Insolvency scheme: Govt, regulator finalising pre-pack framework, MSME scheme

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Updated: Apr 05, 2021 12:26 PM

The government and the regulator are in the process of finalising a so-called pre-pack insolvency scheme, while a special framework for micro, small and medium enterprises (MSMEs) is almost ready

Under both the pre-pack scheme and the framework for MSMEs, the time limit for the resolution will also be drastically reduced.

The government and the regulator are in the process of finalising a so-called pre-pack insolvency scheme, while a special framework for micro, small and medium enterprises (MSMEs) is almost ready, sources told FE.

As authorities brace for a potential rise in bad loan cases with the lifting of a suspension of insolvency proceedings against Covid-related defaults on March 25, the schemes are being tailored to incentivise early identification of stress, facilitate fast resolution and reduce costs and litigation.

“Work is on. Stakeholders’ comments on pre-pack insolvency scheme have been obtained. Both the schemes could be notified soon,” a source said. The Insolvency and Bankruptcy Code (IBC) needs to be amended for the pre-pack scheme.

Under the special framework for MSMEs, only the debtors could be allowed to trigger their own bankruptcy process, albeit with the approval of unrelated financial creditors who account for at least 25% of outstanding claims. Creditors can still trigger insolvency proceedings against MSMEs, but only through the usual corporate insolvency resolution process (CIRP) under extant rules.

The pre-pack insolvency scheme offers greater leeway to the honest promoter, who will retain the control of their firm during the insolvency process. In fact, he will get to submit resolution plans first. This will then face a Swiss challenge, a move that is expected to lead to more resolutions and less litigation.

As part of its measures to soften the Covid-19 blow, the government had last year proposed to bring in a special framework for these small businesses. At the same time, it wanted to firm up a pre-pack scheme that will yield resolution fast before the stressed firm sees substantial value erosion.

The pre-pack scheme will be based on the report submitted by a panel headed by Insolvency and Bankruptcy Board of India chairman MS Sahoo. The panel has suggested that this scheme be available for any stress — pre-default and post-default. The implementation of the scheme can be phased, starting with resolution of defaults from Rs 1 lakh to Rs 1 crore and Covid-related defaults; this is to be followed by defaults above Rs 1 crore, and then defaults from Rs 1 to Rs 1 lakh.

Under both the pre-pack scheme and the framework for MSMEs, the time limit for the resolution will also be drastically reduced. Market participants will get 90 days to submit resolution plans and the National Company Law Tribunal will have another 30 days to approve them. The IBC currently stipulates a maximum of 270 days for the completion of the entire CIRP.

Already, the central bank has warned that, under a severe stress scenario, banks’ gross non-performing assets (NPAs) may almost spike to as much as 14.8% by September 2021 from 7.5% a year before. In the Financial Stability Report released in January, the Reserve Bank of India said even under the baseline scenario, the NPA ratio may surge to 13.5% by September. This means chances of a rise in insolvency cases are for real.

Data available with the IBBI show, of the 1,942 ongoing cases as of September 2020, the resolution of as many as 1,442 has been dragging on beyond the mandatory 270 days. In many cases, analysts have attributed this delay to the legal hurdles posed primarily by defaulting promoters’ dogged pursuit to hold on to their companies. In fact, most of the large cases, including Bhushan Steel, Essar Steel and Bhushan Steel and Power, had witnessed inordinate delays due to litigations. The pre-pack scheme is expected to significantly minimise litigation.

Also, since MSMEs typically account for the largest chunk of these cases, a special framework will help them resolve stress better and faster, analysts reckon.

Similarly, under the MSME framework, several procedural requirements on issues, such as claims of creditors, may be simplified to make the entire process less rigorous. This is aimed at reducing the cost as well as time required for stress resolution. Firms with annual turnover of less than Rs 250 crore or investments less than Rs 50 crore will be covered under the new mechanism.

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