A Guide to Pre-Packaged Insolvency Process For MSMEs

The COVID-19 pandemic has severely impacted businesses, financial markets and economies all over the world including India’s. The pandemic has impacted the business operations of micro, small and medium enterprises (MSMEs) and exposed many of them to financial distress.

Micro, small and medium enterprises are critical for India’s economy as they contribute significantly to its gross domestic product and provide employment to a sizable population. 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 (CIRP) to INR one crore, and suspending filing of applications for initiation of CIRP in respect of the defaults arising during the period of one year beginning from 25th March 2020.

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 was promulgated on April 4, 2021. It amends the Insolvency and Bankruptcy Code, 2016.

The amendment addressed the specific requirements of MSMEs relating to the resolution of their insolvency, due to the unique nature of their businesses and simpler corporate structures.

The Code mandates revival of a company in a time-bound manner, as undue delay is likely to reduce the enterprise value of the company. When the company is not in sound financial health, prolonged uncertainty about its ownership and control may make the possibility of resolution remote. The strict adherence to timelines is of essence to both the triggering process and the insolvency resolution process. It is mandatory to complete a CIRP within 180 days, with a one-time extension of up to 90 days. The regulations provide a model timeline for each task in the 19 process, which needs to be followed as closely as possible. During CIRP, the affairs of the company are managed by the resolution professional (RP), who is appointed to conduct CIRP.

The resolution professional is supposed to perform the following duties, namely:

• Confirm the list of claims submitted by the corporate debtor under Section 54G of the Code,
• Inform creditors regarding their claims,
• Maintain an updated list of claims,
• Monitor management of the affairs of the corporate debtor,
• Inform the committee of creditors in the event of breach of any of the obligations of the Board of Directors or partners and corporate debtor,
• Constitute the committee of creditors and convene and attend all its meetings,
• Prepare the information memorandum on the basis of the preliminary information memorandum submitted under Section 54G of the Code,
• File applications for avoidance of transactions under Chapter III or fraudulent or wrongful trading under Chapter VI of the Code.

Pre-pack has emerged as an innovative corporate rescue method that incorporates the virtues of both informal (out-of-court) and formal (judicial) insolvency proceedings. It seems to be the preferred hybrid framework, as it empowers stakeholders to resolve the stress of a Corporate Debtor as a going concern, with the minimum assistance of the State. It is considered fast, cost efficient, and effective in resolution of stress, much before value deteriorates, with the least business disruptions and without attracting the stigma attached with the formal insolvency process. It starts with an informal understanding, engages the stakeholders in between, and ends with a judicial blessing of the outcome, though the nuances differ across jurisdictions. The insolvency laws around the world provide a variant of pre-pack, in addition to regular resolution process.

To ensure that the process is undertaken with all seriousness to find a resolution of stress and to prevent any potential misuse, adequate safeguards need to be built into the framework. Several safeguards have been suggested in this report at appropriate places. Before making an application for initiation of pre-pack, the proposal should have buy-in of a certain threshold of its stakeholders to have reasonable assurance of resolution. Such threshold on both sides of the debt, namely, the creditors and CD, should neither be too low nor too high. If it is too low, the likelihood of resolution becomes less. If it is too high, the process may not take off.

An application for initiating pre-packaged insolvency resolution process can be made in respect of a corporate debtor who has committed a default subject to the following conditions, that––

• It has not undergone pre-packaged insolvency resolution process or completed corporate insolvency resolution process, as the case may be, during the period of three years preceding the initiation date;
• It is not undergoing a corporate insolvency resolution process;
• No order requiring it to be liquidated is passed under Section 33 of the Code;
• It is eligible to submit a resolution plan under Section 29A of the Code;
• The financial creditors of the corporate debtor, not being its related parties, have proposed the name of the insolvency professional to be appointed as resolution professional for conducting the insolvency resolution process of the corporate debtor;
• The financial creditors of the corporate debtor, not being its related parties, representing not less than sixty-six per cent in value of the financial debt due to such creditors, have approved such proposal pre-packaged;
• The majority of the directors or partners of the corporate debtor, as the case may be, have made a declaration;
• The members of the corporate debtor have passed a special resolution, or at least three-fourth of the total number of partners, as the case may be, of the corporate debtor have passed a resolution, approving the filing of an application for initiating pre-packaged insolvency resolution process.

Approval of financial creditors:

The Corporate Debtors must initiate pre-pack with the consent of a simple majority of:

• unrelated Financial creditors
• its shareholders.

No two proceedings - pre-pack and CIRP - shall run in parallel. There shall be a cooling-off that a pre-pack cannot be initiated within three years of closure of another pre-pack.

 

The scope of resolution plan to provide for resolution of business or an undertaking was considered. However, keeping in view the jurisprudence that has emerged so far, it was felt to continue with the extant definition of resolution plan. The resolution plan may provide for any permutation and combinations of measures, as available for a CIRP. Regulation 37 of CIRP Regulations provides an inclusive list of measures for insolvency resolution of a CD for maximisation of value of assets.

Section 29A prohibits persons with specified disabilities to submit resolution plan in a CIRP. The sub-committee was of the firm view that this provision must not be diluted in design of the pre-pack framework, as it has been instrumental in bringing about significant behavioural change and establishing a fair debtor-creditor relationship. The people with questionable background and who let down their companies, employees, lenders and stakeholders do not deserve a second chance.

 

The committee of creditors, at any time after the pre-packaged insolvency commencement date but before the approval of resolution plan by a vote of sixty-six percent. of the voting shares, can resolve to initiate a corporate insolvency resolution process in respect of the corporate debtor, if the corporate debtor is eligible for corporate insolvency resolution process.

When the resolution professional has informed the Adjudicating Authority of the decision of the committee of creditors, the Adjudicating Authority within thirty days of the date of such intimation can pass an order to:

• Terminate the pre-packaged insolvency resolution process and initiate corporate insolvency resolution process under Chapter II of the code in respect of the corporate debtor;
• Appoint the resolution professional referred to in under clause (b) of sub-section (1) of section 54E as the interim resolution professional, subject to submission of written consent by such resolution professional to the Adjudicatory Authority in such form as may be specified; and
• declare that the pre-packaged insolvency resolution process costs, if any, shall be included as part of insolvency resolution process costs for the purposes of the corporate insolvency resolution process of the corporate debtor.

Moratorium is a core feature of insolvency proceedings under the Code. It provides a calm period for working out a resolution plan, while the business of the corporate debtor continues uninterrupted and its assets remain intact. The moratorium prohibits:

• institution or continuation of suits or proceedings against the corporate debtor;
• suspension or termination of supply of essential services to the corporate debtor ;
• any action to foreclose, recover or enforce any security interest; transfer or alienation of the assets of the corporate debtor, etc.

 

It is important to have similar calm period to facilitate resolution during pre-pack. It should, however, be for a minimum period and no extension may be granted to prevent any misuse of the process. The sub-committee recommends that the moratorium under Section 14 should be available from the ‘Pre-pack Commencement Date’ till closure of process, whether by approval of resolution plan or otherwise.

The moratorium should not, however, cover essential and critical services as the promoters will continue to run the operations and the RP would neither decide critical services nor control the operations.

Providing an efficient alternative insolvency resolution process for corporate persons classified as micro, small and medium enterprises under the Insolvency and Bankruptcy Code, 2016 was important to ensure quicker, cost-effective and value maximising outcomes for all the stakeholders, in a manner which is least disruptive to the continuity of their businesses and which preserves jobs. In order to achieve these objectives, the pre-packaged insolvency resolution process for corporate persons classified as micro, small and medium enterprises was introduced.