Pre-Packaged Insolvency: A Paradigm Shift in Resolving Financial Distress – By Riya Sagar and Shubhankar Agnihotri

Pre-Packaged Insolvency: A Paradigm Shift in Resolving Financial Distress

Riya Sagar, 4th-year B.A.LL.B. student at Symbiosis Law School, Noida
Shubhankar Agnihotri, 5th year, B.A.LL.B (H), student at Bennett University, Greater Noida

Introduction

1. The Indian economy depends heavily on Micro, small, and medium enterprises (“MSMEs”). They support a significant number of people with employment and make a major contribution to GDP. Their commercial operations have been impacted by the COVID-19 pandemic, which has put several of them under financial strain. Due to the unique characteristics of their enterprises and simple organisational frameworks, they require a particular mechanism to resolve their stress. In order to guarantee more rapid, more cost-effective, and value-maximizing outcomes for all stakeholders while causing the least amount of disruption to their businesses and job stability, it became apparent that a productive alternative insolvency resolution process under the Code for corporate MSMEs was essential.

Background

2. Several companies took out loans during the pandemic but were unable to reimburse. Undoubtedly, the lenders or creditors will demand their money back. IBC is equipped to handle such circumstances, although the procedure is known to be time-consuming. Additionally, the regulation added an opportunity for MSMEs to choose pre-pack insolvency resolution if they default. A pre-pack procedure is done when operational or financial creditors and corporate debtors agree to settle the debt of a struggling company without holding a formal auction. In the UK and Europe, this form of insolvency proceedings has gained popularity as a means of insolvency management. Financial creditors will negotiate arrangements with the corporate debtor pursuant to the pre-pack procedure and ask NCLT to approve their resolution strategy. Sections 54A to 54P are now a component of the code as a result of the creation of Chapter III-A in Part II by the Amendment. Further, PPIRP was limited to corporate entities (Company, LLP, or body corporate with limited liability) that are designated as MSMEs under Section 7(1) of the Micro, Small, and Medium Enterprise Development Act of 2006 (MSMED) Act.

Eligibility for Pre-Packaged Insolvency

3. Section 54A of the Insolvency and Bankruptcy talks about the eligibility for initiation of PPIRP. If a corporate debtor wants to file an application for initiation of PPIRP he must fulfil the requirement given under section 54A of the IBC.^[1] The PPIRP proceedings can be initiated against that Corporate Debtor who is classified as the MSME under section 7(1) of the MSME Development Act, 2006^[2], and committed default as per section 4 of the IBC^[3]. Section 54A also laid down that the Corporate Debtor should not have undergone any CIRP or PPIRP proceedings or completed any CIRP or PPIRP proceedings during the three years preceding the initiation date. There should not be any liquidation order under section 33 of IBC, 2016^[4] and CD is eligible to submit a resolution plan under section 29A^[5].

Approval for the appointment of an IP as RP

4. Before filing the application, there are many informal processes that must be done by the Corporate Debtor. As per section 54A(2)(e), he must get approval from the Financial Creditor for the appointment of IP as the RP, and according to section 54A(3), he has to get approval from the financial creditor for filing the application for initiation of PPIRP. To get approval, CD will call the meeting of Unrelated Financial Creditors (UFCs) if there are not any FC or all the FCs are the related parties, then CD will call the meeting of Unrelated Operational Creditors (UOCs). The notice for the meeting shall be served by the CD to UFCs or the OFCs at least 5 days before the day of the meeting or any shorter time which is agreed upon by all of them. The notice served by the CD will contain the information related to the time, date and venue related to the meeting and the list of creditors along with the amount due in Form P2.

5. In the meeting, the UFCs that have more than 10% of the value of debt due shall propose the name of the IP for the appointment of RP. And the UFCs representing not less than 66% of the total value of the debt e shall approve the IP as the RP. In the meantime, the majority of the partners or the member as the case may be of the corporate debtor will be made a declaration stating-

I).  That CD shall file the application for initiating the PPIRP within 90 days.
II).  That the process is not being instituted to defraud any person
III). That the IP whose name is proposed and approved will be appointed as the RP.

Approval for filing an application for initiation of PPIRP

6. According to section 54A(2)(g) of the IBC^[6], before filing the application for initiation of PPIRP the applicant must get approval from the members of the CD. The members of the CD shall pass the special resolution or pass a resolution with the vote of at least three-fourths of the total member of the CD for approving the filing of an application for initiating the PPIRP process. In the meantime, the CD shall submit a Base Resolution Plan to the RP within two days of the Pre-packaged insolvency commencement date. The RP shall present it to the CoC. Before getting the approval under section 54A (3) of IBC, 2016, the CD will provide the following information to the FC.

