Pre-pack under the IBC: an option for MSME Corporates to resolve its financial distress without losing control

IBC 15 Minutes

India has made drastic change on the way insolvency is resolved for corporate entity with limited liabilities with the enactment of much coveted Insolvency and Bankruptcy Code, 2016 (the IBC). And recently it has witnessed the 6th amendment to the IBC. This shows that while the IBC is in the making (work in progress), what is heartening is that based on experience gained, necessary amendments are made, from time to time, to smoothen the process.

Earlier the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 was promulgated on 4th April 2021, which introduced the Pre-packaged Insolvency Resolution Process (PPIRP) for corporates classified as micro, small and medium enterprises (MSMEs)[1]. 

The Preamble to the said Ordinance stated its objective as an attempt to provide an efficient alternative insolvency resolution process for MSMEs under the IBC, ensuring quicker, cost-effective and value maximising outcomes for all stakeholders, in a manner which is least disruptive to the continuity of their businesses and which preserves jobs[2].

Considering preamble to the said Ordinance, but not the provision of Sub-sec.(2) of Sec.54A of the IBC or the Rules and the Regulations thereunder[3], it can be said that the PPIRP is available only to corporate debtor (either LLP or Pvt Ltd or Ltd company)[4], classified as MSME[5]. 

On 11th August 2021, the said Ordinance is repealed and replaced with the Insolvency and Bankruptcy Code (Amendment) Act, 2021, with a savings clause for anything done or actions taken under the Ordinance. The said Amendment Act is operative (retrospectively) from 4th of April 2021 (same as the repealed Ordinance). However, unlike the said Ordinance, there is no pre-amble to the IBC (Amendment) Act, 2021. Thus, suggesting that PPIRP is not intended to be restricted to MSMEs only, though initially its available for MSMEs only.

The igniting point for PPIRP is a ‘default’ by a Corporate Debtor (CD), on or after 9th April 2021, of INR 10 lakh (INR 1 million) or more[6]. Unlike RBI circular no. DBR.No.BP.BC.18/21.04.048/2018-19 dated 1st January 2019, upper cap for default is not prescribed and hence MSME borrower (which is CD) with default of INR 10 lakh (1 mn.) or more (without upper limit) can avail the benefit of PPIRP.

And CD making default, on or after 25th March 2021, of INR 1 crore (INR 10 million) or more[7] can resolve its insolvency by Corporate Insolvency Resolution Process (CIRP) u/s.10 of the IBC. 

At present, the IBC does not permit creditors to initiate PPIRP. However, in case of default of INR 1 crore (INR 10 million) or more, creditors can initiate CIRP u/sec. 7 of IBC (by Financial Creditor / FCs) or u/sec. 9 of IBC (by Operational Creditor / OCs).

The consequence of two different limits for PPRIP and CIRP is explained with examples below:

Where amount of default by CD is of:

(1) INR 10 million or more, and CD which is classified as MSME has option of either initiating CIRP u/s.10 of the IBC or to initiate PPIRP u/s.54A(2) of the IBC. Here, FCs and OCs are eligible to initiate CIRP (but not PPIRP). It may be noted that, presently PPIRP can be initiated by CD only. 

(2) INR 1 million (10 lakh) or more but below INR 10 million, and CD is classified as MSME, then it may initiate PPIRP u/s.54A of IBC. In such cases, as the value of default remains below INR 10 million, CIRP cannot be initiated either by CD or by FCs and OCs.

(3) less than INR 1 million (INR 10 lakh), CD cannot initiate PPIRP u/s.54A of IBC. However, if such CD is MSME, it can avail RBI’s one-time restructuring facility for MSME (stated infra).

Introduction of PPIRP is timely and is of relevance considering that:

  • suspension of CIRP (due to Pandemic COVID-19) has ended on 24th March 2021. 
  • While default made by CD during 25th March 2020 to 24th March 2021 is shielded u/s.10A of the IBC, the said protection is not available from 25th March 2021, though disruption due to the pandemic continues. 

