Pre-pack insolvency for MSMEs: How it differs from corporate insolvency resolution process; key features

May 02, 2021 8:53 PM

Ease of Doing Business for MSMEs: The minimum default threshold of Rs 10 lakh, which has been prescribed for initiating the process, would provide much respite to MSMEs by enabling them to have access to an effective resolution process under the pre-pack process.

As against CIRP, which follows ‘creditor in control’ model, the pre-pack process would work on ‘debtor in possession’ model.
  • By Harish Kumar and Itee Singhal

Ease of Doing Business for MSMEs: The pre-pack insolvency resolution process (pre-pack process), which has been in many discussions since the publication of the Insolvency Law Committee’s (committee) recommendations on the subject, was notified on April 4, 2021, through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021. The minimum default threshold of Rs 10 lakh, which has been prescribed for initiating the process, would provide much respite to MSMEs by enabling them to have access to an effective resolution process under the pre-pack process. This would not have been otherwise feasible under the Corporate Insolvency Resolution Process (CIRP) owing to enhanced default threshold of Rs 1 crore. As against CIRP, which follows ‘creditor in control’ model, the pre-pack process would work on ‘debtor in possession’ model and as such would enable the MSMEs to resolve their stress as a going concern.

Key features of the pre-pack process and distinction vis-à-vis CIRP: 

  • Initiation: The process may be initiated by corporate debtor (CD) itself with approval of (a) its members via special resolution or 3/4th of the partners, as the case may be; and (b) unrelated financial creditors (FCs) representing 66 per cent of the financial debt (or unrelated operational creditors (OCs) where there is no financial debt or where all FCs are related).
  • Restriction on running CIRP and pre-pack process in parallel: A pre-condition for initiating the process is that the CD is not undergoing CIRP and no order to liquidate it has been passed under Section 33 of the Code. Besides, a cooling-off period of three years has been provided for initiating a fresh pre-pack process from completion of the previous CIRP or pre-pack process. However, it should be noted that the Committee of Creditors (CoC), may at any time after commencement of pre-pack process but prior to the approval of the resolution plan, resolve (with at least 66 per cent voting share) to initiate CIRP against CD. In such a case, the Adjudicating Authority (AA) may approve termination of the pre-pack process and initiation of CIRP.
  • Submission of the base resolution plan by CD: The CD is required to provide a base resolution plan to FCs for seeking their approval to initiate the process. The base resolution plan should meet the requirements referred under sub-section (1) and (2) of Section 30 of the Code, which among other things, contains provisions to protect the payment of debts of OCs and of FCs who do not vote in favor of resolution plan.
  • Appointment of Resolution Professional (RP): As a pre-requisite to initiate the process, the unrelated FCs of the CD having an outstanding debt of at least 10 per cent of total financial debt are required to propose the name of the insolvency professional to be appointed as RP, which would have to be then approved by unrelated FCs representing 66 per cent of the total financial debt. The proposed RP should be independent of the CD. It is pertinent to note that unlike CIRP, where the applicant brings Interim Resolution Professional (IRP), who is then retained or replaced with RP by the CoC, the pre-pack process does not envisage appointment of IRP and rather provide for direct appointment of RP. This has been done given that the pre-pack process initiates with the consent of the unrelated FCs and therefore their consent to the choice of RP may be obtained simultaneously. As per the Committee report, this move would minimize the business disruptions, which are otherwise caused due to shifting in control from IRP to RP.
  • Role of RP prior to commencement of the pre-pack process: The RP nominated by creditors has certain duties to perform prior to commencement of the pre-pack process, which among other things include preparation of a report confirming (a) that the CD meets the requirements / pre-conditions to initiate the pre-pack process; and (b) that the base resolution plan received from the CD confirms the stipulated requirements.
  • Commencement of the pre-pack process: The CD is required to make an application to the AA for initiating the pre-pack process. Along with such application, the CD is required to inter alia furnish (a) approval of members/partners and creditors obtained to initiate the process; (b) approval of the creditors recommending the name of RP, and (c) the report of the RP. Within 14 days of receipt of such application, the AA may either admit the application (if compete) or reject the application (if incomplete). Simultaneously, AA is required to confirm the appointment of RP (as nominated by creditors) or appoint another RP on IBBI’s recommendation (if any disciplinary proceedings are pending against the RP nominated by creditors). The pre-pack process shall commence from the date of admission of application by the AA.