I).  Declaration of the directors or partners as per section 54A(2)(f) of IBC, 2016.^[7]
II).  The special resolution passed by the member of the CD under section 54A(2)(g) of IBC, 2016.
III). BRP made by the CD.

7. According to section 54K of the IBC,2016^[8] the BRP must comply with the requirement of section 20 of this code and the provisions of section 30 shall be applied on the BRP in mutatis mutandis. If the BRP is according to the provisions of this code and does not impair the dues of the OC, then CoC will approve the BRP for submission before the AA. If the CoC does not approve the BRP then RP will invite the prospective resolution applicant to submit the resolution plan. After the submission of the resolution plan by the prospective resolution applicant, CoC will compare BRP, and the new plan submitted by the prospective applicant and approve the best plan among them. Thereafter UFCs shall approve the filing of the application for initiating the resolution plan by the majority representative who is representing not less than 66% of the total value of the debt due to FC.

Duties of IP before initiation of PPIRP

8. The IP who was proposed to be appointed as the RP has many duties before the initiation of PPIRP. Section 54B^[9] prescribed the following duties of the IP before the initiation of PPIRP.

I). Prepare the report on whether Cd meets the requirements referred to under section 54A and BRP submitted by the CD meets the requirements given in the IBC, 2016
II). File reports and the documents specified.
III). Ther duties as specified.
The duties of the RP will cease if the CD fails to file the application for initiation of PPIRP process within time or AA admitted or rejected the application for initiating the PPIRP.

Mechanism

9. PPIRP process doesn’t start until a minimum of 66% of financial creditors affirm the identity of the Resolution Professional or approve the PPIRP proposal, and the CD approves a special resolution with 75% of its members voting in support of PPIRP. Finally, a draft information memorandum is composed once CD has put together a Base Resolution Plan & FC and CD have decided upon the name of the RP. A corporate applicant could submit a PPIRP application in Form 1 as specified in the PPIRP Rules, together with the necessary annexures and the AA by the Corporate Applicant. The AA has to approve or reject the application within 14 days of receiving it. If accepted, establishes a moratorium in accordance with Section 14(3)(1) of the Code^[10], selects an RP, & directs them to issue a public notification of the commencement of the PPIRP. Further, The RP is expected to organise a Committee of Creditors (the “COC”), examine the claims made by the CD, keep an eye on how its business is being handled, collect informational memos, and other things. The Code’s Section 21 applies mutatis mutandis to a PPIRP, and the COC must be established within 7 days of the initiation.

10. The plan for resolution needs to be submitted as well as authorised by the COC within the period of 90 days of the order of admission through AA, and the entire PPIRP process must be completed over 120 days, which is broken down into two phases: 30 days for adjudication by the adjudicating body along with 90 days to enable the COC to give its approval the resolution plan. Before the NCLAT, this 120-day threshold period was under discussion in Krrish Realtech Private Limited^[11]. Several homebuyers raised objections to the PPIRP application in this, stating it had not been submitted in accordance with the Act. The NCLT gave the CD and the Objectors the opportunity to present their reasons for the objection. The CD claimed on appeal that the NCLT had the jurisdiction to give Objectors any chance to respond. The opportunity that an objection was intended for anyone, even the Objectors/Financial Creditors, as the PPIRP is time-bound. In upholding the NCLT’s decision, the Appellate Authority pointed out that the CD did not experience any harm because the Objectors had the opportunity to file their objections and the Appellant had ample time to react. Additionally, the NCLAT stated that as homebuyers and creditors have significant stakes, their concerns must be allayed through guaranteeing that the PPIRP is used in accordance with the law.^[12]

11. Further, The RP shall submit an application to terminate the PPIRP if the COC fails to approve a resolution plan under 90 days. Following 14 days, the resolution professional must complete the information memorandum containing the information required by Regulation 40(2) and send it to the COC members. Any information regarding the CD that is accessible by them from the financial institutions administering the CD holdings must be provided to the RP. A list of claims u/ s 54G(1) of the Code must be submitted by the CD to the RP in Form P10. There will be frequent updates to the claims.

12. The BOD or the Partners remains to continue to have authority over the administration of the CD’s affairs. The RP must nevertheless appeal before the AA to grant this in some circumstances, such as when the COC decides to give the RP authority of the CD. Upon receiving such an application, the AA may, if persuaded that the corporate debtor’s affairs are being handled dishonestly or carelessly, order the CD to be administered by the RP. The CD is obligated to submit the BRP to the FC ahead of PPIRP’s initiation and to the COC in two days of it. The Code’s Sections 30(1), (2), and (5) must be accompanied by the plan. If the COC agrees, it can alter the BRP. In the case Krrish Realtech Private Limited Basement^[13], three orders passed by the Adjudicating Authority regarding a pre-packaged insolvency resolution process under the Insolvency and Bankruptcy Code, 2016. The appellant, a corporate debtor, filed an application for pre-packaged insolvency and obtained approval from financial creditors. Objectors raised concerns about non-compliance with statutory provisions and alleged fraudulent intent to harm the rights of homebuyers. The main issue in the appeal is whether the Adjudicating Authority can hear objectors before admitting the application. The court concludes that the Authority has jurisdiction to consider objections before admitting the application.

