This article is written by Dhruv Sharma, pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.
In India, a transforming turnaround was brought about by the advent of the Insolvency and Bankruptcy Code of 2016. This has given a new lease of life to a company whose destiny had previously been conditional on an abundance of debt restructuring arrangements introduced in the past, the failings of which have often led the company to be relegated to closure or to a situation of sitting on unproductive assets with a depreciation of the value. In the Indian context, most organisations are driven to a large extent by the promoters and IBC now retains control of the company’s management and related parties, which have the task of driving the company into insolvency. This creates an imbalance situation that can best be addressed via pre-pack arrangements.
What are Pre-Pack Schemes?
Pre-pack is a scheme in which the debtor negotiates with the creditors to remain in the enterprise and to maintain their business or pre-pack can be understood as the resolution of debt of the distressed company through an agreement between secured creditors and the investors instead of a public bidding process. The scheme is termed fruitful in relation to corporate insolvency resolution process as the corporate insolvency resolution process is more time consuming. At the end of December 2020, over 86% of the 1717 ongoing insolvency resolution proceedings had crossed the 270 days threshold. One of the key reasons behind delays in corporate insolvency resolution process are prolonged litigation by erstwhile promoters and potential bidders. The pre-pack is limited to a maximum of 120 days with only 90 days available to the stakeholders for bringing up the resolution plan to the NCLT.
This system of insolvency proceeding has become an increasingly popular mechanism for insolvency process in UK and Europe over the past decade.
If a company is in insolvency because of macroeconomic disorders and not due to management problems, then the promoter could be adhere to a practical alternative, as he is fully aware of dynamics and operating difficulties, to resuscitate its company. The newest step in the progress of IBC is the pre-packaged scheme to blend various tools for corporate restructuring, such as the sale and refinancing of debtor assets to another company, interim financing, management changes, etc. before debtor enters the IBC insolvency process.
The interim Report of the committee on Bankruptcy Law Reform, February 2015, discussed the viability of the pre-pack scheme and expressed the opinion that pre-pack schemes are not a viable mechanism for insolvency resolution because the Indian markets have no facilities to allow ‘out of court’ restructuring without court intervention. But, in light of a pandemic that was compiled in a report by the Insolvency Law Committee on a Pre-Packaged Insolvency Process dated 31.10.2020, government and regulator, i.e. the Insolvency bankruptcy board of India considered introducing pre-packages schemes later.
Just after the one–year suspension of the government’s insolvency initiation in light of Covid-19 on 04.04.2021, Center issued an order introducing pre-packed Insolvency for Micro, Small and Medium Enterprises (MSMEs), [the definition of micro manufacturing and services unit was increased to ₹1 crore of investment and ₹5 crore of turnover. The limit of small unit was increased to ₹10 crore of investment and ₹50 crore of turnover. This revision was done after 14 years since the MSME Development Act came into existence in 2006] with defaults up to Rs. 1 Crore in accordance with the IBC, soon after the end of its insolvency provision. The preamble to the above mentioned Ordinance affirms that such action is necessary and urgent due to the different economic challenges that the pandemic poses.
The economies face a challenge to keep themselves afloat as a result of the possible rise in corporate and individual insolvencies following the COVID-19 pandemic. Various measures have been proposed by the World Bank and the international monetary fund and a three-phased approach could help the economy to transition smoothly to the positive side of the graph. During the first stage, numerous interim measures are required to stop insolvency and debt execution. In the second phase, when the wave of insolvencies is anticipated, transitional measures can be taken to ‘flatten the curve’ of insolvencies, including special out-of-court workouts. The third stage is for regular debt-resolution instruments to deal with remaining debt surpluses and to sustain medium-term economic growth.
In response, governments have implemented certain actions such as a loan repayment moratorium, sector-relevance provisions, infusion of liquidity into the banking system to lend to financially disadvantageous companies, relief from asset classification banking standards, flexibility to implement the insolvency obligations of the manager, and the suspension of insolvency proceeding by the creditors. In response, In order to protect the MSMEs’ interest from being put into insolvency proceedings, the government has increased the insolvency application threshold from Rs 1 lakh to Rs 1 crore.
Important facet of the ordinance
In the IBC, Chapter IIIA was inserted to cover the process of prepackaged insolvency resolution, which was in the light of the Ordinance dated 4.04.2021. A company applicant with the adjudicating authority can submit a pre-packed insolvency resolution application in respect of corporate debtors classified as MSME subject to various terms listed in Section 54A.
Pre-pack insolvency provisions for MSME shall not apply when the application has been made pursuant to IBC, Sections 7, 9 or 10 and is pending as of the date of 2021. If a pre-pack insolvency resolution request is pending pursuant to Section 54C, the Adjudication Authority shall accept or reject Section 54C on priority before considering any application files pursuant to Sections 7, 9, or 10 of IBC. The Adjudicating Authority is required to dispose of the application pursuant to Section 54C within 14 days of any application under Section 7, 9 or 10 pending. If a request is filed under Section 54C, after 14 days after submission of any request under Section 7, 9, or 10, then it shall be disposed of under Section 7, 9 or 10 Application is filed under the Adjudicating Authority.