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  • Moratorium: Similar to CIRP, upon commencement of the pre-pack process, the moratorium would commence. However, the moratorium would not cover essential goods and services, which shall mean electricity, water (for drinking and sanitation purposes and not for generating hydro-electricity), telecommunication services, and information technology services, to the extent these are not direct input to the output produced/supplied by the CD.
  • List of claims and preliminary information memorandum (IM): Within two days of the commencement of the pre-pack process, the CD is required to furnish the following with the RP:
  1. Preliminary IM: Distinct from the CIRP process where the IM is required to be prepared by the RP, the pre-pack process has casted the responsibility of preparing the preliminary IM on the CD. The RP is required to finalize the IM, so received from CD and submit the same to the CoC for making an informed opinion.
  2. List of claims: The CD is required to provide the list of claims along with details of the respective creditors, their security interests and guarantees to the RP. Based on the records and other material information available of CD, the RP is required to confirm the said list of claims and is required to update the same as and when the claim is satisfied (partly or fully). Here the role of RP is slightly less burdensome as compared to CIRP, where, RP is required to collate as well as verify the claims.
  • Constitution of CoC: Within seven days from commencement of the pre-pack process, the RP is required to constitute the CoC based on the list of claims received from CD and subsequently verified by him. However, the CoC may be reconstituted as and when the list of claims is updated. This shall, however, not affect the decisions taken by the CoC prior to such re-constitution.
  • Management of CD: The management of the CD shall continue to vest with the Board of Directors (Board) or partners. However, to undertake certain critical actions, as specified under Section 28 of the Code, the CD shall require prior approval of CoC. Further, the CoC is empowered to specify any other matters for which CD shall obtain its prior approval. Where the affairs of CD have been grossly mismanaged or conducted in a fraudulent manner, the CoC (by a vote of at least 66 per cent) may submit an application to AA to vest the affairs of CD with the RP.
  • Role of RP during the pre-pack process: The RP is required to conduct the overall pre-pack process. In this context, the RP has been casted with certain specific duties and powers. Further, while RP is not required to manage the operations of CD, however, he is expected to monitor the management of affairs of CD. In this regard, inter alia, the CD is empowered to attend the meeting of the Board, partners, members, and committee of directors of the CD.
  • Consideration and approval of the resolution plans: Upon commencement of the process, the CD is required to submit the base resolution plan to the RP who would present the same to CoC for approval. It has been clarified that CD may submit the base resolution plan either individually or jointly with any other person. Where the base resolution plan provides for impairment of any claims of OCs, then, CoC may require the promoter to dilute their shareholding or voting or control rights in CD.
    If the CoC does not approve the base resolution plan or if the base resolution plan impairs any claims owed to OCs, then, the RP would invite prospective resolution applicants to submit their resolution plan. The CoC would then evaluate all resolution plans and select a resolution plan from amongst them for approval (which should be approved with at least 66 per cent voting share of the CoC). The RP shall submit the resolution plan approved by CoC to the AA for final approval. The CD and other resolution applicants should be eligible to submit a resolution plan under Section 29A of the Code.
  • Timeline: A timeline of a total period of 120 days has been provided for completion of the pre-pack process, out of which 30 days have been reserved for AA to approve/reject the resolution plan, and the other entire process (till submission of resolution plan with AA) is required to be completed within 90 days period.

Harish Kumar is Partner and Itee Singhal is Senior Associate at L&L Partners. Views expressed are the author’s own.

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