Resolution of MSMEs: A Critique of the Pre-Packaged Insolvency Resolution Process under IBC

(By Mohd Sikandar, LLM Candidate, NALSAR University of Law, Hyderabad)

Introduction

The Micro, Small and Medium-Sized Enterprise (MSME) sector occupies a significant place in the economies of developing countries. Referred to as engines of growth, the MSMEs are a major contributor to the growth and job creation. In India, the sector contributes no less than 30% to the country’s GDP, has a cumulative share of 48% in total exports and employs approximately 110 million people. Given the economic and commercial significance, resolution of distress MSMEs needs to be done on a priority basis, especially when the COVID-19 crisis has worsened business sentiments across the globe. In this context, the present paper attempts to highlight some of the shortcomings of the recently introduced Pre-Packaged Insolvency Resolution Process under the Insolvency and Bankruptcy Code, 2016 (IBC).

Pre-Packaged Insolvency Resolution Process

The formal Corporate Insolvency Resolution Process (CIRP) do not adequately meet the needs of distressed MSMEs. Often the process takes too much time and costs to be of any benefit for small enterprises. In contrast, Pre Packs offer a hybrid solution to the complex and formal insolvency process by integrating the elements of an informal and legally recognised resolution plan. Taking cue of the flexible nature of the plan and the dire needs of MSMEs, the Indian Government promulgated the Insolvency & Bankruptcy Code (Amendment) Ordinance, 2021 (Pre-Pack Ordinance) on 4th April 2021, introducing the Pre-Pack insolvency process for MSMEs.

Building largely on the guidelines suggested by the Sub-Committee of the Insolvency Law Committee, the ordinance provides for the initiation of the Pre-Pack with the corporate debtor filing an application with the NCLT following approval from 66% of unrelated financial creditors. The approval must be accompanied either by a shareholders’ resolution or resolution by the Board of Directors for the initiation of the Pre-Pack. Post submission, the NCLT scrutinises the application on specific grounds of validity and adequacy and may or may not admit the application for initiation of Pre-Pack. Once the application is admitted and the Pre-Pack begins, the process must be mandatorily completed within 120 days from the date of admission. During this period, the Committee of Creditors (CoC) must necessarily come up with a base resolution plan within 90 days which is then made open to competition to prospective resolution applicants. Finally, the approved resolution plan is submitted to NCLT for approval. 

Drawbacks of the Process

Despite being tailor-made to the needs of small enterprises, the Pre-Pack process comes close to the formal CIRP that it was supposed to simplify for small businesses. Right from the beginning till the end, the NCLT plays a dominant role in the whole process, diluting to a great extent the cherished informal character of the Pre-Packs regime. It leads to the creation of structural barriers to speedy completion and a cost-effective resolution process. In contrast, the US government introduced a new sub-chapter to the Bankruptcy Code to simplify the insolvency procedure by doing away with the formal requirements of creditors’ committees, disclosure statements and payment of professional fees.

Secondly, in the resolution of small businesses where time is of the essence, Section 54-M of the Pre-Pack seems to dilute the whole purpose of introducing the ordinance. The aforesaid Section enables appeal even at the final stage of the process when the resolution plan as passed by the CoC has been approved by the NCLT. The Section strikes at the core objectives of finality and time-bound completion of the insolvency process.

Noteworthy is the scope of the application of the ordinance. Notwithstanding the beneficial character of the plan, it is available only to a handful of small and medium enterprises possessing a valid licence and registered under the MSME Act, 2006. As against 26.42 lakh MSMEs registered under the MSME Act, there are around 6.34 crores unregistered MSMEs that will not be able to avail the benefits of the plan. The situation is further compounded by the fact that the IBBI hasn’t yet notified provisions relating to personal insolvencies in India. Except for individuals who have given guarantees for loans taken by corporations, current insolvency framework leaves individual and partnership firms beyond the plan’s ambit. 

Conclusion

In sum, the Ordinance doesn’t seem to fully meet the needs of the vastly unincorporated Indian MSME sector. The Pre-Pack is undoubtedly a step in the right direction but it may seem to lose itself along the way. Pre-Packs are inherently built on the ideas of flexibility, easy accessibility and timely completion of the process. The rigid and formal character of the Indian Pre-Pack Ordinance stands in the way of cushioning the stressed MSME sector. Rather a flexible mechanism needs to be made part of the process taking into consideration the needs of all the stakeholders lest the Ordinance faces the same fate as that of the Fast Track Corporate Insolvency Resolution Process.