Pre-Packaged Insolvency: A Stumbling Block for the MSME Sector

[Gunjan Singh and Umang Chaturvedi are 3rd year B.A. LL.B. (Hons.) students at Rajiv Gandhi National University of Law, Punjab]

The disruption of economic processes and business cycles owing to the pandemic caused a major blow to the functioning of the industrial sector. Additionally, it impacted the entities who had already borrowed money from the market or financial institutions, as they were not able to utilize that money due to the nation-wide lockdowns. Amongst such businesses and industries, there were a huge number of small-scale entities that faced the wrath of Covid-19. These entities can further be categorised and defined as Micro, Small, and Medium Enterprises (“MSMEs”) The Government of India proposed an Ordinance in April this year targeting the MSMEs to provide relief to the strata that has suffered the most.

Ordinance, 2021

The Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (“Ordinance”) was promulgated on April 5, 2021to provide a pre-packaged insolvency resolution mechanism for small scale industries, i.e., MSMEs. The basic framework for the process is laid down by the Ordinance. However, the notified ancillary rules, i.e., the Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Rules, 2021 (“Rules”) along with the Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Regulations, 2021 (“Regulations”) have a greater significance.

The issued Ordinance introduces a pre-packaged insolvency resolution process (“PIRP”) for the MSMEs. It aims to provide an efficient and effective alternative insolvency mechanism for the aforementioned sector. The primary focus of these Rules are at ensuring “quicker, cost effective and value maximizing outcome for all the stakeholders, in a manner which is least disruptive to the continuity of their businesses and which helps preserve jobs.”

It has been introduced as an “out of court settlement” process to reduce the burden on tribunals and reduce the lengthy time period invested in the corporate insolvency resolution process (“CIRP”). Under the principal Insolvency and Bankruptcy Code, 2016 (“Code”), Chapter III-A has been inserted in the form of sections 54A to 54P to give effect to the pre-pack process in the Indian regime.

The pre-pack mechanism of insolvency proceedings is welcomed in India as it has become a huge success in foreign jurisdictions like the United Kingdom and the United States America. Although there are advantages in the step taken by the Ordinance, 2021, this post aims to critically analyse the potential pitfalls of this new framework in the context of Indian jurisprudence.

Critical Analysis

The pre-packs, referred to as “expedited reorganization proceedings”, intend to reduce the burden of formal court procedure. The existing mechanism has several issues and challenges that may defeat the intended purpose. The following section highlights certain concerns that can contribute to the detrimental effect of PIRP.

Restricted scope of applicability

According to the Ordinance, corporate debtors classified as “micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006” are eligible to file an application for PIRP. Furthermore, the Regulations apply to the companies that fall within the PIRP framework, excluding other types of MSMEs, including partnerships, sole proprietorships, Hindu undivided families (“HUFs”) and other unregistered enterprises. This limits the number of MSMEs eligible for PIRP.

As per the reports of India Brand Equity Foundation, the MSME sector in India comprises approximately 6.3 crore businesses. Although India is a land of MSME enterprises, not all MSMEs are registered under the provisions of law. Looking at the recent statistics available at Udyam Registration portal for MSMEs, only 26.42 lakh MSMEs are registered. Hence, the Ordinance covers only a handful of entities in this sector. Therefore, the legislative intent to provide a cushion to MSMEs against the repercussions of Covid-19 stands defeated. The restricted applicability of these provisions reduces the number of MSMEs that can reap the benefits of these schemes. 

Multifarious approvals

Chapter III-A of the Code lays down the provisions for a corporate debtor to obtain several permissions before initiating the PIRP, namely from shareholders, unrelated financial creditors, and the adjudicating authority. In terms of approval by financial creditors, regulation 14(1) states that this permission must be acquired at a meeting of unrelated financial creditors, which must be held according by the procedure laid down in the Regulations.

Furthermore, regulation 14(8) states that if there are no financial creditors for a particular corporate debtor, the above-mentioned approval must be procured from the unrelated operational creditors following the procedure laid down in regulation 14(1). This implies that the corporate debtor is required to convene a meeting with all its operational creditors. However, the number of operational creditors is considerably greater than unrelated financial creditors, thereby making the entire process more complex and logistically infeasible. Instead of holding a meeting, it is advised that a speedier approval can be obtained by obtaining a “Letter of Assent” signed by the operational creditors.

Excessive reliance on NCLT

Although the pre-pack process is primarily an out-of-court procedure, the legal framework of PIRP is primarily dependent upon the adjudicating authority, i.e., the National Company Law Tribunal (“NCLT”) at every level. From the admission of PIRP application to the appointment of an insolvency professional to manage the PIRP and until the final resolution plan is approved, everything depends upon the NCLT’s mandate. Different benches of the NCLT across the nation are overburdened with cases leading to chronic delays. These delays may undermine the timeline as even the admission for the commencement of a PIRP may be delayed for months.

Giving alternative regulatory bodies like Insolvency and Bankruptcy Board of India (“IBBI”) the jurisdiction to grant approvals for minor issues that arise during the PIRP can resolve this issue.  Sectoral regulatory bodies like IBBI can expedite the process, reducing the burden of the NCLTs and enabling them to save valuable time by adjudicating only the final stages of PIRP.

Inconsistency of DIP approach

The PIRP provides for a debtor-in-possession (“DIP”) strategy for administration of company operations, which offers the corporate debtor a guarantee that it would revive the operations with the management unchanged. The DIP method, as defined by the Ordinance, allows the corporate debtor’s board of directors to oversee its business operations, subject to the insolvency professional’s surveillance and certain limitations that may be enforced.

However, this approach of DIP is rendered ineffective by the specifications in regulation 50(2).According to this regulation, the approval of the Committee of Creditors (“CoC”) for transactions exceeding a minimum threshold (which shall be decided by the CoC) is mandatorily needed. Regulation 50(2)(b) allows the CoC to determine any further conditions that the corporate debtor must bear in mind and abide by while taking any actions. This would increase the likelihood of the CoC imposing unnecessary requirements, thereby producing a creditor-in-possession (“CIP”) approach rather than the desired DIP.  As a result, the corporate debtor controlling the operations will fall prey to the powers of CoC.

Timeline to complete PIRP

Under regulation 49, a corporate debtor has 90 days to submit a CoC-approved resolution plan before the adjudicating authority. It has 30 days to pass an order accepting or rejecting the resolution plan. This strict timeline of 90+30 days is an unrealistic one, keeping in mind the past records of adherence to CIRP timelines. The 90-day timeframe includes the creation of a CoC, corporate debtor appraisal by registered valuers, and transaction inquiry. It might also take a long time to get clearance from a creditor. As a result, this will only function if the corporate debtor lays down the spadework prior to the PIRP’s formal start date.

Conclusion

The authors are of the opinion that the proposed PIRP is a significant facilitator for MSMEs, if the legislation widens the scope of the mechanism and lays down provisions to provide lenders and corporations more flexibility in adapting the restructuring process. The legislation should plug in the highlighted loopholes to cater to the needs of the relevant industry and creditors at the same time. Creditors possess financial wisdom and are equipped to decide if a PIRP or a CIRP under the Code should be adopted. Therefore, they should be given the liberty to exercise this wisdom.

The final sanction by the adjudicating authority should be necessary only when all parties agree at the end of the procedure. This stands true in other jurisdictions like the UK, where the court’s approval for the PIRP is granted within a day. Considering the present circumstances, the step is welcomed as a necessary regime to keep a firm in financial distress as a going concern. The long-term economic and financial impact of PIRP on the fabric of corporate India, however, is yet to be gauged.

Gunjan Singh & Umang Chaturvedi

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