A Critique of the Pre-Packaged Insolvency: A Flawed Framework?

[By Unnati Sinha]

The author is a student of Narsee Monjee Institute of Management Studies.

 

Introduction

The Pre-Packaged Insolvency Resolution Process (“PPIRP”) was added to Chapter III of the Insolvency and Bankruptcy Code, 2016 (“Code”) in 2021. It was introduced in view of the worldwide economic downturn brought on by the lockdown prompted by the epidemic. Corporate insolvencies are on the increase because of the recession. In the latter half of the previous year, 283 companies in India were accepted into the Corporate Insolvency Resolution Process (“CIRP”).

The purpose of using PPIRP is to align the needs of creditors and debtors while preserving the operations of defaulters and it becomes very crucial when the debtor is an MSME (Medium Small and Micro Enterprise). These businesses are mostly reliant on their promoters for their day-to-day management and financial needs and hence, it would be impossible to revive the company if management were transferred to a resolution professional in accordance with Section 35 of the Code.

This article’s assessment of the PPIRP framework highlights the Debtor-in-Possession (“DIP”) approach’s problematic provisions, the function of operational creditors, and an examination of the lack of a tranquil time are highlighted. In order to tackle the aforementioned issues, the author also offers an analysis of the effects of such shortcomings and further investigates the potential for rebuilding the framework.

PPIRP: An Overview

The report of the subcommittee led by M.S. Sahoo (“Sub-committee”) served as the foundation for the PPIRP framework. A corporate debtor designated as an MSME that is also qualified to propose a resolution plan under Section 29A may apply for PPIRP in accordance with the requirements of Section 54A of the amended Code. This happens if a statement to that effect is issued by a majority of the partners and is accepted by creditors who account for 66% of the amount owed.

Furthermore, according to Section 54D, the PPIRP must be finished within 120 days. This is different from the current framework, which advocates a 270-day window for the procedure’ completion, with the option to extend it by 90 days.

The change in the function of the resolution professionals is a substantial modification. The new structure vests management in the existing board of directors, as contrast to CIRP, where the professional oversees the business as a subsisting concern. The separation of the resolution professional’s functions in India signifies the end of the creditors-in-control strategy. With the current strategy, the promoter lost actual control of the firm to the creditors. A shift in this strategy would mean that the debtor still had management control over the creditor, who would then have less power over them. Additionally, it denotes a decrease in the amount of responsibility placed on the resolution specialist. However, the resolution specialist still has a lot of power, particularly over the completion of the PPIRP.

Inconsistencies with the DIP framework

There is a substantial difference with the advent of the DIP strategy, which gives the board of directors of the defaulting firm the power to run the affairs. The model’s introduction has caused what seems to be inconsistencies in the framework. The relevant provisions show that the creditors have authority over the settlement process, even though it might appear that the Code has accepted the DIP model. The reason behind this is because under Section 54J(xii) the creditor has the authority to change the company’s management from the board to the resolution professional. When the Committee of Creditors (“CoC”) is certain that the company’s affairs have been handled fraudulently, they may exercise the provision by submitting an application. . The addition of such a clause was recommended by the Sub-committee to stop the promoters from siphoning off company assets, but it runs the risk of delaying the process if the promoters disagree with the creditors’ assessment.By submitting pointless petitions that would take up a lot of time during the resolution process, creditors might obstruct the insolvency process.

Furthermore, by initiating the resolution after receiving 66% of the voting share, the CoC has also exercised its power to start the CIRP against the Debtor. By doing this, the PPIRP would be terminated beforehand. It has been codified in the Code’s Section 54-O. This clause emphasizes the incorrect terminology used to describe the DIP model, which is what the amendment aims to do. As a result, the management powers of the corporation and the settlement procedure are biased in favor of the creditors.

Preclusion of Operational creditors

The PPIRP does not apply to operational creditors. The Code, among other things, traditionally denied operational creditors the opportunity to participate in the CoC but gave them the ability to start a CIRP against the debtor. The modification doesn’t apply to operational creditors’ rights since only the debtor may start a PPIRP. The CoC established thus is like that established under CIRP and forbids involvement of operational creditors.

The Apex Court’s justification for the exclusion in the Swiss Ribbon’s case relies on the faulty assumption that financial creditors have the knowledge to assess the sustainability of the resolution plan, while operational creditors are only interested in recovering the value of products and services. The justification is strong because it is based on the presumption that the creditors would support the plan based on its feasibility rather than on their desire to maximize their asset recovery. The policies in other jurisdictions, such as the United States, where a committee of unsecured creditors is constituted to defend the interests of such creditors who may not be given enough attention. Similarly, any corporation facing resolution in the United Kingdom must have the consent of creditors who account for 75% of the total value of each class of creditors.

Since MSMEs themselves are regarded as operational creditors, the deprivation is also detrimental to their interests. Given that MSMEs would not be able to vote or express an opinion, any future PPIRP structure for larger corporations would undoubtedly be detrimental to MSMEs.

Truancy of Calm Period

The terms of the current CIPR procedure involve a “calm period” in which the resolution expert attempts to restore the company’s operating outlooks without involving the CoC unduly. It offers the expert enough time to ask for approval of a resolution plan that could provide a workable substitute for the company’s bankruptcy.

The framework’s examination reveals that the PRIRP does not provide the advantage of the calm period since the CoC may meddle with management and resolution by imposing its choices on the Board. Failure to comply might lead to the CoC terminating PPIRP. The issue presumably arises because the corporate debtor, rather than the interim professional, filed the settlement plan. The Bankruptcy Law Reform Committee (“BLRC”) study, which advocates eliminating the quiet period, served as the basis for this exception. The argument is that an expert in interim resolution lacks decisive authority over the debtor, which causes value to decline. To safeguard the debtor’s inherent worth, the CoC was selected by the BLRC. The advice is given with creditors’ interests in mind, disregarding the debtor’s business value protection. Moreover, the CoC’s intervention in the company’s decision-making and the inherent power to start the CIPR would hinder the continuation of business and undoubtedly would not equalize the promoters’ interests with relation to the creditors.

Concluding Remarks

The PPIRP makes significant changes to India’s insolvency laws. The redesign would help the MSME corporate debtor’s business be preserved while also facilitating an early resolution. Although the structure is undoubtedly applauded, the shortcomings of the regulations cannot be disregarded. While approving the resolution plan, it is important to consider the operational creditor’s viewpoint. After a complete deployment of the PPIPR, the inclusion of such creditors would allow MSMEs to participate in the CoC, which would be advantageous. However, the excessive power given to the creditors runs counter to the DIP model and the framework’s goal of balancing each party’s interests. If the PPIRP model intends to implement a DIP strategy, it must instill a more sympathetic mindset toward defaulters. The current architecture may allow the CoC to obstruct the settlement process by interfering constantly. Alternately, if the company’s management does not share its viewpoints, this can be derailed by threatening to renounce the PPIRP by submitting an application for CIRP. However, the legislative intention emphasized in the Sub-committee report is to experiment with the framework’s evolution, thereby reviving the hope that the current concerns will be quickly addressed.

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