The Corporate Debtor has to obtain an approval of 66 percent from its Financial Creditors, and not from its related parties to file a pre-pack insolvability application in a form that may be specified. The competition schedule for the pre-pack insolvency process for MSME is 120 days from the start date of pre-pack insolvency.
Within 14 days of receipt of an application by order, the adjudicating authority may acknowledge or reject the request. However, the Adjudicating Authority must notify the applicant, before rejecting an application, in order to rectify a defect within 7 days in the Application.
A moratorium shall be mutatis mutandis for the insolvency pre-pack process for MSME as prescribed under Article 14 IBC. The moratorium is available until the process is closed from the pre-pack start date. The control and ownership during the pre-pack process lies with the current proponents and management of the debtor, in opposition to the usual Corporate Insolvencies Resolution process. The Resolution Plan as submitted by the present Management in case of not being approved or of not being fully payable by the Basic Resolution Plan shall invite the Resolution Professional prospective applicant to submit the Resolution Plan or to enter into competition with the basic Resolution Plan. The Resolution Plan Section 61(3) of the IBC provides for an appeal against the orders approving the Pre-Pack resolution process.
That a 66% vote of the Committee of Creditors may resolve, at any time post-package startup date but prior to resolution of the plan approval in accordance with Section 54K of IBC, to launch the Corporate Insolvency Resolution Process on Corporation Debtor. In the event of fraudulent conduct and/or gross maladministration of the company and the insolvency process termination pass a winding-up order.
Analysis of the aforesaid scheme
- Limitation OR Restriction of the wholesome pre-pack process by companies other than MSME companies.
- Transparency: The success of Pre-Packs will depend heavily on the transparency of the existing management in conjunction with the Resolution Professional. The approach of both the creditor and the debtor to operate must be integrated into the work of various stakeholders in the best interest of the company.
- Approval of NCLT: Under the Ordinance, a Resolution Plan is not finalised until it has been approved by the Adjudicating Authority/NCLT, even with 66 percent consent of Financial Creditors. Such approvals not only takes time but also result in a lack of clarity in the whole pre-pack scheme process.
A win-win situation for both the borrower and the creditors
- The NCLT would welcome pre-packages because they reduce their burden. The court is flooded to put pressure on the NCLT infrastructure in a number of IBC cases. The aim of the IBC mechanism is after all to quickly resolve it. Prepackaged transactions are even faster than the conventional CIRP procedure. The NCLT is therefore more than happy to stamp the deal.
- For the borrower, the insolvency agreement is very useful because it enables the MSME borrower to retain the control of the company until a solution has been reached. This increases opportunity to regain control of the company by means of a resolution process or an investor. In typical IBC cases, once the cases are admitted to the NCLT court, the borrowers do not have a role. In addition, the legal costs of the borrower under this mechanism are substantially reduced.
- This is also good news for lenders because resolution typically occurs quicker – the insolvency process prepackaged must be completed within 120 days of the date the insolvency has begun.
The introduction of the MSME Pre-Pack insolvency has strengthened the Indian Framework for Insolvency Resolution. This is to promote IBC goals to bring the distressed organisation to a constant and smoother resolution. While the pre-pack is currently limited to small, small and medium-sized enterprises, it is intended to be implemented by the Government in other companies. In drafting the pre-pack schème for other companies, account must be taken of the success and failure of MSME Pre-pack. To work more effectively in pre-packing, cooperation between the various creditors and debtors classes is preconceived. Unlike the insolvency procedure under IBC the promoters will remain controlled by the company in the pre-pack discussion and if they are unable to provide the creditors with the necessary information concerning the scheme and the valuation of the assets (though the draught scheme provides criminal responsibility).
As this agreement usually operates in consultation with the company’s management, it respects the interests of debtors and guaranteed creditors before operational creditors. The success of pre packs is, therefore, directly linked with the role of process participants – the managing director, the financial creditor, the decision-maker and the administering authority. The company and its creditors’ entire economic culture should be aligned to the objective of introducing pre-packaging, i.e. resolution and value-maximization in the new stage. Pre-packs must be checked and balanced adequately throughout the process. In the case of wilful suppression, information asymmetry, i.e. managed, requires full disclosure with rigorous consequences. Selling/eliminating assets at low prices by related parties and or linked parties guarantees the Resolution Professional’s highest behaviour, in order to face likely challenges.
In view of the nature of Pre-Packs, however, the same may be a successful instrument in the blindness of creditors to solve a unified process of financial stress for companies specifically group enterprises to maximize.
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