The advent of the Insolvency and Bankruptcy Code, 2016 ("IBC") has led to a transformative turnaround in the corporate distress resolution framework of India. It has given a new lease of life to a Company whose fate was earlier dependent upon a plethora of debt restructuring schemes introduced in the past, the failures of which often resulted in the Company being relegated to winding up proceedings or being stuck with a situation of sitting over unproductive assets whose value depreciated with time.
In the Indian context, most of the organizations are largely promoter driven and presently IBC under Section 29A bars the Company management and its related parties, responsible for pushing the Company into insolvency, to regain control over the business of such companies. This results in creating a situation of imbalance which can be best addressed through Pre-Pack schemes.
Pre-pack is a scheme where the debtor negotiates with the creditors to remain in the business and keep its operations as a going concern. For a situation where a Company is going into insolvency because of macroeconomic disturbances and not because of fault in the management, then it would be practical alternative to allow the promoter to resuscitate its Company as he is very much aware of the dynamics and operational difficulties. Pre-Packaged scheme being the latest step in the evolution of the IBC aims at blending various corporate restructuring tools such as sale of assets of the debtor to another company, refinancing and interim financing, change in management etc. before the debtor goes into insolvency proceedings under IBC.
The Interim Report of the Bankruptcy Law Reform Committee, February, 2015 debated over the viability of the Pre-Pack scheme and opined that pre-pack schemes are not a workable mechanism for insolvency resolution as the Indian markets does not have infrastructure to allow 'out of court' restructuring without intervention of the court. However, thereafter, the Government as well as the Regulator i.e. IBBI looked into introducing Pre-Pack schemes, more so in light of Covid-19 pandemic which was compiled into a Report by the Sub-Committee of the Insolvency Law Committee on Pre-Packaged Insolvency Resolution Process dated 31.10.2020.
Recently, soon after the end of a one – year suspension of insolvency initiation imposed by the Government in light of Covid-19 Pandemic on 04.04.2021, Center issued an Ordinance to introduce pre-packed insolvency for corporate entities classified as Micro, Small and Medium Enterprise (MSME) with defaults upto Rs. 1 Crore, under the IBC. The preamble of the said Ordinance asserts the necessity and urgency of such an action due to various economic challenges faced amidst the pandemic.
In the context of possible rise in corporate and individual insolvencies as an aftermath of the COVID-19 pandemic, the economies are presented with a challenge to keep themselves afloat. The World Bank and the International Monetary Fund have suggested various measures and the implementation of the same in a three-phased approach may help the economy transition smoothly towards the positive side of the graph. In the first phase, copious interim measures need to be taken to halt insolvency and debt enforcement activities. In the second phase, when a huge wave of insolvencies is anticipated, it may be addressed by transitional measures, such as special out-of-court workouts, to 'flatten the curve' of insolvencies. The third phase is for regular debt resolution tools for addressing the remaining debt overhang and maintain economic growth in the medium term.
In response to this, Governments have rolled out certain measures such as moratorium on loan repayments, sector specific forbearance, infusion of liquidity into the banking system to provide credit to financially distressed firms, relief in asset classification banking norms, flexibility in director's obligations to initiate insolvency proceeding and suspension of filing of insolvency proceeding by the creditors. The Government has increased the threshold of default for filing of an insolvency application from Rs. 1 lakh to Rs. 1 crore to protect the interest of the MSME's from being pushed into insolvency proceedings.
Pre Packs in the above background gained prominence.
III. HIGHLIGHTS OF ORDINANCE
Vide the Ordinance dated 04.04.2021 a separate chapter, Chapter IIIA has been inserted in the IBC to deal with the pre-packaged insolvency resolution process. Subjected to various conditions as enumerated in Section 54A an application for initiating pre-packed insolvency resolution can be made by a Corporate Applicant with the Adjudicating Authority in respect of Corporate Debtor classified as MSME.
The provisions of Pre-pack Insolvency for MSME shall not be applicable where an application under Section 7, 9 or 10 of IBC has been filed and pending as on date of abovementioned Ordinance, 2021. In case where an Application to initiate pre-pack insolvency resolution process is pending in terms of Section 54C, the Adjudicating Authority before considering any application filed under Section 7, 9, or 10 of IBC shall admit or reject Section 54C on priority. In case, an Application under Section 54C is filed within 14 days of any application filed under Section 7, 9 or 10, which is pending then the Adjudicating Authority must dispose of the Application under Section 54C. Where an Application under Section 54C is filed beyond 14 days from filing of any application under Section 7, 9 or 10, then the Adjudicating Authority shall dispose of the application under Section 7, 9 or 10 of the IBC.
An Approval of 66% has to be obtained by the Corporate Debtor from its Financial Creditors, not being its related parties for filing an application for initiation of pre-pack insolvency process in such a form as may be specified. The timeline for competition of Pre-Pack insolvency process for MSME is 120 days from the pre-pack insolvency commencement date.
The Adjudicating Authority within 14 days from the receipt of Application by an order may admit or reject the Application. However, before rejecting an application, the Adjudicating Authority must give notice to the applicant to rectify the defect in the Application within 7 days.
