Indian Insolvency Law and Pre-Pack Insolvency Resolution Process: An Analysis: Part 1

[Krrishan Singhania is the Managing Partner at K. Singhania & Co. Srishti Singhania is a Senior Associate at K. Singhania & Co. and Ashuthosh V (trainee) is a IV-year law student at Nirma University.]

The Pre-Packaged Insolvency Resolution Process (“PPIRP”) was introduced in India vide the Insolvency and Bankruptcy (Amendment) Ordinance 2021 that was promulgated on 5 April 2021, through which an alternate mechanism was provided to the Micro, Small & Medium Enterprises (“MSMEs”) to the present mechanism, i.e, the Corporate Insolvency Resolution Process (“CIRP”). In furtherance of the Ordinance, the Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Rules, 2021 (“Rules”) and the Insolvency and Bankruptcy (Pre-Packaged Insolvency Resolution Process) Regulations, 2021 (“Regulations”) were also introduced. The Focus of PPIRP mechanism is to ensurequicker, 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”.

The Ordinance introduces PPIRP as a form of out of court settlement mechanism that shall reduce the burden of the National Company Law Tribunals (“NCLT(s)”) and shall expedite the resolution process. The Ordinance inserts chapter III-A, from sections 54A to 54P under the Insolvency and Bankruptcy Code, 2016 (the Code) which lays down the pre-packaged process under the Indian insolvency law.

What is PPIRP?

A pre-packaged insolvency resolution is an out of court settlement plan in which the restructuring of the corporate debtor is agreed in advance with the creditors and other important stakeholders of such debtor before insolvency is declared. In simple terms, it is a plan which offers a quasi-formal mechanism to finalize the resolution plan before insolvency proceedings (under the Code) are initiated by any creditor. Thus, PPIRP strives to achieve a balance between an informal settlement like a one-time settlement plan (which is both economic and flexible but does not have any certainty or statutory backing) and a regular CIRP under the Code (which has legal certainty and proper statutory backing but is time-consuming and involves severe costs or massive haircuts).

Therefore, a PPRIP can be considered to be a hybrid mechanism. A specific legal framework governing pre-pack under the Code was recommended by the sub-committee of the Insolvency Law Committee in its report released in October 2020. This sub-committee was constituted in June 2020 by the Ministry of Corporate Affairs to recognize the importance of pre-packaged insolvency regime in the Indian insolvency ecosystem. The sub-committee in its reportadopted such a hybrid mechanism that draws certain features from the existing CIRP mechanism to make the procedure semi-formal.

Advantages and Disadvantages

The advantages of PPIRP are:

  1. Cost Effectiveness: As the corporate debtor continues with the management of the company, there is no cost to be paid to a resolution professional (“RP”). Further, there will be no cost of disruption as the management is not shifted from the debtor to the RP and then to the resolution applicant. Moreover, as this process is ‘out of court’, the company would avoid bearing any significant cost of litigation along with a potential loss due to a ruined reputation and goodwill of the business.
  2. Speedy Resolution: A pre-pack ensures a faster resolution process with a shorter time period, as compared to the general CIRP under the Code which has a lengthy time period. The maximum time limit for the completion of PPIRP is 120 days. This helps preserve the value of stressed assets and preventing them from being degraded, thereby making resolution efficient and possible.
  3. Maximization of Value: As mentioned above, a pre-pack is a hybrid mechanism that avoids many of the formal process undertaken during CIRP. Therefore, by removing the time required to complete the process, a PPIRP mechanism will maximize the value of assets by preventing the depreciation of such assets due to a longer period of 270 days (180+90) days and 330 days in special cases under CIRP where the debtor would be in stress.
  4. Less Burden on the NCLT: Keeping in mind the population in India, the tribunals are over-burdened with insolvency petitions and they do not have the capacity with respect to the number of judges and infrastructure to deal with this mountain of cases which has delayed the CIRP. Further, the case overload of the NCLTs has increased as the Code was suspended for a period of 12 months during the pandemic and the tribunals could not function to its full capacity due to the Covid-19 restrictions. A PPIRP mechanism will reduce this burden by shifting a stream of cases from the tribunal to an out of court restructuring process that will reduce the time period. Although informal, this process would require the bare minimum interference from the tribunal. Similar to the concept of pre-litigation mediation in commercial disputes, the PPIRP would require the NCLT to act as a court of last resort only in cases where no settlement could be reached.
  5. Confidentiality and Flexibility: A PPIRP mechanism is similar to alternative dispute resolution mechanism which boasts ‘confidentiality’ during the process. This is beneficial as the dispute would be far away from public scrutiny. Moreover, this new mechanism would not require debtors to make advertisements and disclosures in newspapers or on its website which will be an incentive for parties to reach a better settlement that will protect the overall continuity of the business by maintaining its goodwill and reputation. Another advantage is that of ‘flexibility’ as the PPIRP mechanism is a semi-formal process that would enable the corporate debtor to have control over its management but such freedom is subject to the interests of the creditors and stakeholders who have relevant remedies under the Code in case of mismanagement by the debtor. For example, one such remedy is to transfer the control from the corporate debtor to the resolution professional in case the interests of the creditors are impacted.

