very successful and is one of the prime reasons for India gaining 14 places in the 2019 Ease of Doing Business Index.

Even with such great success, the Code has failed to enforce its time-bound nature as litigation at every stage of the resolution process prolongs the resolution process well beyond what is prescribed under the Code. This affects the viability of the resolution plan as well as the liquidation process because the longer it takes for the process; more the value depreciates. To fill this gap present in the Corporate Insolvency Resolution Process (“CIRP”) mechanism, the pre-packed mechanism was suggested as another option available for debtors.

There are other similar options to pre-pack available, like the mechanism under Section 230 of the Companies Act 2013 or the mechanism of RBI where a consortium of creditors attempt to resolve the debtor, however, these methods lack the speed of resolution, and the legal sanctity that IBC provides to past debts. Due to their informal out-of-court nature, pre-pack provides greater flexibility in the resolution process, which in turn will lead to a major boost for investments in India. A lot of discussions happened over the need for a pre-pack mechanism in India, and finally, in 2021 a pre-pack mechanism is introduced for MSMEs.

Pre-Pack for MSME

The MSME sector is backbone of Indian economy and contributes about 30% to the Indian GDP. In wake of the exhaustion of 1 year prohibition on the institution of fresh CIRP, the government quickly came to the rescue of the MSME sector by introducing the Pre-pack mechanism.

Pre-packs are widely used in various other jurisdictions and are recognised by international bodies such as the UNCITRAL and IMF. The IMF and the US recognise two types of pre-packs, one is the pre-packaged plan and the other is the pre-negotiated plan. The pre-pack mechanism introduced by India is similar to the pre-negotiated plan as the negotiations of the plan take place before the commencement of the Pre-Packed Insolvency Resolution Process (“PPIRP”), but the voting happens after the initiation of PPIRP and appointment of an IRP. This mechanism is largely influenced by the model in the UK where the model of pre-negotiated plans is followed. The PPIRP envisages a mix of a formal and an informal process which will encourage quicker resolution of the corporate debtor. The pre-pack process is supposed to get over within 120 days from the commencement date (section 54D of the Amendment), and the process will run in consonance to the Corporate Insolvency Resolution Process (“CIRP”) as the Committee of Creditors (“CoC”) can decide to end the PPIRP process and move CIRP during the PRIP process. Under the PPIRP, the management will vest with the corporate debtor itself, and most of the work for the pre-pack will have to be done before the initiation date of PPIRP. The CoC and the Adjudicating Authority (“AA”) can both decide to change the management and vest it with the Resolution Professional (“RP”) decided by the financial creditors, but the default rule will be of the debtor in possession.

The process of Pre-pack as has been notified by IBBI is initiated by the corporate debtor, and before initiating the PPIRP mechanism, the corporate debtor needs to prepare a Base Resolution Plan (“BRP”) and submit this to the financial creditors for approval. Subsequently, the corporate debtor also has to get approval from 3/4th of its shareholders, and 66% of its financial creditors for initiating the process. After initiating the PPIRP, this BRP is presented before the CoC and if the same is accepted, then the BRP is the resolution plan that has become final and is submitted to the AA for approval. If the BRP is rejected by CoC, then the RP will invite fresh resolution plans from the public and the best plan out of these plans from the public will be selected. This best plan and the BRP will compete as per the Swiss Challenge Model, and the better plan as per the RP will be presented before the CoC. On the approval by CoC, the plan will be sent to AA for approval. If the PPIRP process fails, then the AA will order for the liquidation of the Corporate Debtor, and the costs incurred in the PPIRP will be treated as liquidation costs.

Challenges and Limitations of the PPIRP

Strict Eligibility criterion- The recourse of PPIRP is available only to MSMEs that are registered under the MSME Act. A large number of MSMEs (about 94%) are not registered under the MSMED Act, thus the pre-pack is only available to a small number of MSME. Further, for invoking the PPIRP, the MSME has to give a declaration regarding avoidance transactions and regarding books of accounts. MSMEs rarely organised to have well-structured procedures or books of account. They therefore rarely will have the clarity to give a declaration on the things required under the pre-pack. Most MSMEs are unorganised and they do not have the requisite information freely available for the declaration. In such a case, furnishing declaration by MSME would be challenging and would deter opting for PPIRP over CIRP. With time the functioning of MSMEs will improve, however at the early stages the requirement will have to be relaxed to encourage businesses to take recourse to PPIRP.

Short Timelines- one of the major concerns surrounding the PPIRP is the short timelines provided under the legislation. PPIRP makes a brave move by providing a 90-day timeline for the submission of the accepted plan to the AA. Till now there have been a handful of cases in CIRP that have been able to actually stick to the timeline and finish the whole process in 180 days. Within the 90 days period, the RP is supposed to do multiple things like the evaluation of the CD by registered valuers and forming the CoC. The PPIRP imposes a stricter timeline as compared to CIRP and thus there will be challenges in sticking to the timeline, especially when the BRP is not accepted by the CoC. Further, the RP is supposed to review and investigate avoidance transactions within 30 days of PPIRP commencement. This is inadequate time because identification of avoidance transactions requires an in-depth analysis of the business and books of debtor. This becomes a bigger concern with MSMEs as most of the businesses do not have organised and readily data available.

Role of Adjudicating Authority- the pre-pack mechanism provides for the intervention of the AA once for admission of CD into PPIRP mechanism, and the other for confirmation of pre-pack plan to bring an end to the process. The benefit of pre-pack is that it’s an informal and quicker mechanism. More the intervention of AA, greater is the risk of the time bound nature of process failing as the AA itself causes delay in taking decision. Removing the requirement of AA to intervene for approval to initiate the pre-pack process would ensure a faster resolution. The RP is itself taking the decision whether the corporate debtor is eligible for pre-pack and submitting a report to the AA. Requiring the AA to further approve is a redundant and a time consuming step that can be done away with.

Exclusion of Operational Creditors- Operational creditors do not have much say in the pre-pack procedure as all the decisions on selection and approval of the plan are limited to financial creditors. This trend is continued from the mechanism in CIRP and will raise greater concerns for the operational creditors. One of the pros of the pre-pack process, the confidentiality of the process, is also a major cause for concern. The confidentiality of the pre-pack process makes the process all the more opaque for the operational creditor, thereby adding to the distrust of operational creditors. The Pre-pack mechanism provides that CoC can opt for a Swiss Challenge bidding process, and the plan submitted subsequently only needs to ensure that the liquidation value of the operational creditor is provided. The liquidation value for operational creditors is very less because of the low priority under section 53 of the Code; hence, the minimum standard that each plan has to ensure is very low in itself. Additionally, these operational creditors are subsequently important for the resolved debtor, hence providing transparency in the procedure would be helpful in the process as well as subsequent functioning of the debtor after resolution.

Conclusion

The introduction of PPIRP is definitely a positive and landmark change in the Indian insolvency regime. It is the need of the hour as PPIRP provides an opportunity for businesses to restructure their liabilities and start again from a clean slate. At a time where resolution applicants under CIRP are less and many businesses as being forced into liquidation due to the pandemic, PPIRP provides a mechanism where the management of the debtor plays an active role in making a resolution plan which would ensure the future viability of the business. The PPIRP mechanism notified by the IBBI is a very well thought out mechanism; however, there are a few challenges and concerns that have to be resolved so that MSMEs opt for pre-pack rather than CIRP. Further, the mechanism can be made more efficient and attractive by making the process more transparent and by reducing the scope of intervention of AA.  

*The author is a fourth-year student at National Law University, Delhi.