Introduction
The introduction of the Insolvency and Bankruptcy Code, 2016 (“IBC”)[1] has resulted in a significant change in India’s corporate distress resolution structure. It has provided a fresh lease of life to a company whose fate had previously been determined by plenty of debt restructuring schemes, the failures of which often resulted in the company being forced to file for bankruptcy or being stranded with unproductive assets whose value deteriorated over time. In India, most organizations are predominantly promoter-driven, and the IBC currently prohibits the Company management and its related parties, who are responsible for driving the company into insolvency, from regaining control over the business of such corporations under Section 29A of IBC. As a result, an imbalance is created, which can be best addressed by Pre-Pack schemes.
The COVID-19 pandemic has had an impact on businesses, financial markets, and economies all over the world, including India, and has harmed MSMEs’ business operations and put many of them in financial trouble. From March 25, 2020, the Central Government has suspended the filing of new applications for the initiation of the corporate insolvency resolution process in respect of defaults that occurred over one year, as well as raising the minimum amount of default for the initiation of the corporate insolvency resolution process to one crore rupees. MSMEs[2] are vital for India’s economy because they contribute significantly to the country’s GDP and employ a large number of people. Due to the particular nature of their operations and simpler corporate structures, it was deemed necessary to address the specific concerns of MSMEs relating to the resolution of their insolvency as soon as possible.
Pre-Packaged Resolution Process
The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 was proclaimed by the President of India on April 4, 2021, to implement a Pre-Packaged Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016. This law was enacted to offer corporate entities classified as micro, small, and medium enterprises (“MSMEs”) an efficient alternative insolvency resolution process. Instead of a public bidding process, a pre-pack is the resolution of a distressed company’s debt through an agreement between secured creditors and investors. Financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT) under the pre-pack system. Before a resolution plan could be submitted to the NCLT, it would need the approval of at least 66% of financial creditors who are unrelated to the corporate debtor. Furthermore, before considering a petition for a CIRP, NCLTs must either accept or reject any application for a pre-pack insolvency proceeding.[3]
Need for Pre-Packaged Resolution Process
The typical process of IBC is the Corporate Insolvency Resolution Process, in which creditors take a distressed borrower to the bankruptcy court for a quick settlement. The company is auctioned off to a potential investor in a competitive bidding process. This mechanism prevents the asset’s original promoter from bidding on it. When a company is admitted to the NCLT, control is transferred to a resolution professional (RP), who acts as an administrator throughout the process until the company is sold to a bidder, allowing banks to recover their debts with a large haircut. The issue is that the entire IBC procedure takes roughly six months, and in some circumstances, might take up to 270 days. Such a protracted process is both time-consuming and costly, as it involves legal fees as well as the risk of the asset’s value eroding further. During this time, the company will become much more stressed, and the lenders will not be able to recover anything.
In November 2019, DHFL became the first finance company to be referred to NCLT by the RBI using special powers under Section 227 of the IBC.[4] DHFL defaulted on its repayments, and rating agencies downgraded the CPs of the company on account of delay in servicing the debt obligations. It owes a total of around Rs 83,000 crore to banks, National housing boards and bondholders. Furthermore, In the bidding process, the Adani group has submitted the bid after the stated timeline. Rival bidders such as the Piramal Group and Oaktree Capital Management were dissatisfied with the revised bid, claiming that the Adani Group was late in submitting their bids and is unacceptable. The process is often not completed within the stipulated time. The most significant problem was that the bidding process takes much time and involves many disagreements, which makes this resolution process futile.[5]
On the other hand, a pre-packaged insolvency framework allows a stressed borrower to establish a strategy for either secured creditor settlement or resolution — which might include the sale of the company to an investor — before entering the IBC court. It is a type of restructuring that the borrower can take advantage of with the consent of the creditors, rather than having to go through the time-consuming and expensive IBC process. Importantly, the borrower can keep control of the situation until a resolution is reached. This process was needed to improve the borrower’s chances of regaining control of the company through a resolution process or by enlisting the help of an investor. In a typical IBC resolution process, Borrowers often have no role once they are admitted to the NCLT court. In addition, the borrower’s legal fees are greatly lowered as a result of this mechanism. This is also advantageous for lenders, as a resolution is often faster – the pre-packaged bankruptcy resolution procedure must be completed within 120 days of the start date. [6]
Downsides of the Pre-Packaged Resolution Process
Though the pre-packaged IBC Scheme has its advantage, it also comes with several challenges and cons that cannot be overlooked.
