Unraveling pre-pack in India: Analyzing application to large corporations, addressing underlying issues and proposing solutions
Author: Ayushee Singh, Advocate at Delhi High Court.
Micro Small and Medium Enterprises (“MSME”) play vital role in Indian economy but inherent constraints in terms of size and capital of the MSME, makes them more vulnerable to economic shocks than larger corporations. This vulnerability leads to challenges in sustaining operations and defaulting on financial commitments.The issue of increasing defaults in MSME sector was exacerbated by the COVID-19 Pandemic, and it continues to be a pressing issue now as well.
Insolvency and Bankruptcy Code, 2016 (“IBC/Code”) was implemented to ensure time bound resolution of stressed entities while balancing the interest of stakeholders but the process involved in IBC is time taking, complex and costly therefore, MSME owing to their limited capital and size, avoid resorting to the Code for resolutions. MSMEs apprehend the complexities involved will disrupt their business.
Therefore, with the objective to enhance the accessibility, cost-effectiveness, expediency, and minimal disruption to the business operations of MSMEs, the scheme of Pre-Packaged Insolvency Resolution Process (“PPIRP”) was introduced under Part-III A of the Code in 2021. This analysis critically examines the provisions of PPIRP, evaluating its effectiveness in achieving the intended outcomes. Furthermore, the article explores the potential expansion of PPIRP beyond MSMEs to larger corporations.
Pre-pack arrangements in foreign jurisdictions
Pre-packaged bankruptcy proceedings owes its genesis to United States which consist of three types as specified under US Bankruptcy Code, namely, pre-plan sales, where the trustee sells all the assets of the insolvent company after obtaining approval from the court, pre-packaged bankruptcy where the insolvent company formulates a resolution plan with the involvement of key creditors and circulate it for the review of other creditors and pre-arranged bankruptcy plan which requires court’s approval immediately after drawing up a resolution plan and consent of creditors are sought post court’s approval.
In UK, the pre-pack arrangements are carried by the IP who acts as an advisor to the company and once the terms of sale are agreed, ordinarily, the IP is appointed as administrator who effectuates the sale. The administrator is required to give disclosures to the creditors regarding rationale behind choosing pre-pack over other alternatives, asset being sold, method of valuation etc. Pre-pack in UK does not require any approval of court or creditors.
Singapore, in 2020, introduced simplified insolvency proceedings for MSMEs which does not require convening meetings of creditors. Instead, the court approves the scheme if it is satisfied that at least two-third of the creditors would have approved the scheme if the meetings were conducted.
Fundamental framework of PPIRP under the Code
Basic structure of PPIRP can be divided into two stages, first pre-initiation phase which is informal in nature and second, post-initiation phase which is formal in nature. Section 54A and 54B of the Code sets out the statutory requirements at the informal stage, whereas, the rest of the provision of the part III-A of the Code governs the formal process.
Section 54A, interalia, prescribes the eligibility criteria which sets out the default range of MSMEs to be between INR 10 Lakhs and 1 crore. It also prescribes that there should no clash between the PPIRP and CIRP applications or any liquidation order for the same Corporate Debtor (“CD”). Additionally, CD must be eligible to submit a resolution plan under Section 29-A of IBC.
Further, Section 54A also sets out that for applying for PPIRP, the CD must obtain approval of at least66% of its financial creditors (“FC”) (in value of debt due to creditors) who are not related parties of the CD. Before seeking such approval, the debtor must provide creditors with a base resolution plan (“BRP”). The FC also appoints the Insolvency Professional (“IP”) who is ordinarily appointed as the Resolution Professional (“RP”) after admission of PPIRP.
Upon appointment, the RP is required to undertake various activities such as preparation of reports, examining the BRP, etc. in accordance with Section 54B of the Code.
