Pre-Packaged Insolvency for MSMEs in India: A Shot in the Arm?
[Shivam and Naman are students at Gujarat National Law University, Gandhinagar.]
The pre-packaged insolvency resolution process (PPIRP) was brought into effect by way of an ordinance in April 2021 by amending the Insolvency and Bankruptcy Code 2016 (Code), to provide relief to the distressed micro, small and medium enterprises (MSMEs) affected by the pandemic. Recognizing the need for reviving the MSME sector, Chapter III-A comprising of Section 54A to 54P was added to the Code to provide an alternative, rapid and cost-effective insolvency mechanism for the revival of these companies, marking a major shift away from the traditional process of insolvency resolution. This speedy resolution under the Code was felt way back in 2015, evident from a report prepared by the Ministry of Finance wherein it was stated that “speed is of the essence for the working of the Bankruptcy Code”.
In this article, the authors analyse the reasons for the introduction of this resolution process, the objectives it seeks to achieve, its advantages over the traditional insolvency process, and the potential challenges it faces.
Why was it brought into effect?
With businesses shut down due to a series of lockdowns, consumer demand being seemingly low and businesses not preferring to go through the conventional insolvency process, the pre-packaging resolution plan has come as a saviour and a tool for revival for the distressed companies. It envisaged the restructuring of liabilities of the company by way of an informal agreement between the corporate debtor, creditors and other stakeholders of the company. Furthermore, the gamut of eligible MSMEs was increased by modifying the criteria for being a MSME, by stating that any business entity having a turnover up to INR 250 crores can claim benefits of the PPIRP process.
Benefits over the traditional insolvency process
The advantages of PPIRP over the traditional corporate insolvency resolution process (CIRP) can be characterised into the following pointers:
Efficiency / value maximization
In contrast to the time taken by conventional CIRP for resolution, pre-packaging serves as a much faster and more efficient process for debt resolution of a distressed company. It provides that the entire resolution plan has to be submitted before the adjudicating authority (NCLT) within 90 days, and the NCLT has to decide on its approval within 30 days.
The restructuring procedure is further helped by the provision of stimulus package, which would ensure that adequate liquidity is maintained in the system and adjustment in the asset classification norms by the Central Government. It would thereby lead to a much-needed impetus to the businesses affected by the pandemic, a chance to recover and rejuvenate itself.
The ‘debtor-in-possession’ feature, introduced via Section 54 H(a) of the Code, provides that the effective management of the distressed company would continue to be vested with its board of directors, and the activities of the company would be continued to be controlled by them. They would be responsible for supervising the process of revival of the company. The major benefit arising out of this feature would be that the existing management, being aware of the functioning of the company, would be in a better position to make decisions affecting the future of the company. It would also provide a strong protection against business disruption or derailment of the activities of the company.
Binding nature of the final order
The statutory protection provided by the NCLT approval would greatly aid in ensuring the finality of the order passed. The conclusive and binding nature of the approval plays a significant role in easing the apprehensions of the stakeholders for the recovery of their due amounts. It would imply that the company would be able to focus solely on its revival, without being bothered about any further disputes or counter-claims, thereby avoiding any court litigation.
Key objectives of this resolution mechanism
The main objective of this resolution process is to work out a solution in an informal manner, through collaborative efforts between the creditors and the debtors, so that the debt resolution of the company is done in a systematic and efficient manner. The statement of objects of the ordinance provides a key insight, by stating that the main objective is to provide MSMEs with a swift and value maximizing mechanism for the resolution and debt recovery.
Moreover, a clear-cut benefit of this process is that the maximum period involved in the pre-pack resolution process was 120 days, as opposed to the conventional CIRP procedure wherein the time limit was set at 270-days. PPRIP has a clearly delineated timeline for completion - 90 days for the preparation of the resolution plan and 30 days for the approval of the plan by the adjudicating authority.
Another key feature is the cost-effectiveness of this process. The conventional insolvency process involves a lot of expense for the corporate debtor. These costs have to be managed from the stressed assets of the company, making it an extremely difficult task for them. PPIRP, on the other hand, “allows for a smooth transition of the assets of the company in a cost-effective manner”.
The mix of formal and informal mechanism in this process provides the management of the company with the requisite flexibility to take decisions without being restrictive in their approach. The pre-initiation phase where the debtors, creditors and the other stakeholders of the company negotiate amongst themselves for reviving the company is informal in nature, whereas the post-initiation phase which involves submitting the resolution plan and seeking approval from the NCLT is formal in nature.
Potential challenges of this insolvency resolution model
One of the biggest challenges for the success of the pre-packs in India is that it is only applicable to MSMEs which are registered with the government entity. The apex court had in a recent case of Silpi Industries v Kerala SRTC stated that, for an MSME to claim benefits, it should be registered under the Micro, Small and Medium Enterprises Development Act 2006. However, a staggering 90% of the MSMEs are currently not registered, according to a report, thereby vitiating the entire purpose of providing relief to the stressed MSMEs.
Also, the provision that the ‘corporate debtor’ would need the approval of 66% of the financial creditors for filing the application for the initiation of the process could prove to be detrimental in case the distressed company is not able to bring on board the required number of creditors.
Finally, a key point which has a divided opinion within this model has been the over-reliance on the board of directors and thrusting upon them the responsibility of reviving the company. The critics of this are of the opinion that entrusting the same people under whom the assets of the company became stressed, with the responsibility of revival, might not lead to the desired results, and instead, it would have been better if external auditors or experts are appointed.
The ramifications of this new model on the MSME sector in India have been huge, with several of them being saved from becoming insolvent or being burdened with bankruptcy proceedings. With its central theme of providing an efficient, alternative scheme of resolution and providing support to MSMEs during difficult times, the scheme has led to a fresh lease of life in the sector.
At the same time, this transition from the formal insolvency procedure to a pre-packaging resolution has not been smooth, and there is still a lot of ground to be covered. Though there are still some challenges which need to be addressed as has been stated above, this model has been a major positive step forward in providing for an efficacious, comprehensive and alternative model for insolvency resolution.