- Most of the MSMEs are not eligible for this process
As per the ordinance, only those MSMEs that are registered under MSME Development Act,2006[7] can take advantage of this scheme. Currently, only the MSMEs who are registered under MSME Act, 2006 can take benefit from this resolution process. There are an estimated 6 crore MSMEs that exist in India to date (as per National Sample Survey), and the data available on the Udyam Registration (MSME registration) website shows that only 26 lakhs MSMEs have registered to date. Also, this resolution extends to only Companies and Limited Liability partnerships, keeps Sole Proprietorship, Hindu Undivided forms out of the ambit of this process. Thereby further restricting the number of MSMEs eligible for pre-pack.
- Reduced transparency compared to CIRP
Transparency would also be a significant barrier in this resolution process as financial creditors would engage with a possible investor privately rather than through an open bidding procedure. This could lead to problems of fairness being raised by stakeholders such as operational creditors when financial creditors strike deals to minimise the distressed company’s liabilities.
- Inconsistent with the provisions of Section 29A
Section 29Aof IBC[8]would be a major impediment to the introduction of the pre-pack process in India since they would put the debtor in charge of the process rather than the IRP, which would go against the spirit of Section 29A of IBC. It would be difficult to shift away from Section 29A or make an exception for pre-pack schemes because the legislature has already placed so much attention and weight on the provision, which has also been evaluated and restated in the Supreme Court decision in Essar Steel. It would be one of the most significant drawbacks of the pre-package scheme.
- The risk associated with recovering the funds
The major challenge that pre-pack schemes will have initially is that they will not have capital lenders lending money to them while the possibilities are being examined by the company. This is because there is an obvious risk associated with recovering the funds, and lenders would rather not accept the financial risk, given that the company is already strapped.
- More in favour of Secured creditors
Operational creditor means a person to whom an operational debt is owed and includes any person to whom such debt has been legally assigned or transferred. As Pre-pack is an agreement between secured creditors and investors, operational creditors can raise the issue of fair treatment. This scheme favours secured creditors, while operational creditors do not have much influence in the negotiations or receive a fair part of the proceeds.
Optimal Solutions
- The Micro, Small, and Medium Enterprises (MSME) sector is an integral aspect of India’s historical economic model and a crucial component of the product and service supply chain. This sector is regarded as a job creator, and it is critical in delivering large-scale employment and industrialization in rural and underdeveloped areas. Thus, it is vital to assist them in whatever manner possible.
- According to the Ordinance, only the MSMEs who are registered under MSME Act, 2006 can take benefit from this resolution process. Out of 6 crores MSMEs, only 25 lakhs are eligible for this process which simply means that a negligible number of MSMEs are getting benefited. The legislature must strike an appropriate balance between implementing the programme as quickly as feasible while also ensuring that it is implemented successfully. The coronavirus has severely impacted MSMEs, which are the backbone of India’s inclusive economic storey, which has disrupted people’s cash cycles. MSMEs’ situation is of great concern because they are such an integral part of domestic and global value chains. More MSMEs should be qualified for this process, and it should be made more inclusive of various forms, particularly in light of the Covid-19 pandemic. A lack of procedural safeguards will lead to more chaos than progress.
- Stakeholders have legitimate concerns about this procedure, even though it was designed to be a basic and straightforward process, as the ILC has acknowledged. This process has many flaws, including a lack of transparency, valuation concerns, and confidentiality concerns. Especially regarding issues of transparency that may lead to abuse, a proper framework must be established before implementing any such scheme.