PPIRP for COVID-19 affected CD, is an alternative to:

  • the Reserve Bank of India’s (RBI) one-time restructuring facility for MSME borrower upto INR 25 crore (INR 250 million), which were classified by lenders as ‘standard’ as on 1st March 2020 but may have slipped into ‘Non-Performing Asset’ (NPA) category, has ended on 31st March 2021[8]. For those MSMEs who had not availed this facility, are eligible under extended facility[9] till 30thSeptember 2021, if accounts of MSMEs are classified by lenders as ‘standard’ as on 31st March 2021.
  • the RBI’s Resolution framework dated 6th August 2020[10] for borrowers (includes MSMEs as well) facing stress on account of Covid-19. It applies, inter alia, to borrowers whose aggregate exposure to lending institutions collectively, is more than INR 25 crore (INR 250 million); and 
  • the Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019, dated 7th June 2019.

Above resolution frameworks of RBI requires CD to approach and negotiate with individual lender banks/NBFCs (except under RBI’s 7th June 2019), whereas PPIRP requires that resolution is proposed and negotiated with all the unrelated FCs. Thus, PPIRP provides better option, as it avoids time, efforts and cost in negotiation with every lenders required under the RBI framework. PPIRP involves all unrelated FCs and not restricted to banks/NBFCs. PPIRP requires approval of only 66% in value of total debt due to unrelated FCs whereas RBI framework of 7th June 2019 requires inter-creditors agreement amongst lender banks/NBFCs and twin consent of (i) 75% in value of total debt due to banks/NBFCs and (ii) 60% in number of banks/NBFCs involved.

Lender(s) may treat ‘resolution’ under PPIRP as restructuring under above notifications, particularly the provisioning norms as per the Directions of 7th June 2019 shall apply. If this cannot be achieved, company’s account with lending banks/NBFCs cannot be upgraded. Therefore, to encourage PPIRP, RBI may consider tweaking its notification.

What is PPIRP?

PPIRP in its simplest form can be described as a legal process under which CD, prepares a plan to resolve its state of insolvency. Such a plan is called a ‘base resolution plan’, which may be proposed by the CD either alone or jointly with any other person to its creditors. It is called “pre-packaged” because before formally initiating insolvency resolution process, the CD prepares a draft base resolution plan, circulates to its creditors and negotiates. Once, it is agreed the same is put to the formal PPIRP process for ensuring transparency and seek independent judicial approval for making it legally binding. Thus, PPIRP comprises of informal and formal process, both recognised under the IBC (Amendment) Act 2021.

It is available to CDs who has not undergone CIRP or PPIRP in 3 years prior to formally initiating PPIRP.

Benefits of PPIRP:

  1. Speed: The PPIRP is proposed to be faster than CIRP. If it is planned and implemented well, the pre-pack resolution plan can be completed within a week or even less after nod of NCLT to commence PPIRP! It is not some hype. Consider any delay or negligence can lead account of CD into NPA (if default continues for 90 days) and thereby lenders may need to make higher provisions in its book, though CD being MSME may remain eligible u/s.29A r/w sec.240A IBC, to propose PPIRP. Thus, balancing the needs of CD and lenders – for lenders, early resolution ensues saving higher provisioning in its books and for CD, to retain the control. Thus, it appears that PPIRP taking less than 90 days may become the norm.
  2. Retain management: Unlike CIRP, under the PPIRP, Board of Directors/ Designated Partners retains the control of CD during PPIRP and thereafter, whether the resolution plan is approved or not. (Section 54H).
  3. Least disruption in business and reputation: PPIRP provides opportunity for least disruption in business of CD, privacy and confidentiality, and if the securities of such CD are traded on stock exchanges, there will be least erosion in its stock prices. It also helps maintain reputation of promoters and the CD. 
  4. Moratorium: The moratorium (as in CIRP) is available till the date of closure of the PPIRP process[11]. It thus protects CD from actions of creditors while PPIRP is underway. However, there is no moratorium prior to date of admission of application by NCLT for commencing PPIRP. Thus, CD need to act with speed and in camouflage so that possible actions by OCs and others may be avoided before the draft base resolution plan is agreed by unrelated FCs and formal PPIRP is initiated.
  5. Avoid action by Creditors: PPIRP can be used by CD to avoid CIRP by creditors (as it is believed that in most cases debt and default would exceed Rs1 crore), which is lengthy and costly affairs and mostly results into management losing its control. It is believed that under PPIRP all major stakeholders takes timely action to avoid worst situation and thereby intends to provide win-win situation for all.
  6. Maximise value for stakeholders: It gives option to eligible CD for proposing its resolution plan proposal for quicker approval and implementation, thereby saving its business, saving jobs and maximise value for all stakeholders.

