BACKGROUND TO IBC
In India when it comes to business there are two realities that you cannot escape from. The first is that you can somehow manage to promote a business enterprise but to close it down is not in your hands. Second reality is that enterprises can go bankrupt; but not the entrepreneurs who run them aground. Over the years many attempts have been made to address the thorny issue of insolvency of business enterprises resulting in a plethora of laws being passed and a number of adjudicating mechanisms being set up to deal with sick industrial units. Sick Industrial Companies (Special Provisions) Act, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, Recovery of Debts Due to Banks and Financial Institutions Act, Companies Act have been addressing the issues of corporate debts and insolvency matters, albeit with limited success. On the one hand the banking system has been buckling under the weight of nonperforming assets on the other the corporate debtors (CDs) are seeking some viable mechanism to revive their sick industrial units. The endemic delays in the system of resolution of debts had become a threat to the stability of the financial markets itself. It is in this background that the government introduced the Insolvency and Bankruptcy Code (IBC) in 2016. The Code was expected to provide a time bound resolution process. One of the objectives of the Code was on preserving the value of assets involved. Though there have been instances of successes of the Code during its initial period of implementation thus far, it still has some distance to travel to meet the objectives for which it was enacted. One of the systemic problems for the Code falling short of realising its full potential is that the industrial firmament in India has two distinct parts, one occupied by the large corporate entities and the other comprising of micro, small and medium enterprises popularly known as the MSMEs.
INTRODUCTION TO PREPACK
‘Prepack’ is not a statutorily defined term though it can be found in commercial parlance. Despite the significant contributions that the MSMEs make to the economy in terms of GDP, employment and exports, the problems of this sector is unique as compared to those in the large sector. In one sense the challenges faced by these two sectors are so vast and varied that they could as well be living in two different planets. MSME sector is largely entrepreneur driven and promoter financed with informal working arrangements so much so that even a corporate set up in this sector resembles a proprietorship unit. This sector more often than not, lives in an over leveraged condition during its life cycle. Consequently, applying the same insolvency norms behind the formulation of the policies appropriate for a large unit to the MSME sector would have disastrous consequences to the latter. A ‘one-size-fits-all’ approach for resolution of a highly stressed MSME sector could only ruin this sector. This had been a major dilemma for the policy makers. This called for a different approach to the issue of resolution of stressed assets even while keeping the essence of the IBC in terms of timelines and value maximisation for the stake holders. Thus was born a modified version of the Corporate Insolvency Resolution Process (CIRP) appropriately called Prepackaged Insolvency Resolution Process (PIRP). The practice of the corporate debtors getting into arrangements with the creditors to avert an impending insolvency is nothing new in the developed countries like the United Kingdom. Even in India such arrangements are nothing new in one sense. PIRP is more in the nature of a debt restructuring process albeit with an additional legal sanctification by the National Company Law Tribunal (NCLT). As per the scheme of things under the CIRP the creditor is in control of the process while the NCLT appointed Resolution Professional (RP) manages the company’s affairs till a legally binding resolution is arrived at whereas in PIRP the corporate debtor continues to be in possession of the assets of the company during the entire resolution period. Hence the alluring terminologies like ‘creditor in control’ (of the process) and ‘debtor in possession’ (of the assets) to conceptually distinguish between these two resolution frameworks.
OBJECTIVES OF PREPACK
Broadly the following are the advantages and objectives of the PIRP resolution mechanism:
A PIRP process avoids major disruptions in the running of the unit as almost all the existing arrangements can continue and the corporate debtor can continue to call the shots in running the business unfettered by restrictions imposed by any external agencies.
The costs involved in a PIRP resolution process would be considerably less than a normal CIRP process under IBC.
The financial institutions and the corporate debtors are familiar with debt restructuring processes with all its advantages and pitfalls. The base resolution plan under PIRP gets ready on day one when the resolution process starts. Except for the post facto validation of the process by the NCLT the process is as simple as a debt restructuring exercise.
In the case of a PIRP, unlike in a simple debt restructuring mechanism, the creditors get a feeling of certainty to the commitments and the timelines made by the corporate debtor.
For a highly leveraged unit the moratorium provided by the Code would be of critical importance to stabilise its operations.
As the PIRP finally gets an official nod from the NCLT the financial creditors get a feeling of comfort while recommending haircuts that may be essential to save a unit from certain bankruptcy.
A Resolution Applicant (RA) also gets the confidence that he shall not be prosecuted for any offence committed before the commencement of the resolution process.