13. If the BRP does not affect the CD’s obligations to Operational Creditors (the “OC”), the COC might accept it. The RP must encourage potential resolution applicants to submit different proposals if the COC rejects the BRP or if it affects any claims owing by the CD to OC. Not later than 21 days after the PPIRP commencing date, and in line with Regulation 43, RP will publish an overview of the invitation for resolution plans in Form P11. The criteria for examination will be used to assess resolution plans that were submitted in response to an invitation and that complied with the Code’s and Regulations’ requirements. The best alternative strategy (abbreviated “BAP”) for competing with the BRP will be chosen because the resolution plan with the greatest score. If no resolution plan is submitted, the COC may take BRP into consideration for approval.

14. If no resolution plan is submitted, the COC could take BRP into consideration for approval. If the BAP is noticeably superior to the BRP, the COC might approve it. The procedure is over if it doesn’t accept a BAP that is noticeably superior. The RP must communicate the scores of the BAP and BRP to the submitters of these plans and ask them to modify their plans in compliance with Regulation 48 if the BAP isn’t substantially better than the BRP. Until one of the submitters chooses the option throughout the allotted time, the process of improvement will continue. The COC will evaluate for approval the resolution plan with the higher score at the end of the improvement process. The procedure comes to an end if the COC does not approve it. A plan must receive the AA’s approval plus the support of 66% of the voting shares from the COC. Following 30 days after receiving the resolution plan, the AA must decide whether to accept it or reject it, in which case the PPIRP will be terminated. If the PPIRP terminates, AA can order for liquidation.^[14]

PPIRP over CIRP

15. It has been highlighted from the situation that the PPIRP is going to be of greater benefit when compared to the traditional Corporate Insolvency Resolution Process because the latter is less time-consuming plus gives the corporate debtor an equitable opportunity to restructure the organisation. Following are some of the main advantages of PPIRP over CIRP:

(i). The length of time it takes to resolve a case had become one of the most common criticisms of the CIRP. By the end of December 2020, 1717 active insolvency resolution proceedings had gone longer than 270 days in nearly 86% of the cases. Prolonged legal disputes between former promoters and prospective bidders are one of the main causes of postponement in the CIRP. Only 90 days were given for the stakeholders to submit a resolution strategy to the NCLT under the new insolvency framework for MSMEs.

(ii). Pre-pack and CIRP vary significantly because a resolution professional controls the debtor as the representation of the financial creditors in CIRP, but in pre-pack the current management manages control. The programme minimises interference with CIRP operations. Comparatively speaking, the PPIRP is more cost-effective than the CIRP. Because a lesser amount of time is utilised and numerous actions are taken towards settlement before consulting the adjudicating authority, less money is spent in contrast. The PPIRP offers the parties an opportunity to negotiate between themselves since the judicial system’s interference is minimal.

16. Although the PPIRP was introduced in the Insolvency and Bankruptcy Code, 2016 (IBC) in 2021, there have only been just a couple of instances involving it. One noteworthy instance, nevertheless, is the PPIRP mechanism’s current application to resolve the insolvency of the corporate debtor in Ruchi Soya Industries Limited. Leading manufacturer of soy food products and edible oils, Ruchi Soya Industries Limited, was admitted into the CIRP in December 2017. The NCLT granted approval to Patanjali Ayurved Limited’s resolution plan in September 2019 following a protracted and difficult CIRP process. However, the unsuccessful bidders and Ruchi Soya stakeholders’ numerous legal objections and appeals caused an interruption in the resolution plan’s implementation. The PPIRP mechanism was established in June 2020 as a result of an IBC amendment. Patanjali Ayurved Limited, the successful resolution applicant, presented a resolution plan through the PPIRP process in January 2021 towards the execution of the resolution strategy authorised by the NCLT in September 2019. The NCLT gave its approval to the plan in February 2021, and it was put into effect until April 2021. The PPIRP mechanism’s efficiency and efficacy in addressing corporate insolvency was highlighted by the resolution plan’s successful execution in the instance of Ruchi Soya Industries Limited. By using the PPIRP framework, the successful resolution applicant could negotiate and create a resolution plan beforehand the beginning of insolvency proceedings, that could then be executed right away. Furthermore, the PPIRP system enabled the resolution applicant to swiftly put into practice the resolution plan that had already been authorised, preventing additional postponements and legal complications. Thus, the PPIRP mechanism offers a workable and effective substitute for the CIRP procedure for the settlement of corporate insolvency.