Legal provisions:

The IBC (Amendment) Act, 2021 has inserted 17 provisions. It has inserted new Chapter III-A (Ss.54A to 54P) providing for the PPIRP. Also interplay of applications for PPIRP and CIRP, where default by CD is of INR 1 crore (INR 10 million) or more, is provided by newly inserted S.11A. New provisions are also inserted to deal with fraudulent management during PPIRP (S.67A), punishment for offences related to PPIRP (S.77A); authority to AA to levy penalty for initiating PPIRP with intent to defraud any person or for purpose other than insolvency resolution (newly inserted Sub-sec.(3) to Sec.65); and provision for pro-active functions and duties of insolvency professional prior to formal initiation of PPIRP (newly inserted sub-sec.(1A) to Sec.208). The role of insolvency professional prior to commencement of PPIRP is now statutorily recognised[12]. Name of Insolvency Professional to act as Resolution Professional is to be proposed by unrelated FCs. And is appointed with consent of unrelated FCs with atleast 66% in value of financial debt[13].

To implement the provisions of PPIRP, Ministry of Corporate Affairs/MCA has notified the PPIRP Rules, 2021 dealing with manner of filing application for initiating PPIRP[14] and the Insolvency and Bankruptcy Board of India (IBBI) has notified the PPIRP Regulations, 2021 for the purpose[15]. 

Checks and balances under PPIRP:

To avoid misuse of PPIRP by CDs, safeguards are provided. If during the PPIRP process it is found that:

  • valuation is substantially different from the valuation represented by CD; or 
  • CD had indulged into avoidance transactions or fraudulent activities or 
  • where CD proposes a different plan than what was informally agreed as base resolution plan, 

the creditors may terminate the PPIRP process and in certain cases management gets transferred to Resolution Professional (RP) or CIRP may be initiated or CD may be liquidated.

Management of the CD is not intended to be vested with the RP. However, in exceptional cases, where during PPIRP the affairs of CD is conducted prejudicial to creditors or fraudulently or in case of gross mismanagement of the affairs of CD, the COC may decide with 66% voting to vest the management in the RP. And if the NCLT agrees with the COC, then the management of the CD vests with the RP[16].

The far reaching consequence of vesting management of CD with RP is that if the resolution plan for CD is not approved by the COC, then the NCLT shall order liquidation of CD[17].

Consider alternative options:

India is a competitive market economy. IBC is competing with other options for resolution of financial stress. There is no compulsion on CD to opt for PPIRP or upon bankers to approve base resolution plan under PPIRP proposed by defaulter CD

Other options could be, resolution under the RBI Prudential framework, or RBI’s one-time restructuring framework for MSMEs, or bilateral negotiation, or Scheme of arrangement or compromise under the Companies Act 2013 or even Corporate Insolvency Resolution Process (CIRP) under IBC or takeover / bailout by knight rider(s).

Thus, PPIRP is one more but a significant option and a tool with CD for resolving its insolvency. 

CD also need to factor about time, efforts and cost involved in resolving its insolvency under various options.

If pre-packaged negotiation fails, all concerned have other sets of options, and such options are driving force in negotiating the pre-packed resolution plan. It may be noted that limitation period is not stopped until moratorium is declared by NCLT.

