GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
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.
Conclusion
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.
