Pre-Packaged Insolvency Resolution under the Insolvency and Bankruptcy Code (IBC): An Overview
The new law will help in resolving financial distress in incorporated small businesses, a large number of which have been severely affected by the pandemic
On April 4, 2021, the President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, (“Ordinance”) to introduce a Pre-Packaged Insolvency Resolution Process (“pre-pack process”) under the Insolvency and Bankruptcy Code, 2016 (“IBC/ Code”). This law has been introduced to provide an “efficient alternative insolvency resolution process” for corporate persons classified as 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 (during the process). The Central Government and the Insolvency and Bankruptcy Board of India (“IBBI”) have also come out with notification, rules and regulations for operationalizing the pre-pack process.
What are Pre-Packs?
Formal insolvency processes, such as the corporate insolvency resolution process (“CIRP”) under the Code, can be time-consuming and involve significant direct and indirect costs. On the other hand, while informal workouts provide a flexible and economical option for resolving insolvency, due to lack of statutory backing and legal certainty, the outcomes achieved under such mechanisms do not have the same legal sanctity as a court approved resolution plan.
Pre-packaged insolvency proceedings, or ‘pre-packs’, offer a unique mechanism which aims to combine the benefits of informal workouts with the legal certainty of formal insolvency proceedings. Essentially, pre-packs are hybrid mechanisms allowing out-of-court resolutions to be recognised under insolvency law with appropriate safeguards for all stakeholders.
Highlighting this, Vidhi had released a report drawing on original research, in February 2020, titled ‘Designing a Framework for Pre-Packaged Insolvency Resolution in India: Some Ideas for Reform’, making a case for introducing pre-packs in India and recommending its implementation in a phased manner. Vidhi’s fellows also presented their research findings to the Government in May, 2020.
Subsequently, recognising the importance of pre-packs for the insolvency ecosystem in India, the Ministry of Corporate Affairs constituted a Sub-Committee of the Insolvency Law Committee (“Sub-Committee”) in June, 2020, which recommended a separate legal framework for pre-packs in India. The pre-pack framework introduced by the aforesaid Ordinance, builds on the recommendations made by the report of the Sub-Committee, which was released in October 2020, with certain modifications. The final framework adopts several features of pre-packs, as conventionally understood, while also drawing heavily from the formal insolvency process (CIRP) under the Code.
Key features of Pre-Packaged Insolvency Resolution Process
Principally, 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 key features of the framework are explained below.
- Pre-Commencement Requirements
The pre-pack process consists of a pre-filing stage, where the corporate debtor and its unrelated financial creditors complete certain requirements before formally initiating the process. Once the requirements of this pre-commencement stage are completed, the corporate debtor can file an application with the Adjudicating Authority (“AA”) and the formal proceedings begin if such application is admitted.
Primarily, the corporate debtor should be eligible to initiate a pre-pack process under the Code. This means that the corporate debtor should be an MSME that defaulted on its loans (the minimum amount of default being Rs. 10 lakh). The corporate debtor may prove its MSME status by submitting its ‘Udyam’ registration details, or information about investment in plant and machinery or equipment and turnover, calculated as per a notification issued by the MSME Ministry on June 26, 2020. Further, the corporate debtor should also be eligible to submit a resolution plan under section 29A of the Code (subject to section 240A which carves out certain exceptions for MSME resolution applicants). Additionally, the corporate debtor will be barred from initiating a pre-pack process if it has undergone a CIRP or pre-pack process in the preceding three years, if it is already undergoing a CIRP at the time of filing an application for pre-pack, or if a liquidation order has been passed against it. In addition to fulfilling the basic eligibility requirements, the corporate debtor is also required to fulfil certain other conditions before the pre-pack process can be initiated:
- First, it is required to convene a meeting of its unrelated financial creditors who will propose and approve the appointment of an insolvency professional as the resolution professional for the pre-pack process. The proposed resolution professional will need to provide her consent to be so appointed and fulfil the eligibility requirements provided in the regulations (e.g. not be a related party of the corporate debtor, be eligible to be appointed as an independent director for the corporate debtor, etc.).