Finally it is only fair and proper that the corporate debtor is extended a helping hand to resurrect his labour of love unless he happens to be willful defaulter or had indulged in fraud or malfeasance.
The government promulgated The Insolvency and Bankruptcy Code (Amendment) Ordinance 2021 on 4th April 2021 with the objective of addressing the unprecedented stress in the MSME sector caused by the unprecedented pandemic. This became all the more critical as the moratorium of one year for filing of applications for initiating corporate insolvency process against defaulting companies also had expired on 25th March 2020. In a manner of speaking the government “side loaded” a new Chapter IIIA to address the needs of the MSME sector through the prepack scheme thus effectively carving out a separate mode of resolution process without delinking the prepack process from the larger scheme of debt resolution under the IBC. This Chapter is largely procedural in nature with one omnibus section (Section 54 A to P) laying down the scope and process of PIRP. In addition, the Ordinance also makes a few consequential amendments to a few other sections in the Act to give effect to the new mechanism of debt resolution. Given below are the salient features of PIRP as enumerated in Section 54.
Section 54A: A Corporate Debtor is eligible to apply for a prepackaged resolution process only if it fulfills the following conditions:
An application for PIRP can be made only by a CD who is covered by the MSME Act. (Appendix II for qualifying conditions)
- The CD should not have undergone a prepackaged resolution process during the period of 3 years immediately preceding the PIRP initiation date.
The CD is not currently in the process of undergoing a resolution process.
There should be no order of liquidation pending against the CD on the date of making an application for prepack.
Only those who are not ineligible under the IBC being willful defaulters alone can make an application for a prepack resolution.
The financial creditors (not being related parties) with a majority of 66% must have approved the prepack resolution and also had appointed an RP.
The majority of the directors or partners as the case may be make a declaration stating that the CD shall file an application for prepack resolution within a definite time period not exceeding 90 days and that the PIRP is not being initiated to defraud anyone along with a suggested name of an RP.
The directors of the CD if it is a company should pass a special resolution or in the case of an LLP by at least three fourth of the partners should approve the initiation of the PIRP.
The CD should undertake to obtain the approval of financial creditors representing at least 66% of the debts owed to them by the CD.
The CD has to furnish to the creditors copies of the above declaration under (2)f, the special resolution under (2)g and a base resolution plan prior to seeking their approval for the resolution process.
Section 54B: This section deals with the duties of the RP that, inter alia, include the following:
The RP shall prepare a Report and confirm that the CD is in full compliance as envisaged in Sec 54A above.
File the necessary progress reports or other reports as specified to the IBBI
Section 54C: This Section lays down the procedure to be followed to make a PIRP application that includes:
The CD meeting the requirements above can make an application for a debt resolution in the prescribed form after paying the applicable fees to the NCLT.
The applicant for resolution has to furnish to the NCLT along with the application the Reports, Declaration, Resolutions, etc. as specified in Section 54A in addition to a declaration regarding the existence of avoidable transactions, fraudulent or wrongful trading as specified in the IBC.
The NCLT shall dispose of an application for resolution either by accepting or rejecting the same within 14 days of receipt.
Section 54D: The prepack process has to be completed within a period of 120 days from the date of commencement of the process. This Section also gives the timelines and the forms involved if the resolution process fails to take off.
Section 54E: The NCLT on admission of a PIRP shall declare a moratorium as specified in the IBC, confirm the appointment of the RP and cause a public announcement to be made about the commencement of the resolution process.
Section 54F: This Section outlines the duties of the RP during the resolution process and also the duties of the CD to make necessary information available to the RP, the salient points of them being:
Confirmation of list of claims, information to creditors regarding their claims, continuous updating of claims, monitoring the management of the affairs of the CD, briefing the creditors about any breach, constituting the committee of creditors, etc.
The RP can exercise the powers vis-à-vis the CD to access books of accounts, electronic records, attend the meetings of members and the board, appointment of necessary professionals, collect information regarding assets, collect required business information, etc.
The bankers, promoters, employees, etc., of the CD shall be responsible to extend the necessary cooperation to the RP.
Section 54G: The CD shall submit within 2 days of commencement of the resolution process a list of claims and a preliminary information memorandum with all relevant information from the point of view of facilitating the preparation of a viable resolution plan.
Section 54H: The management of the affairs of the CD shall continue with the CD who shall exercise necessary caution to make sure that the value of the business is protected and preserved.
Section 54I: This section deals with the formation of Committee of Creditors by the RP and the process of conducting its meetings.