- The IBC’s section 54A(2)(d) must read with Section 240A, which is an overriding provision that the Pre-Pack Ordinance has amended to exclude the application of sections 29A(c) and 29A(h) to the pre-packaged insolvency resolution process of MSMEs.[9]To be qualified for the pre-packaged insolvency resolution process, the MSME must comply with the provisions of section 29A, except for sections 29A(c) and 29A(h). This would cause a great deal of confusion in the procedures. To avoid any such issues, the legislature should amend these sections. This would help clarify any ambiguity regarding the application of section 29A of the IBC to MSME’s pre-packaged insolvency resolution process.
- Operational creditors must not be ignored, because allowing the same promoters to control and transfer assets of a defaulting Corporate Debtor would erode trust among both unsecured and operational creditors, as they would have no role in the decision-making process. The promoters should come up with a resolution plan that includes the minimal potential haircut for operational creditors while also being acceptable to the committee of creditors and affirming the creditor’s faith.
Conclusion:
The inclusion of the Pre-Packaged process takes the Indian insolvency resolution system one step further. MSMEs are the soul of the Indian economy, and it is laudable that the ordinance was drafted keeping the MSMEs in mind. There are numerous benefits and drawbacks to this process. Stressed companies will be able to come out of their insolvent position in a more efficient manner if pre-pack insolvency resolution is introduced in India, and various issues such as value destruction, going concern sales, time factor of liquidation, and so on can be effectively addressed. It serves to promote the IBC’s objectives of attaining a quick and orderly resolution of distressed assets by establishing an alternate process that is not as time-consuming or costly. Though the concept has several drawbacks, as discussed above, it will surely surpass them all once the ideal framework is enforced after addressing all the problems. Once implemented, It will pave the way for a smoother implementation of resolution plans and would ensure the company’s viability.
[1]Aravind Gayam , The Insolvency and Bankruptcy Code: All you need to know, PRS, May 10, 2016, https://www.prsindia.org/theprsblog/insolvency-and-bankruptcy-code-all-you-need-know
[2] Nagaraj, R., Vaibhav, V. Revising the Definition of MSMEs: Who is Likely to Benefit from it? Ind. J. Labour Econ. 63, 119–126 (2020), https://doi.org/10.1007/s41027-020-00266-x.
[3] Hitesh Mankar, Understanding the proposed Pre-packaged Insolvency Resolution Process and its implications, Bar and Bench, 11 Mar, 2021, https://www.barandbench.com/columns/understanding-the-proposed-pre-packaged-insolvency-resolution-process-and-its-implications.
[4] The Insolvency and Bankruptcy Code, 2016, §227, No. 31, Acts of Parliament 2016.
[5] Shivangi Pathak, Aherar Patel, Insolvency and Resolution Process of DHFL under the Light of Financial Service Providers Regulations, IBC Laws, January 28, 2020, https://ibclaw.in/insolvency-and-resolution-process-of-dhfl-under-the-light-of-financial-service-providers-regulations/.
[6] Out-of-court Workouts Prepacks and Pre-arranged Cases A Primer, ABI, Apr 2005, https://www.abi.org/abi-journal/out-of-court-workouts-prepacks-and-pre-arranged-cases-a-primer.
[7] A Sathish, S. Rajamohan, Micro, Small and Medium Enterprise – Before and After the MSMED Act, 2006, 8 ZIJBEMR 155, 156-161 (2018).
[8] The Insolvency and Bankruptcy Code, 2016, §29A, No. 31, Acts of Parliament 2016.
[9] Tushar Kumar, Applicability of Section 29A to Pre-Packaged Insolvency Resolution of MSMEs, ICL, April 30, 2021, https://indiacorplaw.in/2021/04/applicability-of-section-29a-to-pre-packaged-insolvency-resolution-of-msmes.html.
[This article is authored by Dipti Tharwani, a 2nd-year law student at the Institute of Law, Nirma University].
NUALS Restructuring and Insolvency Law Journal 