Pre-Packs Insolvency Resolution Option for MSMEs

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The central government promulgated an ordinance allowing the use of pre-packs as an insolvency resolution mechanism for Micro, Small and Medium Enterprises (MSMEs) with defaults up to Rs 1 crore, under the Insolvency and Bankruptcy Code.

About

• The move comes soon after the end of a one-year suspension of insolvency initiation imposed by the government in light of the Covid-19 pandemic.
• The government had last year also increased the minimum default threshold for insolvency proceedings from Rs 1 lakh to Rs 1 crore. 

Objectives  behind the introduction of the Pre-Pack

• Pre-Packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate while still providing adequate protections so that the system is not misused by firms to avoid making payments to creditors.
• It will help corporate debtors to enter into consensual restructuring with lenders and address the entire liability side of the company.
  • The government should consider setting up specific benches of the NCLT to deal with pre-pack resolution plans to ensure that they are implemented in a time-bound manner.

What are Pre-Packs?

• A pre-pack is the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
• This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
• Under the pre-pack system, financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
• The approval of a minimum of 66 percent of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT.  
  • Further NCLTs are also required to either accept or reject any application for a pre-pack insolvency proceeding before considering a petition for a CIRP.
• The pre-pack is expected to be rolled out to all corporations over time as legal issues around the provisions are settled through case law.

Benefits of Pre-Packs over the Corporate Insolvency Resolution Process (CIRP)

• One of the key criticisms of the CIRP has been the time taken for resolution.
  •  At the end of December 2020, over 86 per cent of the 1717 ongoing insolvency resolution proceedings had crossed the 270-day threshold.
    •  The key reasons behind delays in the CIRPs are prolonged litigations by erstwhile promoters and potential bidders.
• The pre-pack in contrast is limited to a maximum of 120 days with only 90 days available to the stakeholders to bring the resolution plan to the NCLT.
• Another key difference between pre-packs and CIRP is that the existing management retains control in the case of pre-packs while a resolution professional takes control of the debtor as a representative of financial creditors in the case of CIRP.
  • Experts note that this allows for minimal disruption of operations relative to a CIRP.

More benefits

• Protection to Creditors: The pre-pack provisions introduced by the central government also provided for adequate protection to ensure the provisions were not misused by errant promoters.
  •  The pre-pack mechanism allows for a swiss challenge for any resolution plans which proved less than full recovery of dues for operational creditors.
    • Under the swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company and the original applicant would have to either match the improved resolution plan or forego the investment.
    • Creditors are also permitted to seek resolution plans from any third party if they are not satisfied with the resolution plan put forth by the promoter.