17. Conclusion: Despite the PPIRP mechanism still being in its infancy, Ruchi Soya Industries Limited’s successful execution of the PPIRP mechanism shows that it has the capability to offer a more rapid and successful procedure for the resolution of corporate insolvency. The success of this instance might inspire additional stakeholders to consider the PPIRP mechanism as a CIRP process substitute.

Any Backdrop

18. Despite having many advantages, the new resolution procedure has the serious drawback of not being accessible to the majority of organisations:

(i) A corporate debtor must have previously registered under the MSME Development Act in order to be qualified for the pre-packaged insolvency resolution process, according to the ordinance that introduced Chapter III-A. In India, there are reportedly 6.3 crore MSMEs, reported to the 73rd round of the national sample survey. However, just 26.42 lakh MSMEs were actually registered, according to information from the Udyam Registration (MSME registration) portal. As a result, a handful of MSMEs are qualified to use this alternative.

ii. Additionally, only companies and limited liability partnerships are eligible to use this approach. Thus, it limits to the amount of MSMEs that are qualified for pre-pack by keeping sole proprietorship, partnerships, and Hindu Undivided Families out of the pre-pack resolution procedure.

19. Therefore, the government should revisit these matters and take the appropriate steps as soon as possible. By taking into account the opinions of the experts in the field, the fresh method might be observed more accurately.

Conclusion

20. The debtor-in-possession approach, that allows the existing management of the MSME to stay onboard to control and supervise the turnarounds is a significant benefit of PIRPs. This offers some protection towards a loss of goodwill or commercial interruptions. According to IBC, this focuses upon the maximisation of value of assets of persona and it balances the interests of all the stakeholders. Of course, there are controls on managerial responsibilities to make sure that the procedure is implemented by MSMEs who are actually impacted by unforeseen events rather than those who are deliberately in financial trouble. For instance, the resolution professional is required to keep an eye on the administration and notify the COC of any violations. By approving the resolution professional with a 66% majority, the COC is also given the authority to replace the management of the corporate debtor during the PIRP procedure.

21. Providing a flexible, quick, and cooperative procedure for resolving financial difficulties in the MSME sector, PIRP is a good move. The process has the potential to be quicker and less expensive than a CIRP process, particularly in the event that the fundamental resolution strategy is approved.

22. While the advantages are clear, the PIRP’s ability to respond quickly and effectively depends on stakeholders acting with initiative and adhering to the established timeframe. Due to the dependence on the AA/NCLT for approval of the resolution strategy regardless of COC authorizations, the necessity of a Swiss challenge procedure in which the base resolution plan is turned down, and the necessity to foster cooperation among multiple stakeholder classes, there could be obstacles to timely fulfilment of the PIRP.

Reference

^[1]  IBC, 2016, S.54A

^[2] S. 7(1) of MSMED Act, 2006.

^[3] IBC, 2016, S.4.

^[4] IBC, 2016, S.33.

^[5] IBC, 2016, S.29A.

^[6] IBC, 2016, S.54A(2)(g).

^[7] IBC, 2016, S.54A(2)(f).

^[8] IBC, 2016, S.54K.

^[9] IBC, 2016, S.54B.

^[10] IBC, 2016, S.14(3)(1).

^[11] (AT)(Ins) Nos. 1008,1009 & 1010 of 2021 (2021) ibclaw.in 620 NCLAT.

^[12] By. (2021, August 12). Govt. introduces a pre-packaged insolvency resolution process for corporate persons classified as MSME – the insolvency and bankruptcy code (amendment) ordinance, 2021 – 04.04.2021. IBC Laws. https://ibclaw.in/govt-introduces-a-pre- packaged-insolvency-resolution-process-for-corporate-persons-classified-as-msme-the-insolvency-and-bankruptcy-code-amendment- ordinance-2021-04-04-2021/.

^[13] Krish Realtech Private Limited Basement (2021) ibclaw.in 620 NCLAT

^[14] By (2021) Govt. introduces a pre-packaged insolvency resolution process for corporate persons classified as MSME – the insolvency and bankruptcy code (amendment) ordinance, 2021 – 04.04.2021, IBC Laws. Available at: https://ibclaw.in/govt- introduces-a-pre-packaged-insolvency-resolution-process-for-corporate-persons-classified-as-msme-the-insolvency-and-bankruptcy- code-amendment-ordinance-2021-04-04-2021/ (Accessed: 17 June 2023).

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