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- GS-2: Government policies and interventions for development in various sectors and issues arising out of their design and implementation.
Resolution ‘pre-packs’ for MSMEs
Context: The Insolvency and Bankruptcy Code (Amendment) Bill, 2021, passed by Lok Sabha on Wednesday has proposed ‘pre-packs’ as an insolvency resolution mechanism for Micro, Small and Medium Enterprises (MSMEs).
What are ‘pre-packs’?
- A pre-pack envisages the resolution of the debt of a distressed company through a direct agreement between secured creditors and the existing owners or outside investors, instead of a public bidding process.
- Under the pre-pack system, financial creditors will agree to terms with the promoters or a potential investor, and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
- The approval of at least 66% of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT.
- The NCLTs will be required to either accept or reject an application for a pre-pack insolvency proceeding before considering a petition for a Corporate Insolvency Resolution Process (CIRP).
- This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade
How are pre-packs better than CIRP?
- One of the key criticisms of the CIRP has been the time it takes for resolution.
- At the end of March 2021, 79% of the 1,723 ongoing insolvency resolution proceedings had crossed the 270-day threshold. A major reason for the delays is the prolonged litigation by erstwhile promoters and potential bidders.
- The pre-pack in contrast, is limited to a maximum of 120 days with only 90 days available to stakeholders to bring a resolution plan for approval before the NCLT.
- Another key difference between pre-packs and CIRP is that the existing management retains control in the case of pre-packs; in the case of CIRP, a resolution professional takes control of the debtor as a representative of financial creditors. This ensures minimal disruption of operations relative to a CIRP.
Is that the reason why the pre-pack has been introduced?
- Pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate while still providing adequate protections so that the system is not misused by firms to avoid making payments to creditors.
- Currently, only corporate debtors themselves are permitted to initiate a Pre-Insolvency Resource Package (PIRP) after obtaining the approval of 66% of their creditors.
- The pre-pack mechanism does however, allow for a ‘Swiss challenge’ to any resolution plan that provides less than full recovery of dues for operational creditors.
- Under the Swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company, and the original applicant would have to either match the improved resolution plan or forego the investment.
What challenges can pre-packs bring?
- The timeline for PIRP may be difficult to meet for lenders and distressed firms,
- Ordinarily where haircuts are involved, forensic/transaction audits become imperative, and a negative report may become a roadblock in resolution involving the same management.
- If a firm restructures its outstanding debt through a PIRP with the existing management retaining control, the NPA status of the company’s account with lenders may not be automatically upgraded under RBI guidelines.
- There is a need for the IBBI and RBI to find middle ground on these regulations to make the PIRP more attractive
- Also, debtor-in-possession model may militate against the Swiss challenge option, as the existing management may create hurdles for an outside investor seeking information to potentially invest in the company.
- Under CIRP, a resolution professional is in charge of running the company and providing information to potential investors.
Experts have noted that the pre-pack mechanism is effective in arriving at a quick resolution for distressed companies, and that the regime should be rolled out to all corporations over time as legal issues are settled through case law.
Connecting the dots: