Contributed by: Samvad Partners
Ever since the pandemic induced stress began, there has been talk of the Government introducing pre-packaged insolvency resolution processes (“pre-packs”) into the Insolvency and Bankruptcy Code, 2016 (“IBC”). Prevalent in other jurisdictions either through statutory provisions or market driven mechanisms, pre-packs aim to provide a more debtor-friendly, cost-effective and faster resolution process in situations where there may already be a broad consensus between debtor and creditors for a resolution. In January 2021, a Sub-Committee of the Insolvency Law Committee published a report on what a pre-pack framework under the IBC might look like and also considered the broader question of whether the Indian insolvency ecosystem was “ready” to experiment with pre-packs. Following on the heels of the Sub-Committee’s Report, the Government, on April 4, 2021, enacted the Insolvency and Bankruptcy Code (Amendment), Ordinance, 2021 (the “Ordinance”) that enables pre-packs for one category of corporate debtors under the IBC – micro, small and medium enterprises (“MSMEs”).
How does the pre-pack framework for MSMEs work?
In contrast to a typical corporate insolvency resolution process (“CIRP”) under the IBC, which can be initiated by a financial or operational creditor or by the corporate debtor itself, only the MSME corporate debtor can initiate a pre-pack. However, initiating a pre-pack requires approval from the MSME’s shareholders as well as from 66% in value of the unrelated financial creditors of the MSME. Pre-packs, therefore, cannot be initiated without the consent of the significant financial creditors of the MSME. Further, in connection with seeking such approval from its financial creditors, the MSME must provide its financial creditors with a base resolution plan that conforms to the requirements of the IBC. Pre-packs, accordingly, require much of the preparatory work towards a feasible resolution to be completed by the MSME prior to initiation of the pre-pack application.
Another significant difference between a pre-pack and a CIRP is that the pre-pack is a debtor-in-possession regime, where the board of directors/partners of the MSME retains control over the management and affairs of the MSME during the entire pre-pack process. However, it should be noted that the Ordinance places fiduciary duties on the directors/partners of the MSME to ensure that the assets of the MSME are protected for the benefit of its creditors and that the MSME continues to operate as a going concern. Further, at any time during the pre-pack period, the committee of creditors (“CoC”) through a vote of at least 66% in value of the financial creditors, has the power to vest the management of the MSME with the resolution professional. Thus, while pre-packs, by necessity, place a lot of responsibility on the MSME corporate debtor, the Ordinance also has safeguards intended to prevent abuse of the process by MSMEs.
The approval process for a resolution plan under the pre-pack regime is fairly complicated and provides for various permutations and combinations. At the first level, the CoC may approve the base resolution plan submitted by the MSME, as long as the plan provides for full payment of all dues owed to operational creditors. In the event that the base resolution plan does not provide for full payment of operational creditor dues (which is often likely to be the case) or the CoC chooses not to approve the base resolution plan, the resolution professional is required to invite resolution plans from other prospective resolution applicants to compete with the base resolution plan. The IBBI (Pre-packaged Insolvency Resolution Process), Regulations 2021 provides for the manner in which the various resolution plans may compete with each other, and also provides all the resolution applicants an opportunity to improve their plans during a 48-hour window. Approval of a resolution plan then requires the affirmative vote of 66% of the voting share of the CoC and thereafter needs to be approved by the National Company Law Tribunal (“NCLT”). It is interesting to note that the IBC Ordinance specifically provides that if the resolution plan submitted by the MSME impairs any claims owed by the MSME to its creditors, the CoC may require the promoters to dilute their shareholding/voting/control in the MSME.
The pre-pack process is to be completed within 120 days (in contrast to 330 days for a CIRP). However, the reasons for the shortened process are primarily because of the fact that a lot of the work for building consensus and proposing a resolution plan is done prior to initiating the application. Apart from this, other requirements of the CIRP, such as the requirement for registered valuers and the conditions that a resolution plan must comply with, remain unchanged.
Are Pre-packs likely to be used extensively by MSMEs?
Pre-packs fall in the middle of the continuum between out-of-court restructurings and a CIRP and tend to work well where there is consensus between debtor and creditors and the creditors are not too numerous or widely dispersed. In such situations, pre-packs can provide the debtor and creditors with the best of both worlds. They can minimize the time spent in the formal insolvency process and the business disruptions that come along with it, while at the same time, arriving at a resolution plan that has the statutory backing of a court-driven resolution process.
The pre-pack framework for MSMEs that the Ordinance has enabled provides some of these advantages to MSMEs over a CIRP as the debtor-in-possession model would mean less disruption to the business. Further, the longer preparatory phase would also mean that the time period from initiating the pre-pack application to a resolution plan being approved is much shorter. However, it is important to note that the pre-pack framework does not greatly simplify the process or costs for MSMEs as it still involves significant roles for the resolution professional and the NCLT. In light of this, it remains to be seen whether MSMEs and their financial creditors would prefer to utilize the pre-pack process as opposed to an entirely out-of-court restructuring, such as a one-time settlement.
The Sub-Committee of the Insolvency Law Committee had, in its January 2021 report, recommended a phased implementation of pre-packs and many commentators believe that introducing pre-packs for MSMEs might well be a precursor to making the process more widely available to other categories of corporate debtors. The experience of MSMEs with the pre-pack process could provide valuable guidance in formulating a pre-pack framework for other corporate debtors going forward.
One issue that would have to be grappled with if pre-packs are made more widely available is the applicability of the controversial Section 29A of the IBC. MSMEs are exempt from certain provisions of Section 29A, as a result of which promoters of the MSME corporate debtor are permitted to submit resolution plans in situations where promoters of non-MSME corporate debtors would be prohibited from doing so. The Sub-Committee’s report did not recommend any relaxation from Section 29A, which would mean that non-MSME corporate debtors and their promoters may not be permitted to submit base resolution plans in a number of circumstances. It is unlikely that a corporate debtor would cooperate with creditors or initiate a pre-pack if it is ultimately prohibited from submitting a resolution plan. Section 29A is an issue that needs to be addressed if pre-packs are to be made more widely available to and, more importantly, utilized by, different categories of corporate debtors.
Contributed by Samvad Partners
The above article has been authored by Ms. Aparna Ravi(Partner).