This article is written by Sumer Karekar who is pursuing a Certificate Course in Insolvency and Bankruptcy Code from LawSikho.

Background

With the unprecedented emergence of the COVID-19 pandemic, the imposition of rigorous lockdown measures resulted in a dramatic contraction in worldwide economic activity, allowing mild opportunities for recovery. According to the UNCTAD Trade and Development Report (2020), recent estimates highlight a global recession identical to the Great Depression of the 1930s.[1] In consonance, the Indian economy was also projected to contract by 10.3% as per the IMF[2], 9.6% as per the World Bank[3] and 9% as per the Asian Development Bank[4] in 2020-21.

Considering the impending economic slowdown, and the potential rise in corporate insolvencies, the IMF[5] and the World Bank[6] recommended the immediate suspension of insolvency and debt enforcement activities and the increase of barriers to creditor-initiated insolvency applications to prevent viable corporates from being forced into insolvency. In adherence to these guidelines, the Government of India announced the suspension on filing fresh applications for initiation of Corporate Insolvency Resolution Process (“CIRP”) in respect of defaults arising after 25^th March 2020[7], extending up to a period of one year, with the primary aim of insulating companies, especially vulnerable Micro, Small and Medium Enterprises (“MSMEs”), from financial stress during the pandemic.

In anticipation of the surge in the number of insolvency applications after the suspension was lifted, the Insolvency Law Committee set up a Sub-Committee to explore viable counter-measures to strengthen the Indian insolvency framework. The Sub-Committee recognized the need for a hybrid framework which combines out-of-court restructuring schemes with the sanctity of a formal process[8] and examined the implementation of “pre-packaged insolvency resolution” as a supplement to the Insolvency and Bankruptcy Code (“IBC” or “Code”), to ensure expedited insolvency resolution.[9] Further, it deliberated upon the contribution of MSMEs to India’s GDP and employment creation and recognized that they might not have the endurance to survive prolonged insolvency proceedings as stipulated under the Code.[10]

Taking the aforementioned aspects into consideration, it was deemed expedient to introduce a pre-packaged insolvency resolution mechanism for corporate persons classified as MSMEs under the IBC, to ensure quicker, cost-effective and value maximizing outcomes for all the stakeholders involved, in a manner which is least disruptive to the continuity of their businesses and employment.

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021[11] (“Ordinance”) provides for the implementation and facilitation of the “pre-packaged insolvency resolution process”. It prescribes other ancillary definitions, relevant timelines, rights and duties of the parties involved and a mechanism for appeals and penalties if required.

This article shall analyse the fundamental aspects of the Ordinance, while providing key insights about the rationale behind the recommendations of the Sub-Committee of the ILC and the intention of the legislature.

Objectives of the Pre-Packaged Insolvency Resolution Process

In light of the imminent surge in insolvency applications upon expiry of the suspension period, the Sub-Committee recognized the need for a ‘semi-formal’ alternative for insolvency resolution, to prevent delays and maximize value. Thus, in response to this need, and to catalyse the evolution of the Indian insolvency framework, the introduction of pre-packaged insolvency was deemed justified in furtherance of the following objectives:

Revival of the corporate debtor

Analogous to the primary objective of the Code, the PPIRP seeks to encourage resolution of the corporate debtor, with liquidation only as the last resort.[12] In pursuit of this goal, the provisions of the amended Code promote resolution as far as possible. It offers opportunities for amendment of the base resolution plan[13], sufficient time for examination[14], a swiss challenge for the procurement of the most viable solution[15], safeguards against fraudulent activity[16] etc., to ensure the rehabilitation of the corporate debtor. Further, since a substantial portion of the process occurs outside the court, the parties have a better opportunity to negotiate a suitable outcome.

Optimizing value of assets

Insolvency laws across the globe seek to maximize the value of the assets, as they are subject to the claims of the creditors.[17] In this regard, the NCLAT in Binani Industries Limited v. Bank of Baroda & Anr.[18], concluded that;

“The maximization of the value of assets of the ‘Corporate Debtor’ cannot be ignored and nor can it be ignored that the same should balance all the stakeholders.”