Some of the important factors for CD in considering PPIRP

  1. Resolution applicant(s) shall be eligible under Section 29A of the IBC. It may be noted that for MSMEs, benefit of relaxation from the provisions of clause (c) of section 29A i.e. even if account of CD is classified as NPA and clause (h) of section 29A i.e. even if guarantee given by resolution applicant(s) is invoked by creditor(s) and remains unpaid (fully or partly). [Per section 240A IBC]
  2. To commence PPIRP, CD needs: (i) prior consent of members of CD by special resolution / and where CD is LLP, prior approval of three-fourth partners; and (ii) consent of unrelated FCs with atleast 66% in value of the financial debt[18]. 
  3. Early proposal of PPIRP may be better since limitation period of 3 years for FCs to initiate appropriate action starts from the time the loan becomes NPA. 
  4. CD need to furnish declaration regarding the existence of any avoidance transactions that may be within the scope of provisions under Chapter III or fraudulent or wrongful trading under Chapter VI of the IBC[19]. Also, the RP is duty bound (even under PPIRP) to determine existence of such transactions and seek its avoidance[20].
  5. From the date of admission of application for PPIRP by the Adjudicating Authority (NCLT), moratorium (as in CIRP) is available to CD till the date of closure of the process[21].
  6. During the PPIRP, the management remains with the CD. However certain transactions by CD requires prior approval of the COC and disclosure of information by CD is expected at a higher degree[22].
  7. RP to appoint two independent registered valuers to determine fair value and liquidation value of the CD. RP to maintain its confidentiality and share the same with COC members, only after receipt of a resolution plan, and upon written undertaking of confidentiality from the COC members[23].
  8. The public announcement (PA) upon admission of application for commencing PPIRP is to be sent, inter alia, to every creditor of the CD[24] for informing that CD is undergoing PPIRP and not for submission of claims. The claim details will be provided by the CD in the preliminary Information Memorandum prepared by it and submits the same to the Resolution Professional (RP). RP is proposed by unrelated FCs[25] and appointed by NCLT[26]. RP will confirm the amount of claim from the records of the CD and then inform about the same to each creditors of the CD and seek their objections, if any.
  9. Base resolution plan is prepared and proposed by the CD to its unrelated FCs for approval. It is only where a base resolution plan is not approved by the COC or if the base plan impairs the claims of OCs then RP shall call for competing resolution plan(s) for CD from open market, adopting a method commonly known as Swiss Challenge method[27].
  10. Unrelated FCs are grouped together and called Committee of Creditors (COC). Before approval of resolution plan, COC may with atleast 66% voting decide to either (i) terminate PPIRP at any time[28], or (ii) initiate CIRP, if default amount is INR 1 crore (10 million) or more[29], and thereby terminate PPIRP.
  11. COC may not approve a resolution plan, resulting in termination of PPIRP[30]. And in such an eventuality, CD need to bear the entire cost of PPIRP, if any[31].
  12. If the COC approves the resolution plan, further approval is required from the NCLT and then it becomes binding on all concerned[32].
  13. The approval of COC to the resolution plan need to be obtained in maximum of 90 days of commencement of PPIRP[33]. And thereafter, NCLT may either approve[34] or reject[35] the resolution plan within next 30 days. Thus, maximum period envisaged to complete PPIRP is 120 days.

It is pertinent to note that period of 90 days is the outer limit. And along with the Application for admission of PPIRP, consent of unrelated FCs (atleast 66% in value of total debt) is required. Thus, much water would have undergone before filing of application for PPIRP with the Adjudicating Authority. Considering no regulatory intervention provided before filing of application with NCLT for commencing PPIRP, the CD, its creditors and probable resolution professional would do a lot of homework, meetings and negotiations, documentation, draft base resolution plan etc. And where the market value is not being reflected in the base resolution plan, COC would go for a Swiss challenge otherwise it should be like a green channel process where CD can come and immediately get the regulatory benefit of PPIRP.

Thus, practically it may be that PPIRP may conclude much earlier than 90 days from the date of admission of application by NCLT.

  1. There is no provision under the IBC permitting CD to opt out of PPIRP, once the application to initiate PPIRP is admitted by NCLT. This is so because, prior to filing application with NCLT to initiate PPIRP, it is expected that CD and its FCs arrives at mutually acceptable resolution proposal.
  2. There is no provision in the IBC on ipso facto clauses in contracts whereby ‘event of default’ may be specified, such as filing of insolvency application and thereby give right to terminate contract. And until the IBC / law provides for the same, the validity of ipso facto clauses would be decided on facts of each case[36].

Conclusion:

PPIRP in India is an alternative to several options that may be available for CD to resolve its financial distress. PPIRP can be a safety valve to save CD particularly where financial stress is due to COVID-19 or due to factors other than mismanagement / fraud. 

It offers an option to promoters/ management to retain control of CD and propose a resolution to its financial distress in a fair and transparent manner, before it runs out of options.

The success of PPIRP is in (i) maintaining confidentiality thereby giving CD option to propose resolution without alerting OCs who may get panicked, (ii) speed as financial distress of CD and creditors’ action cannot be deferred for long; and (iii) ensuring transparency for instilling confidence in the process.

RBI may consider to recognise PPIRP in its prudential framework (of 7th June 2019 notification) so that PPIRP gets required clarity and boost.The objective is laudable and framework is in place. We need to see how it eventually turns out. 