The post initiation phase is formal in nature, and focuses on value maximization. When an application, under Section 54C, is made to the Adjudicating Authority (“AA”) it shall approve or reject it within 14 days. Approval by AA is followed by public announcement and imposition of moratorium. RP constitutes Committee of Creditors (“CoC”) who may approve the BRP if it does not impair the rights of operational creditors. If the BRP is rejected then CoC may invite third party to compete with the BRP. The RP is required to present the resolution plan approved by CoC to the AA within 90 days of PPIRP commencement date.
Distinction from the standard insolvency proceedings
The PPIRP can be primarily distinguished from the CIRP in terms of control over management of CD and participation in resolution process, the timelines for completion of the process, hybrid procedure. These distinctive features of PPIRP aim to make the process debtor friendly and time efficient.
Debtor-in-possession approach: Debtor-in-possession control means that the CD undergoing PPIRP continues to have control over the management of the company. Further, the CD also gets a chance to present a resolution plan and the BRP prepared by CD is evaluated first by CoC. This feature distinguishes it from CIRP because the CD loses control over the management upon initiation of the CIRP. Further, in CIRP, CD is not allowed to participate in resolution process.
Hybrid process: PPIRP is considered a hybrid process because it combines elements of both formal insolvency proceedings and informal negotiations. It aims to provide a more debtor-friendly approach while ensuring the interests of creditors are considered. Unlike CIRP, that typically involves a more formal and court-driven process, PPIRP allows for a pre-packaged agreement between the debtor and creditors before the initiation of the formal insolvency proceedings which are envisaged to be both flexible and time efficient.
Expedient time limit: Section 54D of the Code prescribes that PPIRP shall be completed within a period of 120 days without any extension as opposed to a time limit of 180 days which can be extended even till 330 days. In PPIRP time is very critical because financial projections and agreement in BRP are generally based on the current outlook, which may change once the critical time is over and can adversely affect the resolution prospects
Scope of implementation of PPIRP to larger corporations
Currently the Code, limits PPIRP to MSMEs. Since inception of the framework, feedback from public consultations and stakeholders has indicated a need to extend its scope to encompass a wider array of CDs. This section delves into the rationale behind limiting the regime to MSMEs and provides its perspective on the ongoing deliberations.
The Insolvency Law Committee’s Report on PPIRP (“ILC Report”) expressed concerns that since the larger corporations have complex debt structure with diversified creditors and supplier conducting negotiations and reaching consensus would be infeasible. The ILC Report also highlighted the challenge of maintaining oversight when the debtor retains control over management during PPIRP in large corporations.
It is acknowledged that owing to the complexity of debt arrangement and number of creditors in a large corporation, the application of PPIRP to all the CDs might appear as a challenging task but flexibility of PPIRP and firm commitment towards a time bound resolution of stressed assets have the potential to make it one of the most preferred ways for the resolution of stressed assets for large corporations. These large corporations have large stakeholder bleeding money with every passing minute and where time is of such great essence, anything which provides room for creative negation and impeccable execution should not be ruled out.
The sub-committee report on PPIRP (“Sub-committee Report”) also suggested that PPIRP is another option of stress resolution with its own set of benefits and this alternative should be made available to all kinds of CDs.
Furthermore, addressing concerns about supervision under PPIRP, it is emphasized that it operates not only as debtor-in-possession but also creditor-in-control regime. Although possession is vested in the debtor, decision-making powers remain with the creditors. The CD is required to take approval of CoC for running the business affairs during PPIRP. Further, creditors can shift functioning to the RP at any time, reject the BRP, and invite third-party applications.
Therefore, PPIRP may be rolled out in a phase wise manner to understand the practical challenges in its application and further allowing it to evolve as per the need of the economy, CD and creditors.
Response to the PPIRP and underlying issues
Since the inception of Part III-A in 2021, the AA has encountered only eight applications for admission of PPIRP. The response has been lackluster, with only one entity successfully resolved, whereas, one application was rejected, two were withdrawn, and four are still awaiting adjudication. This subdued outcome, more than two years into implementing the PPIRP, suggests potential shortcomings either in the formulation of provisions or in the execution process. This section aims to identify key issues within the PPIRP and evaluate their impact on the overall resolution process.