- Second, the corporate debtor is required to obtain certain internal approvals for initiation of the pre-pack process. The majority of partners or directors of the debtor need to make a declaration stating the time-period within which the application will be filed, the name of the resolution professional as proposed and approved by unrelated financial creditors, etc. Its members also need to pass a special resolution, approving the initiation of the process.
- Third, the unrelated financial creditors should, by a 66% majority, approve the initiation of the process. While seeking such an approval, the corporate debtor is required to share sufficient information to enable them to take an informed decision. This includes the declaration provided by the majority of its directors or partners, the special resolution of its members as well as a base resolution plan proposing its resolution as a going concern.
- Admission of application for initiating pre-pack process
Once the pre-commencement requirements are completed, a corporate applicant of the corporate debtor may file an application for initiating the process. The application needs to be filed within the time-period stated in the abovementioned declaration. Along with the application, a report of the proposed resolution professional is also required to be furnished, confirming whether the corporate debtor meets the eligibility requirements and the base resolution plan conforms to the stipulated requirements. The corporate applicant is also required to furnish a declaration regarding the existence of any antecedent transactions under Chapter III or VI of Part II of the Code.
Within fourteen days from the date of filing of the application, the AA is required to admit the application, if it is found to be complete. Where the application is admitted, the AA passes an order of admission which marks the commencement of the process. At the time of admission, the AA will declare a moratorium for the purposes referred to in section 14(1) and (3), appoint the resolution professional (“RP”) and cause a public announcement (to be made by the RP). The public announcement will be sent to creditors, information utilities and published on the website of the corporate debtor (if any) and the IBBI.
- Conduct of the pre-pack process
The law provides a short timeline for completion of the pre-pack process. It is required 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 (“CoC”) and 30 days for adjudication by the AA. The resolution professional is required to apply to the AA seeking termination of the pre-pack process if no resolution plan is approved by the CoC within 90 days.
The pre-pack process may be understood by examining the roles and responsibilities of three key stakeholders in the process- the corporate debtor, the resolution professional and the creditors. Whereas the responsibility of managing the business remains with the corporate debtor, the responsibility of conducting the process (along with facilitating decision-making by the CoC) is with the resolution professional. The CoC, which comprises financial creditors of the corporate debtor, oversees the functioning of the corporate debtor as well as the resolution professional. The roles and responsibilities of these stakeholders is discussed below:
- As mentioned above, the existing management will continue to manage the affairs of the corporate debtor during the process. However, this is subject to certain conditions and duties imposed by the law. For instance, the affairs of the corporate debtor cannot be managed in a manner prejudicial to the creditors of the corporate debtor or in a fraudulent manner. Further, the board of directors or partners of the corporate debtor have the duty to make every endeavour to protect and preserve the value of the property of the corporate debtor, and manage its operations as a going concern. Additionally, the Central Government has reserved powers to regulate the conduct of the corporate debtor’s personnel and promoters during the process.
- The resolution professional performs oversight and facilitative functions during the pre-pack process. She is empowered to collect information in respect of the corporate debtor, file applications to set aside any avoidance transactions or for fraudulent or wrongful trading by the corporate debtor, monitor the management of the corporate debtor, attend meetings of board of directors of the corporate debtor, etc. She also performs other duties such as confirmation of claims of creditors submitted by the corporate debtor, constitution of the CoC, finalisation of the information memorandum on the basis of the preliminary information memorandum submitted by the corporate debtor, etc.
