The Jigsaw of Pre-Packaged Insolvency for MSMEs
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The Jigsaw of Pre-Packaged Insolvency for MSMEs are vital to the Indian economy, contributing significantly to gross domestic product (GDP), employment and exports. However, they face challenges in the corporate insolvency resolution process (CIRP) due to its lengthy timelines and high costs. To address this, the Insolvency and Bankruptcy Code (Amendment) Act, 2021 introduced a process that was designed for MSMEs as an alternative to the traditional insolvency process.
What is Pre-Packaged Insolvency?
The pre-packaged insolvency process (PPIRP) under the sections 54A to 54P of the Insolvency and Bankruptcy Code, 2016 (“the IBC”) was established on April 4, 2021. It introduced an hybrid approach combining out-of-court restructuring with in-court approval, offering an expedited resolution for MSMEs and facilitating their early revival. The main reason for this amendment was to offer MSMEs a faster resolution, with minimal disruption to their corporate affairs, and preservation of their assets value.
The key differences between PPIRP and CIRP lie in their timeframes, control mechanisms, costs, and initiation procedures.
- While CIRP prescribes that the resolution process needs to be completed within 330 days, the PPIRP states that the entire process be completed within 120 days.
- In PPIRP, the existing management of the MSME retains control, whereas CIRP shifts control to a resolution professional (RP).
- PPIRP is generally more cost-effective due to streamlined processes and lower administrative expenses, compared to CIRP.
- PPIRP involves a pre-negotiated resolution plan between the debtor and creditors before formal initiation, promoting a more collaborative approach. CIRP, on the other hand, is initiated by creditors or the corporate debtor itself and follows a more formal, judicial process.
Eligibility Criteria for PPIRP
According to section 54A of the IBC, the process can be initiated by the corporate debtor which is classified as an MSME under the MSME Development Act, 2006. Throughout this process, the management of the corporate debtor, which is the board of directors, continues to operate the business. The directors or partners of the corporate debtor must also make a declaration and pass a special resolution or partners approval with at least 74% support, respectively, to initiate the PPIRP. However, it is necessary for the debtor to meet certain conditions:
- The debtor defaulted on a debt between ₹10 lakh and ₹1 crore.
- The corporate debtor must not be currently undergoing CIPR.
- There should not be an existing order for liquidation of the corporate debtor under section 33 of the IBC.
- The corporate debtor must be eligible to submit a resolution plan under section 29A of the IBC.
- Unrelated financial creditors holding at least 66% of the financial debt must approve the initiation of the PPIRP.
Step-by-Step Procedure of PPIRP
- Base Plan Formulation by the Debtor: The debtor, before initiating formal proceedings, develops a resolution plan in consultation with its creditors. This involves negotiations and reaching an agreement on the terms of the plan.
- Filing with Adjudicating Authority: The debtor and the proposed RP, submits an appalachian to the National Company Law Tribunal (NCLAT), which acts as the Adjudicating Authority. The application includes a declaration, a special resolution passed by the corporate debtor, and approvals from financial creditors.
- Moratorium and Appointment of RP: The NCLAT reviews the application and, if complete, admits it. This triggers the commencement of the PPIRP and a moratorium is imposed, restricting creditors from taking recovery actions against the debtor. Concurrently, the proposed RP is appointed.
- CoC Constitution and Plan Evaluation: The RP publishes a public announcement about the initiation of the PPIRP, and then establishes the Committee of Creditors (CoC) and collects claims from creditors. If completed, resolution plans are submitted, the RP evaluates them based on their feasibility and compliance with the IBC.
- Approval and Implementation: The CoC reviews the resolution plans and with a 66% voting share, approves the plan. The approved plan is then submitted to the NCLT for final approval. If approved, the plan is implemented, leading to the revival to the revival of the corporate debtor.
Role of Stakeholders in Pre-Pack Process
The main stakeholders involved in the PPIRP are the corporate debtor, the RP, and the CoC:
- Corporate Debtor: PPIRP operates under the “debtor-in-possession” model, thereby the existing management retains control of the company’s business operations during the insolvency process. This means that they are responsible for preparing and updating records, formulating a resolution plan, and engaging with creditors to secure their approval.
- Resolution Professional: The RP’s role is to facilitate the pre-pack process, not to manage the company’s operations. They guide stakeholders through the process, ensure compliance with the IBC and its rules or regulations, and assist in decision-making.
- Committee of Creditors: The CoC plays an important role in reviewing and approving the resolution plan. They oversee the corporate debtor’s and RPs actions and ensure the plan is viable and fair to all stakeholders. Decisions related to matters like interim financial, capital structure changes, or creation of security interests require CoC approval.
Advantages of Pre-Packaged Insolvency for MSMEs
The PPIRP offers several advantages for MSMEs facing financial distress:
- It is designed for a quicker turnaround, resolving insolvency within 120 days. This rapid resolution minimised disruption to the business operations and reduces the period of uncertainty for all stakeholders.
