Pre-Packs for MSMEs: A Positive Step with Implementation Hurdles

Introduction

The President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021[1], dated 4-4-2021, to introduce a pre-packaged insolvency resolution process (pre-pack process) under the Insolvency and Bankruptcy Code, 2016.  The Statement of Objects and Reasons of the Ordinance stated that it was introduced to provide an “efficient alternative insolvency resolution process” for micro, small and medium enterprises (MSMEs). It aims to provide a cost-effective, swift and value maximising mechanism for resolving insolvency with minimum disruption to business operations. The Central Government and the Insolvency and Bankruptcy Board of India (IBBI) have also come out with notification[2], rules[3] and regulations[4] for operationalising the pre-pack process.

 

Background

The Covid-19 pandemic is expected to lead to an influx of insolvencies. Accordingly, institutions such as the World Bank and the International Monetary Fund have advised Governments to protect small enterprises from going out of business. In response to this, Governments have rolled out measures like moratorium on loan repayments, sector specific forbearance, infusion of liquidity into the banking system to provide credit to financially distressed firms, relief in asset classification banking norms, flexibility in director’s obligations to initiate insolvency proceeding and suspension of filing of insolvency proceeding by the creditors. The Government has increased the threshold of default for filing of an insolvency application from Rs 1 lakh to Rs 1 crore to protect the interest of the MSMEs from being pushed into insolvency proceedings.

 

This Ordinance is also a step in the same direction, to protect MSMEs through a mechanism already present in other countries, popularly known as pre-packs.

 

Pre-Packs for MSMEs

Formal insolvency processes, such as the corporate insolvency resolution process (CIRP) are time consuming and lengthy, especially in the context of small enterprises. The alternative of informal workouts was not viable, due to non-recognition by statutes.

 

Pre-packs offer a middle way alternative, as a unique mechanism which seeks to combine benefits of informal workouts and legal recognition. Essentially, pre-packs are hybrid mechanisms allowing out-of-court resolutions to be recognised under insolvency law with appropriate safeguards for all stakeholders. The pre-pack process provides an alternative insolvency resolution process for MSME corporate debtors, which involves a “debtor-in-possession with creditor-in-control” model, and envisages a shorter timeline for completion.

 

The Ordinance inserts Chapter III-A into the Insolvency and Bankruptcy Code (IBC) to deal with the pre-packaged insolvency resolution process.  Subjected to various conditions as enumerated in Section 54-A, an application for initiating pre-packed insolvency resolution can be made by a corporate applicant with the adjudicating authority in respect of corporate debtor classified as MSME.

 

Application of Moratorium

Within fourteen days from the date of filing of the application, the adjudicating authority is required to admit the application, if it is found to be complete. Where the application is admitted, the adjudicating authority passes an order of admission which marks the commencement of the process. At the time of admission, the adjudicating authority will declare a moratorium for the purposes referred to in Sections 14(1) and (3), appoint the resolution professional and cause a public announcement to be made. The public announcement will be sent to creditors, information utilities and published on the website of the corporate debtor (if any) and the IBBI.

 

Section 14 moratorium shall apply mutatis mutandis to the pre-pack process for MSME. The moratorium shall be available from the pre-pack commencement date till the process is closed. Unlike the usual CIRP, the control and possession during the pre-pack process lies with the current promoters and management of the corporate debtor. The base resolution plan as submitted by the existing management in case not approved, or in case where the base resolution plan does not provide for the full payment of the confirmed claims, the resolution professional shall invite prospective resolution applicant to submit a resolution plan or compete with base resolution plan. Appeal against the order approving the pre-pack resolution process lies under Section 61(3) of the IBC.

 

The pre-pack process may stretch into three stages—

  1. Submission of base resolution plan by the corporate debtor and its consideration by committee of creditors (CoC).
  2. On failure of base resolution plan to gather support, the resolution professional invites prospective resolution applicants to submit resolution plans to compete with the base resolution plan, which are evaluated by the CoC.
  3. The base plan and invited plans are then compared, and either of the selected ones may be improved based on inputs from the other.