Although the PPIRP mechanism is beneficial, especially during the Covid-19 affected economy where insolvency proceedings, under the Code, had been suspended for over a year, there are several concerns surrounding the complex nature of laws on the PPIRP mechanism and our ineffective legal infrastructure to effectively resolve disputes of MSMEs. The disadvantages of PPIRP are:

  1. 1. Creditors may lose faith: PPIRP follows a ‘debtor in possession model’[i] under which defaulting promoters are allowed to manage the day-to-day operations of the company and have total control over its assets. This is different from the rule under CIRP where the control over the management is shifted from the defaulting promoters to the resolution professional. Creditors are well aware of the stressful situation of the debtor and may not be comfortable with allowing the same people to manage the business who caused the insolvency. This would reduce the faith of creditors in the process and they may prefer CIRP. Section 54H of the Code was inserted to ensure that the management of affairs of the corporate debtor is governed under a statutory provision such that the objective of PPIRP is achieved and in case of mismanagement, the lenders have the power to transfer control over the management under section 54J.
  2. Lack of Moratorium Period: Unlike the CIRP mechanism, a PPIRP does not have a moratorium period that would allow the promoters to revive the operations of the company without any interference from the creditors and other stakeholders. Since support and cooperation from all creditors and stakeholders is uncertain, the peaceful implementation of a PPIRP mechanism will not be able to take place as creditors are free to initiate legal proceedings before any forum for recovery of their dues and this will severely impact the settlement.
  3. Willful Default by Promoters: As the provisions of the Code do not apply in their entirety during the time period for PPIRP, the promoters may undertake fraudulent or unfair transactions that would dispose of assets to avoid making payments to creditors and such acts may trigger the lenders to change the management to an RP and/or initiate CIRP under the Code. This would only increase litigation and not resolve the dispute.
  4. Bad Business due to Connected Parties: Through pre-pack, connected parties may purchase the business of the debtor which would lead to further lack of transparency as there would be no genuine restructuring but merely a façade in such cases. This is not the case in CIRP where connected parties are not eligible to make a resolution application to buy the business of the debtor. Further, if a connected party to the debtor purchases the business of the debtor, such debtor may not exit the company and this may cause future issues to the creditor.
  5. Increasing Reliance on NCLT: Although the PPIRP mechanism works out of court, the legal framework of chapter III-A under the Code is dependent on the NCLT almost at every level of the process. It is the NCLT that has to:
  • admit the application, by the creditor, to initiate PPRIP;
  • appoint an resolution professional to manage the process (in situations where the lenders transfer the process from the promoter to such resolution professional under section 54 J); and
  • approve the final resolution plan.

This will overburden the tribunal that is already facing a mountain of pending cases. In order to reduce this excess burden, a regulatory body, like the Insolvency and Bankruptcy Board of India (“IBBI”) must be granted the power to adjudicate on the above mandates so that there is no delay in the process or overburdening of the tribunal.   

[Continued here]

– Krrishan Singhania, Srishti Singhani & Ashuthosh V

[i] The Ministry of Corporate Affairs, Pre-Packaged Insolvency Resolution Process, pg. 14 (Report of the Sub-Committee of the Insolvency Law Committee, October 2020), https://www.ibbi.gov.in/uploads/whatsnew/34f5c5b6fb00a97dc4ab752a798d9ce3.pdf.

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