In consonance with the primary objective of the Code, the pre-pack process strives to preserve value by saving costs, preventing delays and avoiding business disruptions. It envisages a pre-agreed base resolution plan, which results in minimized litigation and confidentiality until the formal process commences.

Rehabilitation of MSMEs

The Government of India has been actively promoting the establishment and protection of MSMEs, due to their significant contributions towards the GDP and employment opportunities. Considering their simpler corporate structure, the conventional CIRP would be not yield the desired outcome. Therefore, to insulate MSMEs from liquidation, an alternative resolution mechanism was proposed to be added to the Code.

The Pre-packaged insolvency resolution process offers the promoters of MSMEs to negotiate with the relevant parties and agree upon a mutually beneficial resolution plan, before beginning the formal process. Upon arriving at a consensus, the PPIRP can be conducted smoothly with limited costs and disputes, while maximizing the value of the corporate debtor.

Therefore, we observe that the ordinance acts as an additional layer over the basic structure of the Code, providing for an alternative, semi-formal mechanism for the effective resolution of distressed MSMEs.

The Debtor-in-Possession Model

As per the Banking Law Reforms Committee, a company has two main sets of immediate stakeholders i.e., its shareholders and creditors. If the company fails to service its debt, its control must shift to the creditors for resolution of insolvency.[19] This “creditor-in-control” approach was upheld by the Hon’ble Supreme Court in Innoventive Industries v. Union of India[20], where it observed that;

“… when a company defaults on its debt, control of the company should shift to creditors rather than the management who was retaining control after the default.”

Thus, the Code lays special emphasis upon empowering the creditors to take charge of the corporate debtor for swift rehabilitation.

However, the pre-packaged insolvency resolution process (“PPIRP” or “Pre-pack IRP”) promotes a debtor-in-possession model for insolvency resolution. Section 54H of the amended IBC states that during the PPIRP period, the control of the affairs of the corporate debtor shall vest in its Board of Directors or its partners, who shall take the requisite measures to preserve the value of the assets of the corporate debtor and manage its affairs as a going concern.

Albeit a departure from the letter of the Code, the Sub-Committee Report states that this shall avoid the turbulence associated with the shift of control from the debtor to the Interim Resolution Professional and subsequently, from the Resolution Professional (“RP”) to the Resolution Applicant.[21] Further, the model offers an incentive for the corporate debtor to initiate PPIRP, as the management can continue to conduct business with an opportunity to retain the company through a resolution plan.

Yet, the amendment does not entirely disturb the spirit of the Code. While the incumbent management of the corporate debtor enjoys control, the Committee of Creditors (“CoC” or “Committee”) is authorized to supervise its actions. Where the CoC, at any time during the PPIRP, is satisfied that the affairs of the corporate debtor have been conducted fraudulently or where there has been severe mismanagement of the corporate debtor, resulting in depletion of value to the detriment of the creditors, it may resolve to vest the management of the corporate debtor in the RP via an application to the Adjudicatory Authority (“AA”).[22] Furthermore, the approval or rejection of a resolution plan under the PPIRP also rests upon the commercial wisdom of the Committee.[23]

Therefore, we observe that the amended Code stipulates an integration of the debtor-in-possession model with the creditor-in-control approach during a pre-pack insolvency. Such a hybrid set-up ensures that the corporate debtor makes a genuine effort to resolve the stress, while vesting sufficient powers in the hands of the Committee to ensure resolution of the corporate debtor.

The Swiss Challenge Method

The pre-pack insolvency resolution process proposes the negotiation of a resolution plan between the corporate debtor and the creditors, before the commencement of statutory proceedings.[24] While the conventional insolvency resolution process allows wider competition amongst various market players for the submission of resolution plans, the Sub-Committee concluded that following a similar approach for the pre-packaged insolvency process would defeat its purpose. Thus, the Swiss Challenge model was recommended to ensure transparency and maximization of value.

Under the Swiss Challenge model, the corporate applicant submits a base resolution plan which shall be compared with plans submitted by the invited prospective resolution applicants. Ultimately, the most feasible plan, which fulfils the prescribed criteria, shall be sanctioned for the resolution of the corporate debtor.