 

That the committee of creditors by a vote of 66% may resolve to initiate a CIRP in respect of corporate debtor at any time after the pre-pack commencement date but before the resolution plan approval under Section 54-K of the IBC. The adjudicating authority in case of any fraudulent conduct of the company and/or gross mismanagement and where there is termination of pre-pack insolvency process pass an order of liquidation.

Completion

The law provides for the process to be completed within a period of 120 days from the date of admission, which is divided into two parts — 90 days for approval of resolution plan by the committee of creditors and 30 days for adjudication by the adjudicating authority. The resolution professional is required to apply seeking termination of the pre-pack process if no resolution plan is approved by the committee of creditors within 90 days.

The Road Ahead

MSMEs form the backbone of Indian economy, and the Government has rightly been proactive in supporting their growth through protectionist mechanisms. In Budget 2020, the Finance Minister raised the threshold for audit of MSME accounts from Rs 1 crore to Rs 5 crore, to facilitate their growth. To improve MSME financing, a Rs 900 crore package was introduced for debt funding. Even this month, the Government took a revolutionary step of including retail and wholesale trade as MSMEs[5], potentially benefitting 2.5 crore traders. The present system of pre-pack financing is another welcome addition to this list. The Government has thereby introduced numerous laudable measures for facilitating the growth of MSMEs. However, the mechanisms for keeping a check on the success of these schemes remain challenging. The focus now needs to shift to the better implementation of these measures at the grassroots level.

 

For instance, the resolution plan attains finality not on consent of 66% of financial creditors, but on its approval by the adjudicating authority. Such mandatory involvement of the judiciary may be a roadblock in speeding the pre-pack process, thereby structurally defeating its very purpose.

 

The Supreme Court in the recent case of Silpi Industries v. Kerala SRTC[6] held that that an MSME must be registered to claim certain benefits under the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006. With 90% MSMEs being unregistered[7], the judgment can potentially exclude 62 million MSMEs from benefits of the Act. The author has previously argued that the Supreme Court’s verdict effectively contradicts the very legislative intent of the MSMED Act[8], for it disregards that the MSMED Act, 2006 is a welfare legislation with speedy disposal of any issues forming its legislative core. The present Ordinance is a similar legislative instrument aimed at protecting the growth of MSMEs through speedy disposal of insolvency resolution. The Ordinance must be broadly interpreted so as to expansively benefit all the MSMEs in this stressful economic stretch during Covid-19, and even later.

 


Advocate, Supreme Court of India.The author can be reached at advocate.tariqkhan@gmail.com.

The author would like to thank Vanaj Vidyan, Fourth Year Student at Ram Manohar Lohia National Law University for his able assistance.

[1] http://www.scconline.com/DocumentLink/zj9E17ck

[2] https://ibbi.gov.in/uploads/legalframwork/e9b1c4b3489e51213db701b27222b474.pdf

[3] Insolvency and Bankruptcy (prepackaged insolvency resolution process) Rules, 2021 <http://www.scconline.com/DocumentLink/KdLk8eWa>

[4] Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Regulations, 2021 < http://www.scconline.com/DocumentLink/C93OxTv2>

[5] PM Modi hails inclusion of retail & wholesale trade under MSME as ‘landmark step’ (The Print, July 03, 2021) <https://theprint.in/economy/pm-modi-hails-inclusion-of-retail-wholesale-trade-under-msme-as-landmark-step/689304/>

[6] 2021 SCC OnLine SC 439.

[7] What Would Be The Affect on the MSME’s In India, If The Lockdown Increases For 4-8 Weeks (Inventiva, March 30, 2020) <https://www.inventiva.co.in/stories/inventiva/what-would-be-the-affect-on-the-msmes-in-india-if-the-lockdown-increases-for-4-8-weeks/>

[8] Dilution of the statutory protection available to MSMEs: A critique of the Supreme Court’s judgment in Silpi Industries (Bar and Bench, July 01, 2021) <https://www.barandbench.com/columns/dilution-statutory-protection-msmes-critique-supreme-court-judgment-silpi-industries>

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