[1] Section 54A(1) of the IBC.

[2] 6th, 7th and 8th Para of the Preamble to the IBC (Amendment) Ordinance, 2021.

[3] Sub-sec.(1) of Sec.54A states CD classified as MSME may initiate PPIRP and sub-sec.(2) thereof states without prejudice to sub-sec.(1) any CD (MSME or not) in default u/s.4 may initiate PPIRP. Further, neither the Rules notified by the MCA nor the Regulations framed by IBBI specifies that CD shall be MSME!!

[4] Section 3(8) r/w Sec. 3(7) of IBC.

[5] For criteria of classification see https://msme.gov.in/whatsnew/new-criteria-classification-micro-small-and-medium-enterprises-gazette-notification-1st

[6] Vide MCA’s notification no. S.O. 1543(E) dated 9th April 2021 (per second proviso to sec.4 of IBC). Hopefully MCA will notify the same amount under the IBC (Amendment) Act 2021.

[7] Vide MCA’s notification no. S.O. 1205(E) dated 24th March 2020, limit for CIRP was increased from INR 1 lakh (INR 100,000) to INR 1 crore i.e. INR 10 million (as per first proviso to sec.4 of IBC) and suspension of initiation of CIRP u/s.10A ended on 24th March 2021.

[8] RBI’s Circular No. DOR.No.BP.BC/4/21.04.048/2020-21 dated 6th August 2020 to be read with RBI’s Circular No. DOR.STR.REC.20/21.04.048/2021-22 dated 4th June 2021, whereby limit enhanced from INR 25 crore (INR 250 million) to INR 50 crore (INR 500 million).

[9] RBI’s Circular No. DOR.STR.REC.12/21.04.048/2021-22 dated 5th May 2021 to be read with the RBI’s Circular No. DOR.STR.REC.21/21.04.048/2021-22 dated 4th June 2021.

[10] Parts B and C of annex. to the RBI’s Circular No. DOR.No.BP.BC/3/21.04.048/2020-21 dated 6th August 2020

[11] Section 54E of the IBC

[12] Sec. 54B of the IBC prescribes duties of insolvency professional proposed to be appointed as the resolution professional for PPIRP purpose.

[13] Sec. 54A(2)(e) of the IBC.

[14] the Insolvency and Bankruptcy (prepackaged insolvency resolution process) Rules, 2021, notified on and effective from 9th April 2021. The same continues under the IBC Amendment Act 2021 by virtue of Sec.24 of the General Clauses Act, 1897 r/w ruling of Constitutional Bench of Hon’ble Supreme Court in West Ramnad Electric Distribution Co. Ltd. Vs. State of Madras, AIR 1962 SC 1753.

[15] the Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Regulations, 2021, notified on and effective from 9th April 2021. The same continues under the IBC Amendment Act 2021 by virtue of Sec.24 of the General Clauses Act, 1897 r/w ruling of Hon’ble Supreme Court in State of Punjab vs. Harnek Singh, AIR 2002 SC 1074.

[16] section 54J(1) and (2), r/w regulation 50 of the PPIRP Regulations

[17] section 54N(4)

[18] Section 54A(3) of the IBC

[19] Section 54C(3)(c) ibid r/w. regulation 16(2) of the PPIRP Regulations

[20] Regulation 41 of the PPIRP Regulations

[21] Section 54E of the IBC

[22] Section 54F r/w regulations 9, 10, 18, 20, 50 of the PPIRP Regulations

[23] Regulations 38 and 39 of the PPIRP Regulations

[24] Regulation 19(2)(b) of the PPIRP Regulations

[25] Section 54A(2)(e) of the IBC

[26] Section 54E(1)(b)

[27] Section 54K(5) of the IBC r/w Regulation 48 of the PPIRP Regulations

[28] Section 54N(2) of the IBC

[29] Section 54O(1) of the IBC

[30] Ss. 54D(3) and proviso to 54K(12), ibid r/w regulation 49(4) ibid

[31] Sec. 54N(3) of the IBC

[32] Section 54D(2) ibid

[33] Section 54D(2) of the IBC

[34] Section 54L(1) of the IBC

[35] Section 54L(3) of the IBC

[36] Hon’ble Supreme Court of India in Gujarat Urja Vikas Nigam Ltd vs. Amit Gupta and Ors., 2021 SCC OnLine SC 194, Para 145.

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