Status as on- 17/01/2023
The Insolvency and Bankruptcy Code (Amendment) Bill, 2021 has proposed ‘pre-packs’ as an insolvency resolution mechanism for Micro, Small, and Medium Enterprises (MSMEs). In this piece, I will focus on the working of the pre-pack mechanism, how it differs from the existing corporate insolvency resolution process (CIRP) and what challenges this new mechanism is likely to bring.
How do ‘pre-packs’ work?
A Pre-packaged Insolvency Resolution Process (PIRP) relates to the resolution of the debt of a distressed company. Pre-packs work through a direct agreement between secured creditors and the existing owners or outside investors. The agreement is an option instead of a public bidding process. Under it, financial creditors will agree to terms with the promoters or a potential investor. They then seek approval of the resolution plan from the National Company Law Tribunal (NCLT). The approval of at least 66% of financial creditors that are unrelated to the corporate debtor is required before a resolution plan is submitted to the NCLT. The NCLTs will be required to either accept or reject an application for a pre-pack insolvency proceeding before considering a petition for a CIRP (Corporate Insolvency Resolution Process (CIRP) is the existing mechanism.)
What challenges can pre-packs bring?
The timeline for the PIRP (120 days) may be difficult to meet for lenders and distressed firms. Moreover, forensic audits were particularly important in cases where the control of the firm remains with the same management. They become even more imperative when compromises are involved. In such a context, a negative report from the audits becomes a roadblock in resolution involving the same management. Also, a firm can restructure its outstanding debt through a PIRP with the existing management retaining control. So, the NPA status of the company’s account with lenders may not be automatically upgraded under RBI guidelines.
In order to motivate resolution under the pre-pack method, the lenders could be given the benefit of account upgradation as soon as the resolution is formalized. Hence, RBI guidelines ought to be modified to make the pre-pack insolvency resolution process (PIRP) more attractive.
This mechanism of pre-packaged insolvency appears particularly attractive to small-sized businesses such as MSMEs, such that these employment-intensive businesses do not suffer as a result of loss of control by existing management for reasons beyond their control, such as external economic shocks. In this spirit, this new mechanism ought to be touted as primarily supportive of MSMEs, similar to decisions such as increasing the minimum default amount for triggering CIRP from Rs 1 lakh to Rs 1 crore, in the wake of the Covid 19 pandemic.
Finally, the introduction of this amendment brings India in line with international practices such as the Debtor-in-possession model under the US Bankruptcy Code, able it with the slight variance to the effect that pre-packs in India are “Debtor-in-possession” and “Creditor-in-control”.
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