Section 54K of the amended Code provides for the submission of a ‘base resolution plan’ by the corporate debtor within two days of the pre-packaged insolvency commencement date.[25] Thereafter, the CoC may approve the resolution plan if it does not impair any claims owed to the operational creditors of the corporate debtor and offers the best value; or else, it may invite prospective resolution applicants for a swiss challenge. Upon receipt of resolution plans from prospective resolution applicants, the CoC shall evaluate and compare them with the base resolution plan.

Next, having regard to the complexity, scale of operations of the business of the corporate debtor, its feasibility and the manner of distribution proposed, the Committee shall approve a resolution plan, by a vote of not less than sixty-six percent of voting shares. Upon receiving the approval of the CoC, the RP shall submit the approved resolution plan to the AA.

From the above provision, we observe that the amendment promotes healthy competition between the incumbent management and the prospective resolution applicants for the revival of the company. In anticipation of a better competing offer, the promoters shall endeavour to propose the most viable solution in the first instance, thereby preventing delay and saving costs. In the grand scheme, the Swiss Challenge method seeks to balance the incentives and disincentives of the promoters and the swiss challenger to ensure value maximization and efficient revival of the corporate debtor.[26]

Initiation of the Pre-packaged Insolvency Resolution Process

Who can initiate the pre-packaged insolvency resolution process?

In 2019-20, only 3.2% of the total insolvency resolution applications were filed by corporate debtors[27], as opposed 60% in 2016-17. The main reasons for the decrease were; (i) section 29A of the Code rendered many of the promoters ineligible; (ii) the fear of losing the company to competitors, who may offer greater value and (iii) the inevitable liquidation of the corporate debtor if CoC were to reject all resolution plans.

In light of the above, the Sub-Committee also noted that the corporate debtor, in many cases, could be the only entity concerned about the revival of the company. Further, it best understands the economic situation of the company and can potentially offer the most effective solution.[28] Therefore, the amended Code, upon recommendations by the Sub-Committee, provides for the initiation of the PPIRP by the “corporate applicant”, which may include the corporate debtor, based upon fulfilment of the criteria prescribed under Section 54A.[29]

Approval of financial creditors before initiation of pre-packaged insolvency

Section 54A of the amended Code clarifies the eligibility of corporate debtors for initiating the PPIRP. Sub-section (1) states that an application for initiation of PPIRP may be made only in respect of a corporate debtor classified as an MSME under Section 7(1) of the Micro, Small and Medium Enterprises Development Act, 2006. Further, the clause (e) of sub-section (2) of section 54A states that the financial creditors of the corporate debtor, not being its related parties, representing not less than sixty-six percent, should have approved the proposal for initiation of the PPIRP.

In this regard, the Sub-Committee opines that the pre-pack seeks to build consensus around the resolution of the corporate debtor before the initiation of PPIRP and anticipates this consensus to evolve into approval of the resolution plan after commencement of the formal procedure.[30] Thus, to prevent delays arising out of future disputes, the amended Code stipulates a sixty-six percent approval of the resolution plan before initiation of the process.

Moreover, as per clauses (f) and (g) of sub-section (2) of section 54A, the directors or partners are also required make a declaration of bona fide initiation of PPIRP, accompanied by a special resolution approving the proposal. Lastly, the corporate debtor must submit a base resolution plan before the financial creditors, before seeking their approval.

Therefore, as the specifics of the resolution plan and the intentions of the corporate debtor become clearer, the creditors would be more inclined to follow through.

Contradiction between application u/s 7, 9, 10 and initiation of PPIRP

Section 11A of the amended Code states that where an application filed under Section 54C (initiation of PPIRP) is pending, the AA shall first deal with the application, before considering any application under section 7, 9, or 10 (initiation of CIRP), in respect of the same corporate debtor.

It also provides that where an application under Section 54C is filed within fourteen days of filing of an application for initiation of CIRP, in respect of the same corporate debtor, the AA shall first dispose of the application under Section 54C. Similarly, where an application under Section 54C is filed after fourteen days after the filing of an application for initiation of CIRP, the AA shall first dispose of the such application for initiation of CIRP.

