Pre-Packaged Insolvency Resolution Process-A Hybrid Framework to save viable MSMEs

MSME sector in India is second largest employment generator after agriculture, and acts as a breeding ground for entrepreneurs and innovators with considerable support in strengthening business ecosystem. The estimated number of MSMEs in India is 63 million and employs 110 million individuals. Indian MSMEs produce more than 6,000 products for local and global consumption. The announcement of country wide lockdown dragged MSME owners, employers and external stakeholders in unexpected times, where no one had experience to handle this kind of situation. Extended lockdown had negative impact on supply of finished goods, procurement of raw material and availability of employees to work in production and supply processes. During April to June 2020, sector faced challenges related to debt repayments, wages/salaries, statutory dues, etc. Reports have shown that disruptions caused by the Covid-19 pandemic have impacted MSMEs earnings by more than fifty percent, Micro and Small enterprises faced the maximum heat, mainly due to liquidity crunch. Enterprises working in essential commodity business were better off in terms of interrupted but predictable cash flows. Some enterprises innovated their ways by shifting focus from non-essential commodities towards essential commodities; like production of hand sanitizer and toiletries, PPE kits, reusable masks, etc. and are able to survive in tough times. MSMEs present in remote areas also faced lots of difficulties due to interrupted supply chain systems and intrastate lockdown provisions.

The government has promulgated an ordinance to introduce a pre-packaged insolvency resolution process for stressed micro, small and medium enterprises (MSMEs). It will allow the stressed debtor- in this case the MSMEs- and its creditors to quickly work out a plan to revive the company outside the bankruptcy process, which would then be sanctioned by the courts. It is considered expedient to provide an efficient alternative insolvency resolution process for corporate persons classified as micro, small and medium enterprises under the Insolvency and Bankruptcy Code, 2016, ensuring quicker, cost-effective and value-maximizing outcomes for all the stakeholders, in a manner which is least disruptive to the continuity of their businesses. It is considered expedient to introduce a pre-packaged insolvency resolution process for corporate persons classified as micro, small and medium enterprises,” the IBC ordinance 2021.The minimum default threshold of Rs.10.00 lakh, which has been prescribed for initiating the process, would provide much respite to MSMEs by enabling them to have access to an effective resolution process under the pre-pace process. This would not have been otherwise feasible under the Corporate Insolvency Resolution Process owing to enhanced default threshold of Rs.1.00 crore. Prepack Insolvency Resolution Process would work on debtor in possession model and as such would enable the MSMEs to resolve their stress as a going concern.Revised composite criteria is investment in Plant and Machinery/equipment and Annual Turnoveras per the revised definition of MSME

Applicability of Pre-Pack Framework:

The pre-pack framework will be applicable for MSMEs with a maximum default value of Rs 1 crore only. It can be filed under a newly inserted Section 54C of the IBC. For defaults of more than Rs 1 crore, IBC or other resolution mechanisms can continue to be used. A pre-packaged insolvency resolution process or PIRP cannot run in parallel to another corporate insolvency resolution process (CIRP), and must have a three-year cooling-off period from the closure of any other pre-pack or CIRP, as per the rules notified. If a pre-pack application is filed within 14 days of the filing of any application under section 7 or section 9 or section 10 which is pending, then the Adjudicating Authority would have to first dispose of the application under section 54C. If more than 14 days have passed since an IBC plea was filed under Sections 7, 9, or 10, then the court would have to give the existing plea a preference. Sections 7, 9 and 10 deal with the initiation of the corporate insolvency resolution process by financial creditors, operational creditors and the corporate debtor himself respectively.

Initiation/Trigger:

The framework has been modelled on the debtor-in-possession and creditor in control approach. The debtor would have to have a base resolution plan in place before approaching creditors to initiate a PIRP.The financial creditors can initiate the PIRP in case of a default by an MSME if a minimum of 66 percent creditors vote in favour of PIRP, and file an application with the adjudicating authority for the same. Alternatively, if a corporate debtor does not have any financial creditors, the company may approve the application filing through a special resolution with a 75 percent majority, and move the court to initiate PIRP. An insolvency resolution professional, as approved by creditors, is then appointed by the court.

