Pre-packaged insolvency resolution of MSMEs under IBC

Pre-packaged Insolvency Resolution Of MSMEs Under IBC

The Central Government on 4th April 2021, promulgated the IBC Amendment Ordinance 2021, allowing a pre-packaged insolvency process for micro, small and medium enterprises (MSMEs), in unison with international best practices. 

The ordinance in essence has amended the Insolvency and Bankruptcy Code 2016 allowing the central government to notify such pre-packaged process for defaults of not more than Rs. 1 crore to be initiated by the corporate debtor.

The main aim of the Ordinance is to provide relief to MSMEs by way of an alternative efficient process of insolvency, in a manner that is least disruptive to the continuity of their businesses.

As we know that the pandemic affected businesses and the economy at a large scale, the Government has taken several measures to mitigate the distress caused by the pandemic, including increasing the minimum amount of default for initiation of corporate insolvency resolution process to Rs 1 crore rupees and suspending the filing of applications for initiation of corporate insolvency resolution process regarding the defaults arising for one year beginning March 25th, 2020.  Such suspension has ended on March 24, 2021, itself.

1. What is the pre-packaged Insolvency resolution plan?

A pre-packaged resolution plan is essentially a form of restructuring that allows the creditors and debtors to work on an informal plan and then submit it for approval. 

MSME businesses are usually managed by promoters and it is difficult to revive them after the management is expelled under the normal Corporate Insolvency Resolution Process (CIRP). 

Under the new ordinance, participation of eligible existing promoters is encouraged, with the board continuing in control and the debtor proposing the base resolution plan, which then shall be put to competitive bidding through the Swiss challenge. 

Thus Pre-packaged insolvency resolution will help the corporate debtors to enter into a consensual restructuring with creditors and address the entire liability side of the company.

2. Key features of the pre-packaged resolution are:

  1. Approval required by not less than 66 percent of the financial creditors.
  2. Pre-packaged insolvency resolution process to be completed within 120 days.
  3. Management of the firm to continue to vest in the board of directors, subject to conditions.
  4. Govt may specify default thresholds ( not more than Rs 1 crore) for pre-pac eligibility ( IBC has a threshold of Rs 1 crore and above )

3. Pre-pack insolvency resolution framework vs normal IBC process

The IBC currently stipulates a maximum of 270 days for the completion of the entire CIRP. Given that MSMEs have limited resources/finances to go through a long and diligent insolvency process, the reduction in the time limit for resolution comes as a blessing for insolvent MSMEs.

The scheme, where only the debtor will get to initiate the bankruptcy process, is expected to yield a much faster resolution than the extant corporate insolvency resolution process (CIRP) and cut costs. It could also reduce litigation, often triggered by defaulting promoters to retain control of their firms, and help thousands of MSMEs struggling to cope with the havoc wrought by the Covid-19 pandemic.

Further, one of the most important features of the Pre-packaged resolution scheme is that it allows the management of the affairs of the corporate debtor to continue to vest in the Board of Directors or the partners, as the case may be, of the corporate debtor, subject to conditions specified, unlike in the CIRP where the resolution professional gets to run the affairs with guidance from financial creditors. If creditors want to initiate bankruptcy proceedings against MSMEs, they can still do so but only through the CIRP and not through Pre-pack. 

Furthering the same, the Pre-pack resolution plans have to be submitted in only 90 days and the National Company Law Tribunal (NCLT) will have another 30 days to approve them. Thus, the pre-packaged insolvency resolution process shall be completed within a period of one hundred and twenty days from the pre-packaged insolvency commencement date.

There will be lesser possibilities of disputes, which will allow the process to run more efficiently than the normal CIRP.

4. Salient features of proposed Pre-pack vis-a-vis CIRP:

Parametre of differencePre packCIRP
Legal frameworkRelatively less in the statute and more in regulationsRelatively more in the statute and less in regulations
Initiation of process Pre and post default stress, including COVID-19 default. In a phased manner, if requiredDefault above Rs.1 crore, excluding COVID-19 Default 
Interim financeYes Yes
Avoidance transactionsYes Yes 
Insolvency Resolution Process Cost Does not include cost of running operations Includes cost of running operations 
Invitation for resolution plans First right of offer to promoters, Swiss ChallengePublic process 
Ineligibility to resolution planSection 29A appliesSection 29A applies
Early closure of process With approval of 66% of voting share, present and votingUnder section 12A, on request of the applicant
Approval of resolution by CoC (Committee of Creditors)66% of voting share, present and voting66% of voting share
Consequence of termination processLiquidation, with 75% of voting share of CoCNo termination allowed
Regulatory benefitsYes Yes 
Rule of Adjuticating authorityRelatively lessRelatively more
Timeline 90 days for filing of resolution plan with the AA plus 30 days for the AA to approve it180 days till approval of resolution plan by the adjuticating authority
Cooling off periodThree years between two Pre-packs 12 months between two CIRPs

5. MSMEs – A priority

The government has deemed it fit to first introduce pre-packs for MSMEs as they are critical for India’s economy and they contribute significantly to the country’s gross domestic product besides providing employment to a vast population. 

Also, MSMEs in India have relatively suffered most during the current pandemic times, due to which it is essential to uplift them. With a threshold of a debt default at ₹ 1 crore now under IBC, most of the MSMEs are out of this range.

6. Rights of the creditors being protected

The Pre-pack insolvency resolution plan although based on the debtor-in-possession approach vests significant consent rights to financial creditors in order to ensure that the mechanism is not misused by errant promoters. 

These rights include the applicability of Section 29 A (which is a restrictive provision disqualifying those who had contributed to the downfall of the corporate debtor or were unsuitable to run the company from submitting a resolution plan/ participating in the bidding of the corporate debtor) and 2/3rd of the creditors’ consent for both initiation and approval of the base resolution plan. 

In addition, the creditors’ committee can also convert the pre-pack process to the usual CIRP by 66% majority at any time, or require the board to cease control through the intervention of the NCLT in case of fraud or mismanagement by the existing management.

The scheme is available to entities that have neither undergone bankruptcy proceedings in the preceding three years nor are facing liquidation orders. The scheme further disallows a business to avail of it if the major shareholder is an undischarged insolvent or wilful defaulter. 

In addition to these, by insertion of new Articles 67A and 77 A, the amendment provides strict penalties for fraudulent management of the corporate debtor or providing false information or any material omission in the application or the list of claims. Thus, the amendment has been designed in a manner to provide a more friendly and ameliorative mechanism of resolution of stressed assets for MSMEs while ensuring that they don’t go scot-free in case of any manipulation, therefore, keeping a fair balance to protect the interests of creditors as well.

Download the copy of IBC Amendment Ordinance 2021

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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