In this regard, the Sub-Committee opines that although the pre-pack is implemented in addition to the CIRP, it is impossible for the two processes to run simultaneously because they are fundamentally different. Therefore, Section 11A of the amended Code expressly stipulates that the pre-packaged insolvency resolution process and the CIRP shall not proceed in parallel.

The Resolution Professional

Although the RP does not immediately take charge of the management of the corporate debtor upon initiation of the PPIRP, his role is critical to maintain transparency and fairness of the process. The RP shoulders the responsibility of protecting the interests of the creditors, shareholders and the business, as well as ensuring compliance with the law as regards the process.

Duties

The amended Code provides for the duties of the RP before and during the pre-pack process. Section 54B stipulates that the Resolution Professional is obligated to;

• Prepare a report on:
• whether the corporate debtor fulfils the criteria prescribed under Section 54A; and
• whether the base resolution plan conforms with the requirements of Section54A(4)(c).
• File such reports, documents and other paperwork, with the Board; and
• Perform such other duties as may be specified.

These duties shall be carried out from the date of the approval of the financial creditors and before the initiation of the PPIRP.

During the PPIRP, the Resolution Professional shall perform the obligations prescribed under Section 54F which include; confirming and maintaining an update list of claims, constituting the CoC, convening and attending meetings, preparing the information memorandum and the evaluation matrix, etc. Further, the provision also enlists the rights and powers enjoyed by the RP to ensure smooth facilitation of the pre-pack process.

As per the Sub-Committee, the RP shall act in an advisory capacity before the commencement of the formal procedure. He shall aid the corporate debtor in negotiation of the base resolution plan and in completion of pre-admission formalities. Therefore, the formal role of the RP begins with the admission of the PPIRP.[31]

Appointment and Replacement

As per Section 54A(2)(e), the unrelated financial creditors of the corporate debtor, shall propose and approve to appoint an insolvency professional as the RP, by a vote of not less than sixty-six percent in value of the financial debt owed to them.

Likewise, if at any time during the process, the CoC is satisfied that the RP needs to be replaced, they may, by a vote of sixty-six percent of the voting shares, resolve to do so, in the manner prescribed under Section 22 of the Code, which shall apply, mutatis mutandis, to the PPIRP.[32]

While clause (c) of Section 54P specifies that “Section 16” under Section 27 is to be construed as “Section 54E” of the amended Code, it does not expressly mention the reference to Section “54A(2)(e)”, while referring to “Section 22” under Section 27. Section 22 provides for the resolution of the CoC, in its first meeting, to appoint the Interim Resolution Professional (“IRP”) as the Resolution Professional or replace the IRP with another RP. Considering that the procedure prescribed under Section 54A(2)(e) does not involve an IRP, the specification ought to be made to ensure precision and clarity.

Timeline

One of the key considerations of the PPIRP is to reduce the delay caused by litigation and court procedure, thereby maximizing value. Since the corporate debtor and the creditors shall have negotiated the initiation of the PPIRP along with the base resolution plan beforehand, the process is likely to complete sooner. However, taking into account the swiss challenge and time required to examine various resolution plans, the Code stipulates a reasonable time-frame for the completion of the PPIRP.

Section 54D prescribes a time-limit of 120 days from the pre-packaged insolvency commencement date. Sub-section (1) states that the RP shall submit the approved resolution plan to the AA within ninety days of the PPIRP commencement date. If no plan is approved by the CoC within ninety days, the Ro shall, apply to the AA for termination of the PPIRP on expiry of such period.

After submission of the approved resolution plan under Section 54D(2), the AA shall approve the resolution plan within thirty days of its receipt.[33] Section 31 shall apply, mutatis mutandis, to the order passed by the AA under this provision.

Where an application for termination is filed by the RP, the AA shall, within thirty days, terminate the PPIRP under Section 54N(1)(b)(i) of the amended Code.

In providing separate timelines for the swiss challenge and the AA, the Sub-Committee noted that the existent CIRP provides for a consolidated timeline, inclusive of the time-limit for resolution applicants as well as the AA, which has not been effective.[34] Therefore, the amended Code provides for distinct timelines to ensure effective resolution of the corporate debtor.

