The Curious Case of Pre-Package Insolvency Resolution Process: India

Janvi Parihar*

The interruption of economic processes and business cycles induced by the pandemic has caused significant damage to the industrial sector’s ability to function. Additionally, because of the nationwide lockdowns, corporations that had previously borrowed money from the market or financial institutions were unable to use that money. Among these enterprises and sectors, Covid-19 wreaked havoc on a large number of small-scale firms and industries. Micro, Small, and Medium Enterprises (“MSMEs”) are another categorization and definition for these entities. In April of this year, the Indian government presented an Ordinance aimed at MSMEs in order to offer assistance to those who have been hit the hardest.

Ordinance, 2021

On April 5, 2021, the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (“Ordinance”) was enacted to offer a pre-packaged insolvency resolution process for small size industries, also known as MSMEs. Even though the ordinance provide with a rudimentary Framework of procedure to be laid down,  The Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Rules, 2021 (“Rules’), as well as the Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Regulations, 2021 (“Regulations”), have a substantial   impact.

For MSMEs, the published Ordinance establishes a pre-packaged insolvency resolution process (PIRP). Its goal is to create a cost-effective and efficient bankruptcy procedure for the aforementioned industry. The fundamental goal of these Rules is to provide a “quicker, more cost-effective, and value-maximizing solution for all stakeholders in the least disruptive manner possible this benefits their companies and helps to keep jobs.”

What is Pre Package as a phenomenon?

The pre-pack insolvency procedure entails a deal between the debtor and the creditor to negotiate the sale of assets before filing bankruptcy papers with the court or any other suitable forum, allowing for speedier resolution and debt collection than the traditional insolvency process. The negotiation of assets of the corporate debtors occurs before the filing of an application under Sections 7, 9, and 10 of IBC. Since 1978, this practice has been practiced in countries such as the United States and the United Kingdom; however, the Insolvency and Bankruptcy Board of India recently notified the Insolvency and Bankruptcy Board of India (Pre-Packaged Insolvency Resolution Process) Regulations, 2021 (the “Pre-Pack Regulations”) for MSMEs, which are based on the Report of the Sub Committee of the Insolvency Law Committee, chaired by Dr. M.S. Sahoo. The “debtor in possession paradigm” was one of the subcommittee’s most striking suggestions. According to this model, promoters are allowed to remain in charge of the Corporate Debtors’ affairs during the pre-pack insolvency process, with the exception of matters covered by Section 28 of the Insolvency and Bankruptcy Code, 2016 (“the Code”), which require mandatory approval of the Committee of Creditors (‘CoC’).

Benefits of Inclusion of Pre-Pack in the Indian Jurisdiction

According to Indian bankruptcy law, one of the major issues with the appointment of an interim resolution professional (“IRP”) is the harm and deterioration of the corporate debtors’ goodwill and image in the market. As a result of the entire process, the market value of the company’s assets decreases since new investors are unwilling to risk their money. As a result, the entity will not get the full worth of its assets when it is liquidated. The problem of value deterioration, can be avoided if the “Pre-Package Scheme” is implemented. It’s because of the Scheme’s structure, which allows all negotiations to take place in private before the application is filed. Furthermore, this negotiation and conflict resolution method is limited to the fact that the CoC must approve it first, followed by the NCLT, giving the market less time to respond. Besides, the legislation through the inclusion of the scheme tries to cater to the interest of relevant industry sector and ensure that the system is not abused by businesses that avoid to compensate the creditors.

A condemnatory aspect of Pre-pack

Section 29A of the IBC is one of the most notable obstacles to the adoption of the “Pre-Package Scheme.” The Insolvency Bankruptcy Code (Amendment) Act, 2018, included this section, which specifies the disqualification requirements for people who seek to be resolution applicants. Section 5(25) defines a resolution applicant as someone who submits a resolution plan to a resolution professional.