- The CoC exercises significant control over the process. First, certain actions may only be taken if they are approved by the CoC by a vote of 66% of its voting share. This includes actions like entering into transactions above such thresholds as decided by theCoC, creating any security interest over the assets of the corporate debtor, recording any change in the ownership interest of the corporate debtor, undertaking any related party transaction, etc. Second, the CoC has the power to decide the outcome of the pre-pack process as it may decide to approve or reject a resolution plan, or terminate the pre-pack process, or initiate a CIRP where the corporate debtor meets the requirements of Chapter II of Part II of the Code (by a vote of 66% of its voting share). Third, the CoC may pass a resolution to request the Adjudicating Authority to vest the management of the corporate debtor with the resolution professional. The Adjudicating Authority can pass an order vesting management of the corporate debtor with the resolution professional, if it is satisfied that the affairs of the corporate debtor have been conducted in a fraudulent manner or that there has been gross mismanagement. Finally, the CoC is also empowered to seek replacement of the resolution professional at any stage by a vote of 66% of its voting share.
- Consideration and approval of resolution plans
The pre-pack process provides for a three-stage process for consideration and approval of the resolution plan –
Stage I – Submission of base resolution plan and its consideration – The corporate debtor, eligible under section 29A, is required to share a base resolution plan with the financial creditors at the pre-initiation stage, before seeking approval of such creditors for initiating the process. Thereafter, the base resolution plan is submitted to the resolution professional within two days of admission. If this plan does not impair claims of the operational creditors, the CoC may approve it for submission to the AA for final approval. Otherwise the resolution professional will initiate the process for inviting resolution plans for competition with the base resolution plan.
Stage II – Public invitation, evaluation and selection of resolution plan – The resolution professional invites prospective resolution applicants to submit resolution plans to compete with the base resolution plan. The CoC evaluates resolution plans received pursuant to the public invitation and selects a resolution plan. If the selected resolution plan is significantly better than the base resolution plan, the CoC may approve and submit it to the AA. If the selected resolution plan is not approved, it will compete with the base resolution plan in Stage III.
Stage III – Competition between base resolution plan and the selected resolution plan – The resolution applicant whose plan is selected and the corporate debtor who submitted the base plan will compete with each other by improving their plans (in comparison with each other). Such improvement shall be a minimum improvement over the other resolution plan in terms of a score, as approved by the CoC. The applicant who has the lower score will have the option to improve its resolution plan. The other applicant will also have the option to improve their resolution plan. This process will continue till one of them outscores the other within the stipulated time frame (forty-eight hours). The winning plan will be considered for final approval by the CoC for submission to the AA.
The CoC may approve the resolution plans at different stages by 66% voting share, and after considering the feasibility and viability of the plan and the manner of distribution proposed by it. Where the base resolution plan is being approved, the CoC can consider to dilute the promoter’s shareholding, voting or control rights if the plan proposes to impair any claims against the corporate debtor (and record reasons if it chooses to not do so). The resolution plan approved by the CoC shall be submitted to the AA for its approval. Once approved by the AA, the resolution plan shall have the same effect as a resolution plan approved under the CIRP. Further, the AA will not approve the base resolution plan submitted by the corporate debtor, where an order for vesting the management of the corporate debtor with the RP is passed and base resolution plan does not result in a change in management or control of the corporate debtor.
- Closure of process
Once the application for initiation of pre-pack process in respect of a corporate debtor is admitted by the AA, it can only come to an end in four ways: –
- First, the resolution plan approved by the CoC is submitted to the AA and receives its approval.
- Second, the AA passes an order of termination in the following circumstances –
- the CoC passes a resolution seeking termination;
- a resolution plan is not submitted to the AA within 90 days;
- the resolution plan successful in the competition between the base resolution plan and the selected resolution plan is not approved by the CoC; and
- a resolution plan approved by the CoC is rejected by the AA.
- Third, the AA passes an order to initiate CIRP, based on a resolution passed by the CoC seeking the same.
- Fourth, the AA passes an order of liquidation, if subsequent to an order vesting the management of the corporate debtor with the RP, the CoC approves a resolution plan that does not envisage a change in control or management to a third-party or the pre-pack process is required to be terminated.
Vidhi advised the Ministry of Corporate Affairs on this project. We have been fortunate to have played a role in shaping India’s insolvency ecosystem since 2014. Here is a timeline of our prior work in this area- Our Story.