Pre-packaged insolvency resolution under IBC for MSMEs: Challenges that may arise in implementation

May 15, 2021 2:09 PM

The Pre-Package Insolvency Resolution Process (PPIRP) aims at revival of Micro, Small and Medium Enterprises (MSMEs) through submission of Base Resolution Plan along with the other data by the corporate applicant.

Pre-packaged insolvency resolution, MSME, IBCThe biggest issue that pre-pack schemes will face initially is that CD may not raise additional capital or debt from investors or banks.

By Ashok Kumar Gulla

The Pre-Package Insolvency Resolution Process (PPIRP) aims at revival of Micro, Small and Medium Enterprises (MSMEs) through submission of Base Resolution Plan along with the other data by the Corporate Applicant, i.e., MSME itself and the said Base Resolution Plan has to be vetted by the Resolution Professional duly appointed by Financial Creditors (FCs) or Operational Creditors where they are no financial creditors. While the intention of the above-mentioned enactments and notifications released in April 2021 is to ensure effective dealing with the stress assets in the MSME sector, it will also face innumerable challenges in terms of timely approval of the Committee of Creditors (CoC).

Time and Parameters for deciding on the Resolution Plan

The basic premise on which PPIRP has been introduced is that the corporate debtor (CD) shall be in a better position to revive the activities as it is managing the operations and hence, should be allowed to submit a plan which is referred as Base Resolution Plan in IBC. The Base Resolution Plan shall be placed before CoC to approve the said plan or invite new Plans from third parties. The biggest issue that pre-pack schemes will face initially is that CD may not raise additional capital or debt from Investors or Banks.

This is because of the risk involved in recovering the money being provided by these Investors and lenders. Hence a Resolution Plan based on the restructuring of debt may not help realise the adequate amount to FCs and may find it challenging to achieve a turnaround. The timeline given for approval of the Resolution Plan under PPIRP is 90 days with additional 30 days to AA for support of the scheme. It is challenging for CoC members to decide on the Base resolution Plan within this short period without any broad parameters on which the Resolution Plan be approved. It will be prudent if RBI comes out with comprehensive guidelines or IBA provides such parameters to expedite approval. These broad guidelines will also help CD decide whether it can meet these terms governing support of PPIRP.

Conversion of part of the loan to equity

All the stress assets remain highly leveraged as Capital and Reserves get adversely impacted with losses. It requires an infusion of fresh equity for payment of part of the debt to address this issue. The Corporate Debtor may find it challenging to bring new investor and raise fresh equity at a level which can reduce the debt at a sustainable level. Thus, Financial Creditors may consider the conversion of the part of the debt to equity. This is the first step that will work to bring a revival of the Corporate Debtor. FCS may do it with adequate safeguards and controls. The debt levels will thus come down. FCS may hold up to a certain limit, say a maximum of 40% of the total PUC in the Corporate Debtor. There may also be a provision for buyback of these shares after a lock-in period, maybe three years, at a pre-determined rate. The Banks may set these terms and conditions that shall form the basis for converting the loan into equity.

Continuation of personal guarantee and collateral security

It is not clarified that in case the Base Resolution Plan submitted by the Corporate Debtor gets approved in PPIRP by CoC and AA, whether the guarantees (personal or corporate) and collateral security provided to FCs against the loan facilities shall also get released, or FCs can start the process under IBC or any other law for recovery of dues from them for the balance amount. It is suggested that both Personal or corporate guarantees and collateral security be continued in the Base Resolution Plan till the plan is implemented successfully.

PUFE transactions

The time limit for determining any Transactions that fall under the category of Preferential, Undervalued, Extortionate and Fraudulent (PUFE) under Sections 43, 45, 50 and 66 of IBC is 45 days and for reporting with AA is 60 days from commencement of PPIRP. It isn’t easy to complete this process within such a short time. If certain such transactions are determined, the Base Resolution Plan submitted by CD may have to be treated differently. Hence, it is considered feasible that FCs may get such audit conducted either themselves or through Resolution Professional before Commencement of PPIRP.

Uniform interest rate and Right of recompense

FCs generally charge high rates after the account is turned NPA, and such interest gets accrued in the books of the FCs. Hence, for uniformity, all FCs may agree to a uniform reduced rate (e.g., 8% pa or such other as permissible) from the date account is turned NPA. In case of CD start earning adequate profits after a specified period from approval of the Base Resolution Plan, say after initial three years, the Base Resolution Plan may also provide to consider the Right of recompense to FCs to partially compensate for the sacrifices made by them while approval of the plan.

Besides this, there are specific challenges that may arise in approving the resolution plans within the time limit of 90 days. Timely decisions can meet these challenges based on certain broad parameters to be pre-decided by FCs for considering such Resolution Plans

(Ashok Kumar Gulla is Partner, RBSA Restructuring Advisors LLP. Views expressed are the author’s own.)

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