Eligibility Criteria for the Corporate Debtors for filing application for Pre-Pack:

• MSME unit has not undergone pre-packaged insolvency resolution process or completed CIRP during the period of 3 years preceding the initiation date of PIRP
• Order of the liquidation is not passed under section 33 of IBC
• It is eligible to submit resolution plan under section 29A of the IBC
• Financial creditors representing not less than 66% in value of financial debt has proposed the name of the insolvency resolution professional and same is approved the proposal

Timelines:

The entire Pre-packaged insolvency resolution process would have to be completed within 120 days from the commencement date. The resolution professional is expected to submit the resolution plan, as approved by the committee of creditors, to the Adjudicating Authority within 90 days of the commencement date. If the plan is not approved by the committee of creditors (CoC) within the time period, the PIRP would be terminated.

Control of company during PIRP:

Unlike the IBC, under the pre-pack framework, the management of the affairs of the corporate debtor will continue to vest in the Board of Directors or the partners of the corporate debtor. If the CoC at any time during the process feels the company’s affairs are not being run in a transparent, or there is a fraud, it can vote by 66 percent majority to transfer the management powers to the resolution professional instead.

Resolution Plan:

Section 29A of the IBC, which prohibits defaulting promoters/willful defaulters from participating in the resolution process would also apply in the case of PIRP. A corporate debtor is required to submit a ResolutionPlan to the resolution professional within two days of PIRP commencement, and changes are allowed prior to the approval by the CoC. However, in case the resolution plan is not approved by creditors or does not pay the operational creditors in full, new bids can be invited.While considering the feasibility and viability of a resolution plan, where the resolution plan submitted by the corporate debtor provides for impairment of any claims owed by the corporate debtor, the committee of creditors may require the promoters of the corporate debtor to dilute their shareholding or voting or control rights in the corporate debtor: Provided that where the resolution plan does not provide for such dilution, the committee of creditors shall, prior to the approval of such resolution plan under sub-section (4) or sub-section (12), as the case may be, record reasons for its approval.

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 ability of the committee of creditors to require dilution of promoter shareholding/ control, in cases resolution plans submitted by the corporate debtor provides for impairment of any claims owed by such corporate debtor, should also be a significant deterrent against unreasonable terms in resolution plans. The Pre-pack resolution must be approved by financial creditors with a minimum 66 percent voting share by value.

Silent Feature of Pre-Packaged Insolvency Resolution Process vis-à-vis CIRP

Challenges with the framework:

Time and parameter for deciding on the resolution plan is major concern, basic motive of PIRP has been introduced is that the debtor shall be in better position to revive the activities as it is running the unit and doing the operation  and hence better in control and should be allowed to submit a plan for revival of unit and challenge with the prepack scheme is that the Corporate debtor may not raise additional capital from investors because of the risk involved in recovering the money being provided by their investors and lenders.Hence a plan based on the restructuring of debt may not help to realize the adequate amount to Financial Creditors and may find it challenging to achieve a turnaround. secondly timeline for PIRP is 120 days and it is very challenging for CoC member to decide on base resolution plan within this short period without any broad parameter on which the Resolution Plan be approved and main challenge is conversion of part of loan to equity as the stressed assets remain highly leveraged as capital and reserves get adversely impacted with losses. It requires an infusion of fresh equity for payment of part of the debt to address this issue, the corporate debtor may find it challenging to bring new investor and raise fresh equity at a level which can reduce the debt at a sustainable level. Thus, Financial creditor may consider the conversion of the part of the debt in equity. Under Base Resolution plan submitted by corporate debtor which is approved by CoC and Adjudicating authority under PIRP. Whether the guarantees and collateral security provided to financial creditors against the loan facilities shall also get released or financial creditors can start the process under IBC or any other recovery measure for recovery of dues from them for balance amount.

Conclusion:

Pre- pack provide a framework for resolution under the code.It is having blend of both formal and informal options. The main objective of Pre-pack insolvency resolution process was to provide an alternative insolvency resolution process to the viable stressed MSMEs.Under the code no two proceeding Prepack Insolvency Resolution Process and Corporate insolvency resolution process shall run parallel. As resolution under Pre-pack Insolvency Process is time bound with maximum period of 120 days and it is important to note that the role of Insolvency Resolution Professional is very much important in success of PIRP and balancing the interest of all stakeholder, promoters and secured creditors. However, with the increase in the trend of out of court settlement. Prepack insolvency could very well be the next alternative solution to regular legal measures