Moratorium as prescribed under the Section 14 of IBC shall be mutatis mutandis apply to the Pre-Pack insolvency Process for MSME. The Moratorium shall be available from the pre-pack commencement date till the process is closed. Unlike the usual Corporate Insolvency Resolution Process the control and possession during the Pre-Pack process lies with the current promoters and management of the Corporate Debtor. The Base Resolution Plan as submitted by the existing management in case not approved or incase where the base Resolution Plan does not provide for the full payment of the confirmed claims, the Resolution Professional shall invite prospective Resolution Applicant to submit a Resolution Plan or compete with base Resolution Plan. Appeal against the order approving the Pre-Pack Resolution Process lies under Section 61(3) of the IBC.
That the Committee of Creditors by a vote of 66% may resolve to initiate a Corporate Insolvency Resolution Process in respect of Corporate Debtor at any time after the pre-pack commencement date but before the resolution plan approval under Section 54K of the IBC. The Adjudicating Authority in case of any fraudulent conduct of the Company and/or gross mismanagement and where there is termination of pre-pack insolvency process pass an order of liquidation.
- Restriction on seeking Pre-pack resolution process by Companies other than MSME's.
- TRANSPARENCY: The success of Pre-Packs shall greatly depend on the transparency with which the existing management works coupled with the role played by the Resolution Professional. The approach of both the creditor and the debtor to operate, in the best interest of the company is required to be ingrained in the working of various stakeholders.
- APPROVAL OF THE ADJUDICATING AUTHORITY/ NCLT: Under the Ordinance, the Resolution plan does not attain finality, even after the consent of 66% of the Financial Creditors, until the Adjudicating Authority/ NCLT approves it. Such approvals are not only time consuming but also results in an element of uncertainty being cast on the process of the entire pre-pack scheme. Such an element of uncertainty gravely prejudices the success of a Pre-Pack.
The introduction of the Pre-Pack insolvency for the MSME has fortified the Indian Insolvency Resolution Framework. It serves to promote the IBC objectives in achieving steady and smoother resolution of the distressed organization. While currently the Pre-Pack is limited to Micro, Small and medium enterprise, the Government plans to roll out it for other Corporate as well. The success and the failure of MSME Pre-pack should be kept into consideration while drafting the Pre-pack scheme for other Corporate.
Pre-Packs, to work more efficiently, pre-supposes co-operation among different classes of creditors and debtors. Unlike the Insolvency Proceedings under IBC, the promoters will continue to be in control of the business during the pre-pack discussion and if they fail to provide necessary information related to the scheme and valuation of the assets to the creditors (even though a criminal liability has been provided in the draft scheme), the pre-packs scheme would be hapless and would serve no purpose to the creditors, particularly operational creditors. As this arrangement usually works with the consultation of the management of the Company, it gives reverence to the interest of debtors and secured creditors before operational creditors. Consequently, the success of Pre Packs has direct co-relation to the role played by the participants of the process- Management, Financial Creditor, Resolution Professional and the Adjudicating Authority. The entire economic business culture of both the Company and creditors are required to be aligned to fulfil the object of introducing pre-pack i.e. resolution at the nascent stage with value maximisation. The Pre-Packs are required to have adequate checks and balances throughout the process. The asymmetry of information i.e. titled towards the management, requires complete disclosure with strict consequences in cases of any wilful suppression. The related party and/or connected party sale/alienation of assets at deeply discounted prices warrants highest possible conducts of the Resolution Professional to meet the probable challenges. However, given the nature of Pre-Packs, the same can be a successful tool in the armour of the creditors to resolve financial stress of companies specifically group companies through a unified mechanism.
Ms. Varsha Banerjee is a Partner and has been in practice for the last 11 years. She represents corporate entities, institutional creditors, shareholders, investors and large lender groups or entities in insolvency matters, major debt restructurings, and asset sale transactions. She focuses her litigation practice on corporate restructuring and insolvency matters with expertise in the rehabilitation of distressed entities, issues pertaining to recovery of debt, securitisation-related matters and commercial disputes arising out of other contractual matters, civil suits and arbitration law arising in cases of distressed entities. She regularly appears before various judicial/quasi-judicial authorities in the country including the Supreme Court of India, various High Courts and NCLTs/NCLAT. She has been advising clients on various issues pertaining to liquidation processes and other related aspects of insolvency and restructuring law. She is also an active member of 'INSOL India' and the 'International Women's Insolvency & Restructuring Confederation' in India. LinkedIn profile - https://in.linkedin.com/in/varsha-banerjee-37550716
Mr. Mukund Rawat is an Associate with Dhir and Dhir Associates. He is a graduate from Institute of Law, Nirma University, Ahmedabad. As a part of the Insolvency and Restructuring team, he has been actively advising and representing creditors, Corporate Debtors, Insolvency Professionals and investors/bidders in relation to the resolution/liquidation/restructuring process under the Insolvency and Bankruptcy Code, 2016. LinkedIn profile - https://in.linkedin.com/in/mukund-rawat-264a29136
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