[By Neil Kothari and Nidhi Agarwal]
Neil is a student at Government Law College, Mumbai and Nidhi is a student at Rizvi Law College, Mumbai.
INTRODUCTION
On 04th April 2021, an ordinance[i] was passed by the Government whereby a separate chapter, Chapter IIIA, was inserted in the Insolvency and Bankruptcy Code 2016 (“The Code”) dealing with pre-packaged insolvency resolution process. Due to the outbreak of the Covid-19 pandemic, India faced huge economic challenges, and various corporations and individuals were on the brink of insolvency. As a result, an Ordinance was introduced for insolvency resolution of Micro, Small and Medium Enterprises (“MSME”) in a value maximising and cost-effective manner, by the Government.
The Code recognizes this as an “out-of-court” mechanism, wherein the stakeholders benefit from the amalgamation of informal workouts with the legal validity of formal insolvency proceedings. Moreover, appropriate safeguards are also provided for all stakeholders. This process involves a ‘debtor-in-possession with creditor-in-control’ model, whereby the assets of the company would still be under the management of the debtor with the approval taken of the creditors. This scheme further envisions a shorter timeframe for completing the proceedings.
PRE-PACKAGED INSOLVENCY RESOLUTION PROCESS
Ever since the introduction of the “Pre-Packaged Insolvency Resolution Process” (“PPIRP”), MSMEs found it difficult to undertake restructuring under the standard Corporate Insolvency Resolution Process (“CIRP”). Since promoters ran these companies, it was impossible for them to resurrect under the current insolvency resolution mechanism whereby the current administration of the company would be removed, and the promoters would not be allowed to participate. Therefore, the latest amendment prescribes a scheme where the Corporate Debtor (“CD”) would be entitled to negotiate with the creditors to stay in business and keep the operations as a going concern.
Any corporate debtor classified as MSME would be qualified to initiate a pre-pack process under Section 29A of the Code if the default on its loans is a minimum of Rs.10 lakhs. Such a process requires certain conditions to be fulfilled,
- To convene a meeting of unrelated financial creditors and seek approval for the appointment of an insolvency professional.
- A majority vote of 66% of its unrelated financial creditors is required to seek approval for initiation of the process. Also, the members of the corporate debtor are needed to pass a special resolution to approve the initiation of the process.[ii]
When all the pre-commencement requirements are fulfilled, the applicant of the corporate debtor may apply to the Adjudicatory Authority (“AA”), filled with the period stated in the abovementioned declaration. In addition to the application, a report of the appointment of an insolvency professional has to be attached, along with a declaration regarding the antecedent transaction under Chapter III or VI of Part II of the Code.
The AA is obligated to approve the application if it is complete within fourteen days from the date of filing of the application. When such an application is admitted, the AA declares a moratorium under section 14(1)& (3) of the Code officially appoints the insolvency professional and issues a public notice to the creditors, information utilities, etc.
According to the law, the pre-pack process is stipulated to be completed within 120 days from the date of admission. The first 90 days are required to seek approval of the resolution plan from the committee of creditors (“CoC”) and the remaining 30 days for the adjudication by the AA. The insolvency professional under the Code within 90 days can apply for termination of this process if CoC fails to ratify any resolution plan.
INTERNATIONAL PERSPECTIVE
The concept of PPIRP was brought into India after its successful demonstration and application globally. United States has two types of PPIRP process; one requires creditors’ approval, and the other one can be initiated solely by the CD. Furthermore, the district courts themselves are responsible for acting as a bankruptcy court where the matter shall be referred to judges dealing specifically with bankruptcy cases.
In the United Kingdom, a very popular notion known as ‘Phoenixing’ is used, where the promoters of the insolvent company are allowed to bid for the insolvent business without carrying over its debts. The Government, however, has taken some recommendations from the Graham Committee[iii] to improve the transparency of the PPIRP.
CHALLENGES AHEAD
The Pre-Packaged Insolvency Resolution Process had been introduced with benefits arising right from less time taken to complete the proceedings, and low transaction cost being incurred to a continuation of corporate debtor’s business proceedings., etc. However, it still has to face certain challenges during its implementation
Approval of the plan by the Committee of Creditors (CoC)
The Base Resolution plan proposed by CD needs to be presented to the CoC first. The plan has to be approved by 66% of financial creditors by value. Even though Sec29A allows the CD to apply for PPIRP with the exception of clauses (c) & (h)[iv], but if the financial situation of the CD is stressed or if the account of CD is Non-performing Assets, the creditors will be reluctant to approve the proposed plan. Additionally, unsecured creditors might not be much benefitted from PPIRP as the restructuring plan will favour secured creditors better. Therefore, the resolution plan proposed by the corporate debtor before the committee of creditors will only delay the process of PPIRP to put the entity back on track.