Section 54J: This section empowers the Committee of Creditors to take over the management of the business of the CD at any time during the resolution process if they find that the affairs of the CD are being managed in a fraudulent manner or are being mismanaged.
Section 54K: This section is a crucial one that outlines the steps involved while considering the resolution plan. These steps as set forth in this section are given below in a summary form.
The RP has to present to the Committee of Creditors the base resolution plan submitted to him by the CD.
CoC may give an opportunity to the RA an opportunity to revise the proposal if they feel so.
The CoC may recommend the base resolution plan to the NCLT as long as it does not impair any claim of any operational creditors.
If the CoC does not approve the base resolution plan submitted or the proposal submitted affects the claim of an operational debtor the RP should invite bids from any other prospective resolution applicant.
The resolution plans submitted under PIRP shall conform to the requirements set out in detail under CIRP.
The resolution plans submitted shall meet the criteria set out by the RP in consultation with the CoC after taking into account the complexities of the business of the CD.
The RP shall provide the basis of evaluation of the resolution plans and all relevant information about the CD to a resolution applicant.
The CoC may recommend for approval the best possible proposal from among those received to the NCLT for approval.
The approval of the resolution plan shall be with a majority of votes of not less than 66% of the CoC and after taking into account the feasibility of the proposal and the manner of distribution of the proceeds post resolution.
The CoC may demand dilution of the shareholding of the promoters if there is impairment of claims owed by the CD.
Once the resolution plan is approved by the CoC it shall be submitted to the adjudicating authority (NCLT).
Section 54L: If the NCLT is convinced that the resolution plan satisfies the mandatory conditions as contained in the IBC and is confident about its effective implementation, it may approve the plan within 30 days of submission of the proposal. In the alternative if the NCLT finds that the business has been carried out fraudulently and there is no change in the management control in the proposed resolution plan, then the NCLT shall reject the proposal and shall also order liquidation of the CD with the PIRP costs being made part of such liquidation costs.
Section 54M: This section provides for appeal against the order of the NCLT on a PIRP resolution plan for the same reasons as specified in the IBC for a CIRP resolution plan.
Section 54N: This section deals with the circumstances under which the prepack resolution plan ought to be terminated under the following circumstances on an application moved by the RP to the NCLT:
If the CoC does not approve any plan for the resolution of the debt;
If the CoC with 66% votes moves a resolution to terminate the process;
If the affairs of the CD are being managed in a fraudulent manner.
In such circumstances the adjudicating authority may pass suitable orders on how to deal with the avoidance and fraudulent transactions, if any, unearthed during the resolution process.
Section 54O: This section deals with the circumstances and the consequences of the PIRP getting converted into a CIRP under IBC. On an application made by the RP to the NCLT consequent to a resolution passed by the CoC with 66% votes expressing its intention to terminate the PIRP process and to initiate a CIRP process in its place, the NCLT shall pass an order within 30 days of the application covering the following:
Pass an order terminating the PIRP and initiate a CIRP in its place
Appoint the RP as an Interim Resolution Professional (IRP) under the CIRP subject to the RP giving his consent to act as such IRP.
Declare that the PIRP costs already incurred shall form part of CIRP.
An order may be passed continuing the proceedings involving avoidance transactions that may have already been initiated.
Section 54P: This section is intended to seamlessly integrate the PIRP process with other provisions in the IBC that have a bearing on prepack insolvency process also.
This debt resolution mechanism in the form of PRIP has not come one day too soon. Many a corporate debtor belonging to the MSME sector would have found it difficult to continue the operations because of the pandemic. They are also at the same time unable to prevent the destruction of the value of their enterprises without a viable solution. Resorting a CIRP would be difficult for many small enterprises with the threshold value of default being set at Rupees one crore. Moreover, they would also be put off by the very thought of handing over the reins of the company to total strangers under the CIRP process. At last here is an opportunity for an entrepreneur to marry an informal arrangement arrived at with prospective buyers of his business with proper and legal approvals from the courts. The most important aspect is that the promoters of these corporate debtors get to continue to run their companies till a suitable resolution is arrived at. That is important for the entrepreneur because the business set up by him is his labour of love.
The Appendices given below capture the process flow of PIRP along with some basic information on the broad contours of prepack corporate resolution process.
Disclaimer: The views/opinions expressed by the author in the article are intended to facilitate a general understanding about the Prepackaged Insolvency Resolution Process under the Insolvency and Bankruptcy Code. These do not constitute nor can it be construed as legal advice of any kind. Readers are advised to seek necessary legal opinion wherever required before acting on any of the points elaborated in the article.