Insolvency and Bankruptcy Code (Amendment) Bill, 2021 - Pre-Packs
iasparliament
July 29, 2021
Why in news?
The Insolvency and Bankruptcy Code (Amendment) Bill, 2021 was recently passed by Lok Sabha, replacing an ordinance on the same.
It has proposed ‘pre-packs’ as an insolvency resolution mechanism for Micro, Small and Medium Enterprises (MSMEs).
How do ‘pre-packs’ work?
A Pre-packaged Insolvency Resolution Process (PIRP) relates to the resolution of the debt of a distressed company.
Pre-packs work through a direct agreement between secured creditors and the existing owners or outside investors.
The agreement is an option instead of a public bidding process.
Under it, financial creditors will agree to terms with the promoters or a potential investor.
They then seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
The approval of at least 66% of financial creditors that are unrelated to the corporate debtor is required before a resolution plan is submitted to the NCLT.
The NCLTs will be required to either accept or reject an application for a pre-pack insolvency proceeding before considering a petition for a CIRP.
Corporate Insolvency Resolution Process (CIRP) is the existing mechanism.
How do pre-packs differ from CIRP?
One of the key criticisms of the CIRP has been the time it takes for resolution.
At the end of March 2021, 79% of the ongoing insolvency resolution proceedings had crossed the 270-day threshold.
A major reason for the delays is the prolonged litigation by erstwhile promoters and potential bidders.
The pre-pack, in contrast, is limited to a maximum of 120 days.
It has only 90 days available to stakeholders to bring a resolution plan for approval before the NCLT.
In the case of CIRP, a resolution professional takes control of the debtor as a representative of financial creditors.
In the case of pre-packs, the existing management retains control.
This would ensure minimal disruption of operations relative to a CIRP.
What is the objective?
Pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate.
Nevertheless, it provides adequate protections so that the system is not misused by firms to avoid making payments to creditors.
Currently, only corporate debtors themselves are permitted to initiate a PIRP after obtaining the approval of 66% of their creditors.
The pre-pack mechanism, however, allows for a ‘Swiss challenge’ to any resolution plan that provides less than full recovery of dues for operational creditors.
[Under the Swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company.
The original applicant would have to either match the improved resolution plan or forego the investment.]
What challenges can pre-packs bring?
The timeline for the PIRP may be difficult to meet for lenders and distressed firms.
Notably, forensic audits were particularly important in cases where the control of the firm remains with the same management.
Ordinarily, where compromises are involved, forensic/transaction audits become imperative.
And, a negative report from the audits becomes a roadblock in resolution involving the same management.
Also, a firm can restructure its outstanding debt through a PIRP with the existing management retaining control.
So, the NPA status of the company’s account with lenders may not be automatically upgraded under RBI guidelines.
What next?
In order to motivate resolution under the PIRP, the RBI guidelines on account status may be aligned with the objective of IBC (Insolvency and Bankruptcy Code).
Also, the lenders could be given the benefit of account upgradation upon resolution.
There is a need for the IBBI and RBI to find middle ground on these regulations to make the PIRP more attractive.
[IBBI - Insolvency and Bankruptcy Board of India]
Source: The Indian Express
Quick Fact
Insolvency and bankruptcy code (IBC)
Insolvency and bankruptcy code 2016 was introduced to resolve the bankruptcy crisis in corporate sector.
Under IBC, either the creditor (banks) or the loaner (defaulter) can initiate insolvency proceedings.
It is done by submitting a plea to the adjudicating authority, the National Companies Law Tribunal (NCLT).
According to IBC, a financial creditor holds an important role in the corporate insolvency process.
The Committee of Creditors (CoC) under IBC includes all financial creditors of a corporate debtor.
The CoC will appoint and supervise the Insolvency Professional.
It has the power to either approve or reject the resolution plan to revive the debtor, or to proceed to liquidate the debtor.
