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Insolvency Amendment- Pre- Pack For MSME's

Mohini Priya
9 April 2021 8:20 AM GMT
Insolvency Amendment- Pre- Pack For MSMEs
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The Central Government recently promulgated the IBC Amendment Ordinance 2021, allowing a pre-packaged insolvency process for micro, small and medium enterprises (MSMEs), in consonance with international best practices. The ordinance in essence has amended the the Insolvency and Bankruptcy Code 2016 allowing the Central Government to notify such pre-packaged process for defaults of not more than Rs. 1 crore to be initiated by the corporate debtor.

The Ordinance inter alia has inserted a new Chapter-IIIA in the IBC 2016 to provide for making an application for initiating pre-packaged insolvency resolution process in respect of a corporate debtor classified as a micro, small or medium enterprise (MSME) under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.

This ordinace is a welcome step towards the resolution of insolvent MSMEs, in light of the impact that the pandemic has had on the businesses, financial markets and economies all over the world, including India, exposing many of these MSME's to financial distress. The scheme also covers businesses incorporated as partnerships, in addition to companies.

In the recent past, the Central Government has taken several measures to mitigate the distress caused by the pandemic including increasing the minimum amount of default for initiation of corporate insolvency resolution process to Rs. 1 Crore, and suspending filing of applications for initiation of corporate insolvency resolution process in respect of the defaults arising during the period of one year beginning from 25th March 2020 and ending on 24th March 2021. The IBC (amendment) Ordinance 2021 coming within two weeks of the lifting of a one-year suspension of insolvency proceedings against Covid-related defaults is a smart move amid heightened possibilities of a rise in bad loan cases.

What is the pre-packaged Insolvency resolution plan (PPIRP)?

Pre-packs are essentially a form of restructuring that allow creditors and debtors to work on an informal plan and then submit it for approval. MSME businesses are generally managed by promoters and it is difficult to revive them after the management is ousted under the normal CIRP. Under the new ordinance, participation of eligible existing promoters is encouraged, with the board continuing in control and the debtor proposing the base resolution plan, which will then be put to competitive bidding through Swiss challenge. Thus Pre-packs will help corporate debtors to enter into consensual restructuring with creditors and address entire liability side of the company.

The pre-pack insolvency shall be initiated by the corporate debtor after obtaining an approval from its financial creditors representing not less than sixty-six per cent in value of the financial debt due to such creditors.

PPIRP vis-a-vis CIRP

The most significant feature of the Pre-pack scheme is that it allows the management of the affairs of the corporate debtor to continue to vest in the Board of Directors or the partners, as the case may be, of the corporate debtor, subject to conditions specified, unlike in the CIRP where the resolution professional gets to run the affairs with guidance from financial creditors. If creditors want to initiate bankruptcy proceedings against MSMEs, they can still do so but only through the CIRP.

Further, Pre-pack resolution plans have to be submitted in only 90 days and the NCLT will have another 30 days to approve them. Thus, the pre-packaged insolvency resolution process shall be completed within a period of one hundred and twenty days from the pre-packaged insolvency commencement date.

The IBC currently stipulates a maximum of 270 days for the completion of the entire CIRP. Given that MSMEs have limited wherewithal to go through a long and rigorous insolvency process, the reduction in the time-limit for resolution comes as a blessing for insolvent MSME's.

The scheme, where only the debtor will get to trigger the bankruptcy process, is expected to yield much faster resolution than the extant corporate insolvency resolution process (CIRP) and cut costs. It could also reduce litigation, often triggered by defaulting promoters to retain control of their firms, and help thousands of MSMEs struggling to cope with the havoc wrought by the Covid-19 pandemic.

Also, since this process can be initiated only by the companies with consent of 66% of its unrelated financial creditors, there will be lesser possibilties of disputes, which will allow the process to run more efficiently than the normal CIRP.

Procedural checks and balances: Protecting the rights of creditors

The Pre-pack insolvency resolution plan athough based on a debtor-in possession approach vests significant consent rights to financial creditors in order to ensure that the mechanism is not misused by errant promoters. Such rights include the applicability of Section 29 A (which is a restrictive provision disqualifying those who had contributed in the downfall of the corporate debtor or were unsuitable to run the company from submitting a resolution plan/ participating in the bidding of the corporate debtor) and 2/3rd of the creditors' consent for both initiation and approval of the base resolution plan. Operational creditors are protected by requiring market testing of the base resolution plan if it impairs the claims of operational creditors. In addition, the creditors' committee can also convert the pre pack process to the usual CIRP by 66% majority at any time, or require the board to cease control through the intervention of the NCLT in case of fraud or mismanagement by the existing management Further, adopting plan evaluation process akin to Swiss Challenge, it retains competitive tension such that promoters propose plans with least impairment to rights and claims of creditors.

The scheme is available to entities that have neither undergone bankruptcy proceedings in the preceding three years nor are facing liquidation orders. The scheme further disallows a business to avail of it if the major shareholder is an undischarged insolvent or wilful defaulter.

Further, the committee of creditors have the power to require dilution of promoter shareholding/ control, in cases where resolution plans submitted by the corporate debtor provides for impairment of any claims owed by such corporate debtor, which would act as a deterrant to any unreasonable resolution plan.

Further, the committee of creditors, at any time during the pre-packaged insolvency resolution process period, by a vote of not less than sixty-six per cent of the voting shares, may resolve to vest the management of the corporate debtor with the resolution professional which shall be decided by the Adjudicating Authority.

In addition to these, by insertion of new Articles 67A and 77 A, the amendment provides strict penalties for fraudulent management of corporate debtor or providing false information or any material omission in the application or the list of claims.

Thus, the amendment has been designed in a manner to provide a more friendly and ameliorative mechanism of resolution of stressed assets for MSME's while ensuring that they don't go scot-free in case of any manipulation therefore keeping a fair balance to protect the interests of creditors as well.

Prospective and Overriding Effect of PPIRP

Interestingly, the disposal of a pre-pack application has been given priority over the CIRP application for the same stressed MSME under Section 7, 9 and 10 of the IBC, subject to certain conditions. However, in case of already-pending CIRP applications, NCLT will need to dispose them of before considering the pre-pack application for relevant debtors. Thus, the provisions relating to pre- pack applications are prospective and overriding in that respect.

This ordinance adopts a hybrid approach towards the resolution of insolvent MSMEs balancing the interests of creditors on the one hand and the need to preserve the autonomy/ agency of MSMEs on the other hand- to best serve the interests of both of them. The ordinance is thus a calibrated legislative effort at buffering the tumultuous impact on many MSMEs of various cataclysmic changes sweeping the globe in a post- Covid world. However, its full fledged implementation should be coupled with the government taking steps for bettering of NCLT infrastructure which is already overstretched. In summation, this ordinance is a welcome step at this juncture but it's implementation in future will tell us if this ordinance meets it's objectives, and if so, in what measure.

Views are Personal

The Author is a Lawyer at the Supreme Court of India

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