What is a pre-packaged insolvency resolution process?

What is insolvency? 

It is a state when a business or a person is unable to pay debts on time. And it often leads to a bankruptcy filing.

Insolvency and Bankruptcy Code, 2016

Passed in 2016, IBC governs insolvency and bankruptcy proceedings for companies, partnership firms, and individuals. It subsumed several laws such as the Companies Act 2013.

Insolvency process under the bankruptcy code was a significant reform for resolution of companies facing financial distress. Even though it still has a long way to go, the insolvency and bankruptcy code has managed to deal with over 2,000 cases either through resolution or liquidation.

Pre-packaged insolvency resolution process

Micro small and medium enterprises or MSMEs are the backbone of the Indian economy. They generate millions of jobs and the health of these companies is crucial for sustained growth. In the wake of Covid pandemic, a pre-packaged insolvency resolution was introduced in April 2021 to deal with stress of these small and mid-sized companies. The idea was that resolution of distressed MSMEs requires different treatment due to the unique nature of their businesses.

Pre-packaged insolvency process is an alternate and speedier resolution mechanism for micro, medium and small enterprises in financial distress.

However, the scope of pre-packaged insolvency processes is larger than just Covid stress. It seeks to achieve quicker, cost-effective and value maximising resolution and at the same time making it least disruptive for the continuity of businesses. The entire resolution process has to be completed in 120 days from the date of initiation.

If the default amounts range anywhere between Rs 10 lakh to Rs 1 crore, the pre-packaged insolvency process kicks in. If the defaults are higher than the said amount, a corporate insolvency resolution process under the IBC would be initiated.

Unlike in the corporate insolvency process, the pre-packaged insolvency process allows for an informal understanding between creditors and debtors. The informal understanding is the way of debt resolution of distressed companies before insolvency initiation. After 66% of creditors approve the informal proposal, the pre-packaged insolvency resolution process begins.

However, only two cases have been admitted so far under the pre-packaged insolvency process, which is quite low. According to reports, the poor response for the mechanism was due to the hesitancy of financial institutions. In the corporate insolvency resolution process, haircut is a last resort and in pre-packaged process, it is voluntary. Banks are reportedly not willing to initiate pre-packaged insolvency processes due to voluntary haircuts.