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What is the pre-pack insolvency resolution process for MSMEs?

Arfa Javaid

On 4 April 2021, President of India Ramnath Kovind promulgated the IBC Amendment Ordinance 2021, allowing the use of pre-pack insolvency resolution process for Micro, Small and Medium Enterprises (MSMEs) with defaults up to Rs. 1 crore. The main aim behind the introduction of the pre-pack was to provide an alternate insolvency resolution process to the bankrupt MSMEs. 

As per the Chairman of Insolvency and Bankruptcy Board of India (IBBI) M.S. Sahoo, "It is informal up to a point and formal thereafter. It blends debtor-in-possession with creditor-in-control. It is neither a fully private nor a fully public process - it allows the company, if eligible under section 29A (which disqualifies wilful defaulters), to submit the base resolution plan which is exposed to swiss challenge for value maximisation."

As per the Ministry of Corporate Affairs, "It provides an efficient alternative insolvency resolution framework for corporate persons classified as MSMEs for timely, efficient and cost-effective resolution of distress thereby ensuring positive signal to the debt market, employment preservation, ease of doing business and preservation of enterprise capital."

Earlier, in the wake of the COVID-19 pandemic, the government suspended the insolvency for a year and increased the minimum default threshold for insolvency proceedings from Rs. 1 lakh and Rs. 1 crore.

What is the pre-pack insolvency resolution process?

It is a settlement of the debt of a distressed company with the help of an agreement inked between the creditors and the investors. The creditors and the investors will first mutually agree on an agreement and then seek the approval of the National Company Law Tribunal (NCLT) on the resolution plan. 

It is to be noted that before submitting a resolution plan to the NCLT, it must be approved by at least 66% of the creditors who are unrelated to the corporate debtor. Furthermore, it is up to the NCLT to reject or accept any application for a pre-pack insolvency proceeding before considering a petition for a CIRP.

Benefits of pre-packs over CIRP

1- Over the years, the Corporate Insolvency Resolution Process (CIRP) has been criticised due to its 270-day threshold period. In comparison with the CIRP, the pre-pack is limited to a maximum of 120 days and 90 days will be provided to the stakeholders to bring in the resolution plan to the NCLT. 

2- In CIRP, the resolution professional takes control of the debtor as a representative of financial creditors while in pre-packs the existing management retains the control. Experts are of the view that with the introduction of pre-packs, minimal disruption to business and employment will take place. 

At the end of 2020, more than 86%  of the 1717 insolvency resolution proceedings crossed 270 days threshold period. 

Why the Central Government introduced the pre-pack insolvency resolution process?

The main aim of the pre-pack is to provide MSMEs with the opportunity to restructure their liabilities and start afresh. While safeguarding the rights of the stakeholders, it provides enough protection to prevent any potential misuse by the firms to avoid making payments to the creditors. It will also assist corporate debtors with going into consensual rebuilding with lenders and address the entire risk side of the organization. 

What are the provisions in the ordinance to protect the creditors?

The pre-pack mechanism introduced by the Central Government allows for a swiss challenge for a given resolution plan that mentions less than full recovery of dues for creditors. Also, if the creditors are not satisfied with the resolution plans put forth by the promoter, they can seek resolution plans from a third party. 

Under this mechanism, any third party would be able to submit a resolution plan for a distressed company and the original applicant can either go forward with the improved resolution plan or forego the investment. 

Why most MSMEs are not eligible for the pre-pack insolvency resolution process? 

Most MSMEs will not be eligible for the pre-pack insolvency process introduced by the Central Government under the IBC. This is because a corporate debtor must be registered as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act of 2006 to be eligible for the pre-pack process as mentioned in the Chapter III-A of the ordinance.

As per the NSS 73rd Round Survey (2015-16) on MSMEs, 6.3 crore MSMEs exist in India. The MSME registration portal, Udyam Registration mentions that only 26.42 MSMEs have been registered to date. Taking these figures into consideration, the unregistered MSMEs exceeds the registered MSMEs and couldn't benefit under the pre-pack insolvency process. 

Another restriction in pre-pack insolvency is that it is only restricted to the companies and Limited Liability Partnerships (LLPs). The sole proprietorship, partnerships and Hindu Undivided Family (HUF) forms of MSMEs are out of the ambit of the aforementioned process, further restricting the eligible MSMEs for pre-pack.  

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