Plugging Loopholes in Insolvency and Banking Code
By Himanshu Joshi, for Legal Corner LLP. Himanshu is a 2021 graduate from NALSAR University of Law, Hyderabad.
(The views expressed here are not to be considered as legal opinion. You may not rely on this article as legal advice. You should reach out to me (email@example.com) so as to get legal advice specific to your business needs).
Why is the Amendment to Insolvency Code in news?
Recently, the government introduced the Insolvency and Bankruptcy Code (Amendment Bill), 2021 in the Lok Sabha. The Bill is set to replace the Insolvency and Bankruptcy Code Amendment Ordinance 2021 promulgated in April 2021.
It introduced an alternate insolvency resolution process for Micro, Small and Medium Enterprises (MSMEs) with defaults up to Rs 1 crore called the Pre-packaged Insolvency Resolution Process (PIRP). In March 2021 a sub-committee of the Insolvency Law Committee (ILC) recommended a pre-pack framework within the basic structure of the Insolvency and Bankruptcy Code (IBC), 2016.
History of the Insolvency and Bankruptcy Code
The IBC is a reform enacted in 2016 which amalgamates various laws relating to the insolvency resolution of business firms. It lays down clear-cut and faster insolvency proceedings to help creditors, such as banks, recover dues and prevent bad loans, a key drag on the economy. Some keywords worth keeping in mind:-
- Insolvency: is a situation where individuals or companies are unable to repay their outstanding debt.
- Bankruptcy: is a situation whereby a court of competent jurisdiction has declared a person or other entity insolvent, having passed appropriate orders to resolve it and protect the rights of the creditors. It is a legal declaration of one’s inability to pay off debts.
What are these newly changed ‘Major Provisions’?
Distressed Corporate Debtors (CDs) are permitted to initiate a PIRP with the approval of two-thirds of their creditors to resolve their outstanding debt under the new mechanism.
- The PIRP also allows for a Swiss challenge to the resolution plan submitted by a CD in case operational creditors are not paid 100 % of their outstanding dues.
- A Swiss Challenge is a method of bidding, often used in public projects, in which an interested party initiates a proposal for a contract or the bid for a project.
Knowing more about PIRP and their need at present
A pre-pack is the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process. This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
Pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate while still providing adequate protections so that the system is not misused by firms to avoid making payments to creditors. Unlike in the case of Corporate Insolvency Resolution Process (CIRP), debtors remain in control of their distressed firm during the PIRP. Under the pre-pack system, financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
CIRP is a time taking resolution. At the end of December 2020, over 86% of the 1717 ongoing insolvency resolution proceedings had crossed the 270-day threshold. Under the IBC, stakeholders are required to complete the CIRP within 330 days of the initiation of insolvency proceedings. One of the key reasons behind delays in the CIRPs are prolonged litigations by erstwhile promoters and potential bidders.
Key Features and benefits of Pre-Packs:
- Insolvency Practitioner:
Pre-Pack usually requires services of an insolvency practitioner to assist the stakeholders in the conduct of the process. The extent of authority of the practitioner varies across jurisdictions.
- Consensual Process:
It envisages a consensual process – prior understanding among or approval by stakeholders about the course of action to address stress of a CD, before invoking the formal part of the process.
- No requirement of Court Approval:
It does not always require approval of a court. Wherever it requires approval, the courts often get guided by commercial wisdom of the parties. Outcome of the pre-pack process, where approved by the court, is binding on all stakeholders.
- Quick resolution:
It is limited to a maximum of 120 days with only 90 days available to the stakeholders to bring the resolution plan to the NCLT. Besides offering a way for MSMEs to restructure their debts, the pre-pack scheme could also reduce the burden on benches of the NCLT by offering a faster resolution mechanism than ordinary CIRPs.
- Minimises Disruptions to the Business:
Existing management retains control in the case of pre-packs rather than resolution professionals in CIRP, hence avoids the cost of disruption of business and continues to retain employees, suppliers, customers, and investors.
- Addresses the entire liability side:
PIRP will help CD to enter into consensual restructuring with lenders and address the entire liability side of the company.
What Challenges lie ahead for PIRP?
- Raising additional capital:
Initially CDs may not raise additional capital or debt from Investors or Banks, because of the risk involved in recovering the money being provided by these Investors and lenders.
- Small timeline:
Resolution Plan under PIRP is 90 days with an additional 30 days to AA (Adjudicating Authority) for support of the scheme. It is challenging for CoC (Committee of Creditors) members to decide on the Base resolution Plan within this short period without any broad parameters on which the Resolution Plan be approved.
Remarks and way forward
While the PIRP is a timely effort to protect viable MSMEs, it is likely that operationalizing it only for MSMEs now may just be the first step towards a sound Pre-pack and will lead to a much wider coverage in the future which, like the IBC, is expected to evolve with time and jurisprudence. The government should consider setting up specific benches of the NCLT to deal with pre-pack resolution plans to ensure that they are implemented in a time-bound manner.
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