Conclusion

With the introduction of pre-packaged insolvency resolution, the Government seeks to explore alternatives to the conventional corporate insolvency resolution process. The IBC Ordinance 2021 lays special emphasis upon the rehabilitation of MSMEs, considering the unique nature of their business and their contribution to India’s economic growth. Recognizing that such companies lack the resources to endure prolonged periods of stress, the PPIRP aims to offer a semi-formal resolution mechanism, with minimal costs, delays and disputes. All aspects considered, the pre-packaged process promises a more mature, and robust insolvency regime.

References

[1] UNCTAD (2020), From Global Pandemic to Prosperity for All: Avoiding Another Lost Decade, Trade and Development Report, 2020. https://unctad.org/system/files/official-document/tdr2020_en.pdf

[2] International Monetary Fund (2020), World Economic Outlook, October 2020: A Long and Difficult Ascent

[3] World Bank (2020), Half Yearly South Asia Economic Focus Update, October

[4] Asian Development Bank (2020), Asian Development Outlook (ADO) 2020 Update, September.

[5] Yan Liu, José Garrido, and Chanda DeLong (2020), “Private Debt Resolution Measures in the Wake of the Pandemic”, IMF Special Series No. COVID-19, May 27, p.2.

[6] Antonia Menezes and Sergio Muro (2020), “COVID-19 Outbreak: Implications on Corporate and Individual Insolvency”, Equitable Growth, Finance and Institutions, COVID-19 Notes, Finance Series, World Bank Group, April 13, p.2.

[7] The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, which has since been regularised by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020

[8] Aparna Ravi (2020), “Introducing Pre-packs in India – A Useful Tool in Times of COVID-19?”, Oxford Business Law Blog, May 25

[9] MCA (2018), Monthly Newsletter, November

[10] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.16.

[11] The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, No. 3 of 2021, https://images.assettype.com/barandbench/2021-04/f8b16098-fb3c-4b35-bafe-41ceb28e53ac/IBC_Ordinance_2021.pdf

[12] Supreme Court (2020), Kridhan Infrastructure Pvt. Ltd. v. Venkatesan Sankaranarayan & Ors. (CA.3299/2020)

[13] Section 54K(2) of the amended Code

[14] Section 54D of the amended Code

[15] Section 54K(5) of the amended Code

[16] Section 67A of the amended Code

[17] Thomas H. Jackson & Robert E. Scott (1989), ‘On the Nature of Bankruptcy: An Essay on Bankruptcy Sharing and the Creditors’ Bargain’ 75Va L Rev 155 (1989)

[18] Company Appeal (AT) (Insolvency) No. 82 of 2018

[19] Bankruptcy Law Reforms Committee, Ministry of Corporate Affairs. (2015). The report of the Bankruptcy Law Reforms Committee Volume I: Rationale and Design. https://ibbi.gov.in/BLRCReportVol1_04112015.pdf

[20] Civil Appeal Nos. 8337 & 8338 of 2017

[21] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.35.

[22] Section 54J of the amended Insolvency and Bankruptcy Code, 2016

[23] Sub-section (4) and sub-section (12) of Section 54K of the amended Insolvency and Bankruptcy Code, 2016

[24] Jose M. Garrido (2012), Out-of-Court Debt Restructuring (World Bank Study) <http://documents.worldbank.org/curated/en/417551468159322109/pdf/662320PUB0EPI00turing09780821389836.pdf>

[25] Clause (23B) of Section 5 of the amended Insolvency and Bankruptcy Code, 2016 defines “pre-packaged insolvency commencement date” as “the date of admission of an application for initiating pre-packaged insolvency resolution process by the Adjudicatory Authority under clause (a) of sub-section (4) of section 54C.”

[26] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.74.

[27] IBBI (2020), Insolvency and Bankruptcy News, April-June, 2020

[28] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.19.

[29] Section 5(5) of the Insolvency and Bankruptcy Code, 2016

[30] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.22.

[31] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.41.

[32] Section 54P of the amended Insolvency and Bankruptcy Code, 2016

[33] Section 54L of the amended Insolvency and Bankruptcy Code, 2016

[34] Sub-Committee of the Insolvency Law Committee, Ministry of Corporate Affairs, Government of India, “Pre-packaged Insolvency Resolution Process” October 2020, paragraph 3.60.

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