However, with at least 66% vote of CoC, the creditors can transfer the management of the CD to the IP, i.e., from Debtor in Possession Model to Creditor in Possession Model. The IP will then submit an application to the Adjudicating Authority for approval of the application.
Initiation of CIRP by Operational Creditors
If the OC’s are not content with the Base Resolution Plan or have to reconcile in terms like payment delay, reduced interest rate, etc., they may apply for Section 9. In that case, if the PPIRP is not submitted within the framework of 14 days after filing of CIRP by OC, then the CIRP application shall be given preference over the PPIRP application. This will only make the process more inflexible and harm the purpose of opting for PPIRP originally.
Undervalued Transactions Angst
It becomes necessary to identify such transactions that are undervalued or avoided to remove past unwanted debts. According to Section 45(2), a transaction is considered to be undervalued if the CD (a) makes a gift to a person (b) enters into a transaction with a person which involves the transfer of one or more assets for a considerable value which is less and such transaction has not taken place under the ordinary course of business. The IP is given a responsibility by CoC to take note of such transactions but the time limit available to IP is very less (30 days from Commencement). The IP might fail to identify such transactions within a limited period. Moreover, if such transactions are found, the plan needs new changes, which will hamper the initial plan.
Remedies/ Solutions
The whole PPIRP should be transparent and indisputable. Financial Creditors and Operational Creditors should be treated equivalently. The main aim of PPIRP is to put the company back on track and revive its business operations. For this, the debts of OC’s need to be paid so that the operations can restart. Identifying Undervalued/Fraudulent transactions should start as soon as the CoC approves PPIRP[v]. This will give an IP a longer time to investigate and make amends accordingly. The process of viability review is to bring the decision-makers together and bring out a solution with collaboration and cooperation. “Also, akin to the concept of ‘viability review’ in the UK, where the connected party writes a viability review of the ‘new company’, the Code provides for demonstration that the plan addresses the cause of default, it is feasible and viable, it has provisions for effective implementation and the resolution applicant has the capability to implement the plan” [vi].
CONCLUSION
In the midst of a pandemic, the introduction of PPIRP has been like a lifeline for the MSMEs. PPIRP offers various benefits such as privacy, the confidentiality of proceedings, preserving the goodwill of clients, maintaining the employees of the business and majorly better returns to the creditors than they would have got in the process of liquidation. However, there are various challenges to the scheme, for instance, how funds would be arranged to repay the creditors or how would operational creditors per se be taken into confidence in the plan, etc. Furthermore, it is expected by the experts to evaluate all such shortcomings before deciding to extend its scope to large corporations. Though this scheme has been introduced mainly to provide relief to the CD and get the business running again along with the payment of dues to the creditors, it is still to be observed how transparent and approachable it would be to implement this scheme to ensure the stakeholders avail maximum benefits.
[i] Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, No.3, Acts of Parliament, 2021 (India)
[ii] Debanshu Mukherjee, Aishwarya Satija and Others, Pre-Packaged Insolvency Resolution under the Insolvency and Bankruptcy Code (IBC): An Overview, Vidhi Legal Policy (April 15, 2021, 2:30 PM), https://vidhilegalpolicy.in/blog/pre-packaged-insolvency-resolution-under-the-insolvency-and-bankruptcy-code-ibc-an-overview/
[iii] Ram Mohan, M.P.; Raj, Vishakha, Pre-packs in the Indian Insolvency Regime, IIM Ahemdabad Working Papers (Aug 07, 2020, 12:30 PM), https://web.iima.ac.in/faculty-and-research/research-and-publication/working-papers.html&rnp_id=14633
[iv]Tushar Kumar, Applicability of Section 29A to Pre-Packaged Insolvency Resolution of MSMEs, IndiaCorpLaw (June 22, 2021, 3:00 PM), https://indiacorplaw.in/2021/04/applicability-of-section-29a-to-pre-packaged-insolvency-resolution-of-msmes.html
[v] Megha Mittal, Prepack for MSMEs – A Vaccine that doesn’t Work?, Vinod Kothari Consultants (June 22, 2021, 4:00 PM), http://vinodkothari.com/2021/04/prepack-for-msmes-a-vaccine-that-doesnt-work/
[vi] Sikha Bansal, Bringing Pre-packs to India: a discussion on the way forward, Vinod Kothari Consultants (June 22, 2021, 4:15 PM), http://vinodkothari.com/wp-content/uploads/2020/06/Bringing-pre-packs-to-India.pdf