Strict statutory requirements at pre-initiation phase: In the majority of the applications presented to the AA, the issue was that the statutory requirements at the pre-initiation phase were not complied with. In case of Krrish Realtech Private Limited objections were filed by FC that their consent has not been taken as mandated under Section 54A of IBC. In three other applications there were minor issues in the completeness of the application and few clarifications were sought by the AA, but it increased the timeline of admission of the application. The average timeline of 135 days has been taken for admission of case in PPIRP.
The pre-initiation phase was envisaged to be informal in nature to provide flexibility to the stressed entitiesand also to make the process time efficient. Report of sub-committee on PPIRP also suggested that in the interest of flexibility which makes pre-pack advantageous, the process before the admission should be less codified  but strict statutory compliances at pre-initiation phase like approval of creditors with 66% of voting share for the majority of decision of CD for initiation of the PPIRP, codified duties of IP even at the pre-initiation stage, makes the process rigid, increases chances of collusion, causes delay, and permits increased intervention of the AA which also increases the burden on AAs.
Hesitancy and inhibitions of creditors with respect to PPIRP: Another issue is with respect to hesitancy in the FC in approving the PPIRP because of multiple reasons. FC prefers CIRP because it offers a more competitive environment which enhances the chances of recovery of debt this causes instances of clash of CIRP and PPIRP applications. In the case of Shree Rajasthan Syntax, one of the FC filed CIRP application against the CD when negotiations for PPIRP had already begun, without even informing the other creditors. Again, in the case of Sudal Industries Limited, AA observed that the FC was objecting PPIRP only because he wanted to displace the existing management of CD. These kind of clashes wastes time which is of outmost importance in PPIRP because a BRP has already been carved out and delay at the admission stage adversely affects the value maximization prospects of the BRP.
Additionally, while approving the BRP, the FC are required to take voluntary haircuts and therefore, there are apprehensions in the minds of creditors that such a decision might be subject to scrutiny by various authorities at a later date.
Suggestions for addressing the underlying issues
To begin with the suggestion for addressing the issues discussed above it can be argued that statutory compliance should be eased to maintain the informality at pre-initiation phase and enable AA to admit PPIRP applications without tying them down to any pre-defined rigid statutory procedure. This would allow AAs to innovate flexible mechanisms to handle pre-packs on a case-by-case basis and allow market practice to evolve organically.
For instance, the Code should not prescribe whether a meeting of creditors is required to obtain approval and how the votes will be taken. It should be sufficient if the proposal to explore pre-pack has approval of majority of unrelated FCs. In tune of this, IBBI also released a discussion paper wherein it proposed that in order to facilitate quicker and efficient decision-making, the 66% threshold for unrelated FC may be lowered to simple majority. These proposals should be incorporated in the Code. Further, the code should not codify the duties of IP and their formal role should only be post admission of PPIRP application.
Further, to address the issue of hesitancy, the CD should have the flexibility to employ an IP to help and guide them in taking decisions required at the pre-initiation stage. For instance, in UK it is the company who appoints the IP and he acts an advisor to the CD. Singapore has the provision of appointing more than one restructuring advisor, if required.
India should also implement provisions which facilities the IP to aid and advice in pre-initiation phase. This will help them in taking an informative step and aid in reducing the apprehensions in the mind of banking authorities or FC. Since MSMEs have limited financial resource, RBI’s recommendation should be followed which stated that the Code should provide for out-of-court assistance to MSMEs such as mediation, debt counseling, and financial education.
In addition to this, penalty should be also imposed upon the creditors, if the AA establishes that the objection to PPIRP or a clashing CIRP application has been filed by them only with the malicious intention of hindering the PPIRP application in order to deter them from taking such malicious steps.
Also, with respect to the issue of reducing the burden on AA, steps should be taken to effectuate suggestion made by the Parliamentary Standing Committee of finance on implementation of IBC. It stated that there is a need for having specialized benches solely for IBC with specialized benches for sectors applications related to MSME sectors with requisite domain expertise.