IBC ordinance allows prepack for MSMEs, eases resolution with minimum pain

Ordinance is designed to ensure quicker, cost-effective and value maximising outcomes for all stakeholders in a manner that least disrupts their businesses and preserves jobs too

The government has amended the Insolvency and Bankruptcy Code (IBC) through an Ordinance, enabling prepackaged resolution schemes for micro, small, and medium enterprises (MSMEs) and allowing corporate debtors to propose a resolution plan for the stressed company. 

“The minimum threshold of default will be announced as part of the regulation. The prepackaged scheme has given a semi-formal structure to the pre-insolvency stage. We have put in enough checks to make sure the process is not abused,” a senior government official told Business Standard. 

The Ordinance, approved by President Ram Nath Kovind on April 4, keeping in mind the financial stress of MSMEs, is meant for “ensuring quicker, cost-effective and value maximising outcomes for all the stakeholders, in a manner which is least disruptive to the continuity of their businesses and which preserves jobs”.

A prepackaged scheme is an arrangement by which the promoter of the stressed company proposes a resolution plan to the creditors before the company goes to bankruptcy proceedings. The purpose of this scheme is not just to have a timely and faster resolution mechanism but also to give legal sanction to a plan agreed upon between banks, promoters, and the buyer.

In keeping with the debtor-in-possession model proposed by the Insolvency and Bankruptcy Board of India (IBBI), the board of directors or the partners of the corporate debtor will manage the company, “subject to such conditions as may be specified”.

Lawyers also point out while to begin with the minimum threshold of default could be Rs 1 lakh as prescribed initially for corporate resolution insolvency process, the Ordinance allows the government to specify a threshold of payment default of not more than Rs 1 crore for this special arrangement. Accordingly, defaults above the threshold by small businesses can avail of the scheme.

Section 54K of the prepack scheme under the IBC says that while considering the feasibility and viability of a resolution plan, where the resolution plan submitted by the corporate debtor provides for the impairment of any claims owed by the corporate debtor, the committee of creditors may require the promoters of the corporate debtor to dilute their shareholding or voting or control rights in the corporate debtor. If the committee does not do so in its commercial wisdom it has to record the reasons for not doing so.

“A company might gain market value once it goes into the prepack process. In that case the creditor should not be taking a haircut. Sacrifices of the creditor have to be compensated,” the official added. 

Legal experts say where the corporate insolvency resolution process (CIRP) cannot be initiated against a Covid-related default, defined as a default that occurred between March 24, 2020, and March 24, 2021, a prepackaged scheme could be a viable alternative.

A significant advantage that experts believe a prepackaged process would give is that being a debtor-initiated process, it is expected to involve fewer legal disputes and a faster resolution.

A new chapter -- III-A for prepackaged schemes for insolvency resolution -- has been added to the IBC, allowing a corporate debtor to propose a base resolution plan to the committee of creditors (CoC). If the plan is not accepted, the resolution professional would invite other applicants (those who might want to participate) to propose a plan within 90 days.

The CoC can go for the alternative resolution plan if it is “significantly better than the base resolution plan”.

The law also states that if the resolution plan is not being considered for approval, “it shall compete with the base resolution plan, in such manner and subject to such conditions as may be specified”.

This has opened a window for a Swiss challenge which the CoC could opt for if required.

Only those eligible to submit a plan under Section 29A of the IBC will be allowed to take part in the prepackaged scheme to ensure wilful defaulters and related parties stay out of the exercise.

For MSMEs, however, this is not likely to pose a major hindrance and the criterion for 29A was relaxed for such companies in the IBC.

Companies eligible to go through this route must not be undergoing a CIRP. A pre-pack cannot be initiated within three years of the closure of another pre-pack. This is like a CIRP cannot be initiated within 12 months of closure of another CIRP.

“This is a welcome step although it was hoped that such a framework would be available to non-MSMEs as well. The framework of chapter IIIA does not reduce the role and involvement of the National Company Law Tribunal very significantly. Given that this process can be initiated only by companies with the consent of 66 per cent of its unrelated financial creditors, the disputes are minimal, allowing the process to run more efficiently than the normal CIRP,” said Misha, who uses her first name, partner at Shardul Amarchand Mangaldas & Co.

In a contrast to the CIRP under the IBC, the deadlines have been moved up for the prepackaged scheme. For instance, the corporate debtor has to submit the resolution plan within two days of the commencement of the prepackaged insolvency. The entire process has to be completed within 120 days from the commencement date.

If no plan is approved within the timeframe, the process will be terminated after the approval of the adjudicating authority. 

“We are waiting for the rules to be introduced by the Ministry of Corporate Affairs. They will tell us the fine print. This is essentially an accelerated insolvency process where the promoter has been given the benefit of proposing a resolution plan,” said Anshul Jain, partner, PwC India.  

However, at any point till a plan is approved the CoC is allowed to either initiate a corporate insolvency resolution process against the corporate debtor or terminate the prepackaged process. This would require 66 per cent vote share of the CoC. 

Industry experts have suggested that the government should consider setting up specific benches looking at prepack and insolvency above a certain size to expedite resolution of large cases in a time bound manner. 

NCLT can also pass an order of moratorium which would be effective till  the date on which the prepackaged insolvency resolution process period comes to an end. 

Even though it is a debtor in possession model, the CoC can with a 66 per cent vote share make an application for change in  the management of the company and pass control to the resolution professional. This can be done if CoC finds that the company is being run in a fraudulent manner or there has been gross mismanagement of company affairs by the promoter.