- It significantly reduces costs associated with the insolvency process as it involves the existing management to continue to operate, thus, avoiding the expenses of appointing a RP, and other associated costs. Further, the out-of-court restructuring aspect of PPIRP also minimized expensive litigation.
- PPIRP helps preserve the value of MSMEs as it avoids public bidding, which can potentially erode the company’s value and goodwill. This is particularly important for MSMes, where the enterprise reputation and brand image are often closely tied to its continued operations.
- It is designed to be more flexible and adaptable to the specific needs of MSMEs and offers a less complex framework compared to CIRP, making it more accessible to smaller businesses with limited resources.
Challenges in PPIRP Implementation
The primary challenges in implementing PPIRP for MSMEs in India include creditor coordination, potential misuse or delay tactics, lack of aware among MSMEs, and limited interest from investors for stressed MSMEs:
- PPIRP requires approval from 66% of financial creditors before initiation, and uncooperative or dissenting creditors can significantly delay or block the process. The lack of trust between debtors or creditors may lead to reluctance from creditors to approve resolution plans proposed by existing management, fearing potential biases or unfavourable terms.
- Promoters might push for steep haircuts or dues or engage in other delaying tactics by misusing the debtor-in-possession model. Further, legal challenges and procedural bottlenecks can also lead to delays.
- Many MSMEs are unaware of PPIRP and its potential benefits, which may continue to struggle with financial distress instead of exploring this framework.
- Financial institutions may be hesitant to extend additional loans to distressed MSMEs due to the high default risks, affecting the debtor’s liquidity. In addition to this, the absence of a well-developed secondary market for stressed assets further limits investor interest in PPIRP.
Judicial and Regulatory Perspective
The PPIRP has seen limited adoption in India since its introduction in 2021, with a handful of applications admitted and outcomes varying. Some cases have seen resolution plans approved and implemented, while others have been withdrawn or are still ongoing. For instance, the successful implementation of PPIRP in Ruchi Soya Industries highlights the potential of this mechanism for faster resolution compared to the traditional CIRP. Read more Section 34 of Arbitration Act
Global Pre-Pack Models and Lessons for India
India can adapt transparency, timelines and oversight from the United Kingdom and the United States pre-pack models by incorporating robust regulatory frameworks, enhancing creditor rights, and establishing clear timelines for the pre-pack process. In both the UK and US, pre-pack processes involve a pre-arranged sale of a company’s assets or business before the formal insolvency procedure begins. However the UK model primarily focuses on pre-packaged administration where a company is placed into administration and a pre-pack agreed sale of its assets or business is immediately completed. In contrast, the US Model, often associated with Chapter 11 bankruptcy, centres on a pre-negotiated reorganization plan that is often approved by creditors before the formal bankruptcy process commences.
Future of Pre-Packaged Insolvency in India
The PPIRP is India, currently limited to MSMEs, has the potential for expansion to larger companies could offer a quicker and more efficient way to resolve insolvency for a wider range of businesses, potentially leading to high recovery rates for creditors and reduced business disruptions. A key challenge is the lack of awareness and understanding this process, particularly among smaller businesses. Increased awareness campaigns and educational initiatives are crucial to ensure that businesses are aware of this option and how to utilize it effectively. Further, the strict time limit can be challenging, especially for complex cases. This can be addressed by establishing clear and standardized procedures for various aspects of PPIRP, such as application filing, claim verification, and resolution plan, which can promote consistency and predictability. A robust training program for RPs, corporate debtors, and creditors is needed to ensure they have the necessary knowledge and skills to navigate the PPIRP process effectively. Adopting digital platforms for information sharing, communication, and document management can significantly improve the efficiency and transparency of the process, helping to reduce paperwork and streamline workflows.
Conclusion
PIRP is a promising reform for MSME IBC, but it is still evolving and requires careful execution. Realising its potential requires addressing the challenges related to expansion, accessibility, and process efficiency. By focusing awareness, stakeholder engagement, and process improvements, India can unlock the full potential of PPIRP and foster a more robust and efficient framework.
FAQs
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Is PPIRP mandatory for MSMEs?
No, it is not mandatory, it is an optional process that MSMEs can choose to utilize if they meet the eligibility criteria as an alternative to CIRP.
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Can employees or suppliers initiate PPIRP?
No, employees or suppliers cannot directly initiate a PPIRP. Only corporate debtors classified as an MSME can voluntarily initiate the process, and it requires approval from financial creditors.
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Is there a liquidation in PPIRP?
Yes, liquidation can occur in a PPIRP under certain circumstances, but it is not the default or primary outcome. It is ordered when a resolution plan is not approved or implemented within the stipulated timeframe, or if the Adjudicating Authority rejects a plan.
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