A Pre-Package Scheme’s defining feature is that the corporate debtors attempt to bargain with creditors before any legal actions under the IBC. However, Section 29A(c) of the IBC expressly disqualifies the following individuals: first, anybody who has an account that has been categorized as a nonperforming asset (NPA), and second, anyone who is a promoter of a corporate debtor whose account has been classed as a nonperforming asset (NPA), the third is in charge of a corporate debtor whose account has been classed as NPA, and the fourth is in charge of a corporate debtor whose account has been classified as NPA. 

Corporate debtors designated as “micro, small, or medium enterprise under sub-section (1) of section 7 of the Micro, Small, and Medium Enterprises Development Act, 2006” are entitled to apply for PIRP, according to the Ordinance. The Regulations also apply only to firms that are part of the PIRP framework, excluding other forms of MSMEs such as partnerships, sole proprietorships, Hindu undivided families (“HUFs”), and other unregistered businesses. As a result, the number of MSMEs eligible for PIRP is limited.

According to India Brand Equity Foundation estimates, India’s MSME sector has roughly 6.3 crore firms. Despite India being a nation of MSME businesses, not all of them are legally registered. Only 26.42 lakh MSMEs are registered, according to the latest figures available on the Udyam Registration platform for MSMEs. As a result, the Ordinance only applies to a small number of businesses in this industry. As a result, the legislative objective to protect MSMEs from the consequences of Covid-19 has been thwarted. The limited application of these regulations limits the number of MSMEs who may take advantage of these programs.

The requirements of Chapter III-A of the Code require a corporate debtor to get authorization from shareholders, unrelated financial creditors, and the adjudicating authorities before commencing the PIRP. Regulation 14(1) says that consent from financial creditors must be obtained in a meeting of unrelated financial creditors conducted in accordance with the procedures outlined in the Regulations.

Moreover, rule 14(8) specifies that if a corporate debtor has no financial creditors, the above-mentioned consent must be obtained from unrelated operational creditors using the method outlined in regulation 14(8). (1). As a result, the corporate debtor must call a meeting with all of its operational creditors. The number of operational creditors, on the other hand, is far higher than the number of unrelated financial creditors, making the entire procedure more complicated and logistically infeasible. Instead of having a meeting, it is recommended that a “Letter of Assent” signed by the operating creditors be acquired for faster approval.

A corporate debtor has 90 days to submit a CoC-approved resolution plan to the adjudicating body under rule 49. It has 30 days to pass a resolution plan acceptance or rejection order. Keeping in mind the historical records of CIRP schedule adherence, this tight target of 90+30 days is unreasonable. The establishment of a CoC registered valuers’ corporate debtor evaluation, and transaction inquiry are all included in the 90-day timeframe. Getting clearance from a creditor might take a long time as well. As a result, this will only work if the corporate debtor starts digging before the PIRP begins.

The legal structure of PIRP is largely reliant on the adjudicating body, namely the National Company Law Tribunal (“NCLT”). Everything depends on the NCLT’s mandate, from the acceptance of a PIRP application through the appointment of an insolvency professional to supervise the PIRP and until the final resolution plan is accepted. Sectoral regulatory organizations, such as IBBI, can speed up the process, easing the pressure on NCLTs and allowing them to save time by simply adjudicating the last phases of PIRP.

Conclusion

The proposed PIRP will be a key facilitator for MSMEs if the law expands the mechanism’s scope and includes measures that allow lenders and businesses greater flexibility in adjusting the restructuring process. The legislation should close the gaps identified in order to meet the demands of both the relevant industry and creditors. Creditors have the financial knowledge and are well-equipped to determine whether a PIRP or a CIRP should be used under the Code. As a result, they should be allowed to use their wisdom freely. Only when all parties agree at the end of the procedure shall the adjudicating authority issue a final penalty. This is also true in other countries, such as the United Kingdom, where the PIRP is approved by the court within a day. In light of the current situation, the move is viewed as a necessary measure to keep a company in financial trouble surviving. The long-term economic and financial impact of PIRP on the fabric of corporate India, however, is yet to be gauged.

*The author is a third-year student at Institute of Law Nirma University, Ahmedabad.