By: Pulkit Gera

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Introduction

Micro Small and Medium Enterprises (MSME) (registered and unregistered) constitute around 60% of the total active companies in India and make a seminal contribution of nearly 29% to the total GDP.  The MSME sector took a serious hit in the wake of the global pandemic which urged the government to bring in statutory amendments to the laws. This was done to ensure the continuity of the businesses, to advocate their resolution of insolvency, and to ensure the economic stability of the country as a whole.

Yesteryear, pursuant to the shutting down of the businesses due to the pandemic, the government increased the default limit, for filing an insolvency application against the corporate debtor, from Rs. 1 Lakh to Rs. 1 Crore with the object of protecting the smaller firms from going through insolvency proceedings. Recently, the government took another step in a similar direction by proclaiming the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 (“amendment ordinance”) to allow the “Pre-Packaged Insolvency Resolution Process” (PRIRP) for MSME with a minimum default of Rs. 10 lakh and a maximum of Rs. 1 Crore.

PRIRP is a ‘debtor in control’ insolvency process where promoters and financial creditors of the financially distressed business negotiate an informal resolution plan for the restructuring of the business entity, before the commencement of formal insolvency proceedings. Following the finalization of the negotiated resolution plan, the same is submitted before the adjudicating authority i.e. National Company Law Tribunal (NCLT), for its approval. Thus, it is often referred to as the hybrid process of insolvency resolution as it stretches from an informal process of negotiating resolution plans to a formal process of admission by the NCLT.

INSOLVENCY UNDER PRIRP vis-a-vis  CIRP

The Pre-Packaged process of a resolution brought in by the recent amendment ordinance is novel to the Indian insolvency law. Unlike the existing Corporate Insolvency Resolution Process (CIRP) where the control of the debtor’s business is transferred to Resolution Professional (RP) during the insolvency process, PRIRP provides for a ‘debtor in control’ model where the control of business remains with the debtor and continues till the consummation of the resolution process.

The objective behind this model is to keep the businesses running without disruption, to maximize the value of the business and to preserve the interests of the employees working there. Moreover, this model helps in safeguarding confidential information such as a secret formula or any other trade secret, which may be at greater risk of getting divulged when the full control of the firm is transferred to a stranger as in the CIRP process. However, section 54J of the amendment ordinance provides for transferring the control of the business to the Resolution Professional even under PRIRP process, in case the affairs of the business are carried out fraudulently or there is gross mismanagement by the debtor in control.

The PRIRP starts with the Corporate Debtor submitting the base resolution plan, provided he is eligible under Section 29A of The Insolvency and Bankruptcy Code, 2016 (IBC) and the plan submitted by him fulfills the requirements under Section 30 of IBC. The base resolution plan so submitted is put to evaluation before the Company of Creditors (COC) unlike the CIRP proceedings where from the very start any applicant eligible under Section 29A subject to 240A, can submit a resolution plan and there is no concept of base resolution plan. The base plan, if approved by the COC, is presented before the NCLT for its approval. However, if the plan does not get approved by COC for the reasons such as a disability in claims of operational creditors or failure to fulfill any other statutory requirement, the resolution professional is entailed to put the base resolution plan through the Swiss challenge method.[i]

Under the Swiss challenge method, the base plan is put out to the public and competitive bids, against the base resolution plan, are invited. Upon receiving the bids, the same is put before the COC which then has the option to choose the jim dandy resolution plan. The resolution plan so selected then needs to be put before the respective NCLT bench for approval which checks the submitted plan against the statutory requirements and adjudicates accordingly. However, the tribunal is under a statutory obligation to reject the plan if it does not lead to a change in management, i.e. gives control back to the corporate debtor or a promoter of the business.[ii]

LIMITING RESTRICTIONs UNDER SECTION 29A

The application for initiating the process of PRIRP has to be filed under Section 54C of the amendment ordinance, by the corporate debtor pursuant to the concurrence of the creditors holding at least 66% of the total value of the financial debt due to these creditors. Conversely, if the creditors want to initiate insolvency proceedings against the corporate debtor then it can be done only through CIRP and not PRIRP. Further, Section 54A of the amendment ordinance enlists the pre-condition for an MSME to be eligible for initiating the PRIRP.

One of the conditions enlisted under Section states that an MSME corporate debtor has to be not ineligible under Section 29A of IBC to initiate PRIRP. On the face of it, the above-stated condition signifies that an MSME corporate debtor has to stay clear of the wide qualification criteria under Section 29A of the IBC. However, the same is not the case, as Section 54A(1)(d) fails to take into consideration an overriding provision of Section 240A. Section 240A of the IBC excludes the applicability of Section 29A(c), (debars the person and its management whose account has been classified as Non-Performing Asset (NPA) for last 1 year from the commencement of the insolvency proceeding), and 29A(h), (debars the guarantor of the corporate debtor under insolvency), to insolvency proceedings of MSME under both CIRP and PRIRP. Thus, Section 29A must be read together with Section 240A while determining the qualification criteria of the MSME corporate debtor for initiating PRIRP. Further, the author believes that Section 54A(1)(d) should be amended to include Section 240A so as to avoid any unnecessary litigation on this aspect.

Taking into consideration the above arguments, an MSME corporate debtor in order to be eligible to initiate PRIRP has to pass all the qualification criteria laid down under Section 29A except 29A(c) and 29A(h). Thus, there is still an embargo on the willful defaulters, un-discharged insolvent person, and management and the related parties/connected persons to the management, to initiate PRIRP and submit a base resolution plan.

The author is of the view that the disqualification criteria under Section 29A should be further relaxed for MSME under the PRIRP. Firstly because, MSME is considered as the key generator of employment, growth, and contributes significantly to the economy of the nation. Secondly, MSME primarily gathers the interest of the promoters and the connected parties, as not many outside investors may be willing to take charge of the company. Thirdly, the PRIRP unlike the CIRP process has a cap of Rs. 1 Crore default which is a relatively small amount and a second chance could be given to corporate debtors and connected parties, especially in the times where the maximum of these businesses are unable to pay their debts, not because of some management failure, mala fide acts of debtor/ related parties or willful negligence but because of economic downturn caused due to a pandemic. Fourthly, a large number of prospective resolution applicants including the existing promoters who are labeled ineligible may be willing to pay higher than the other bids received. However, due to certain stringent restrictions, the creditors have to settle for a lesser amount than the prospective resolution applicant may be willing to pay. Fifthly, COC should be given wider commercial discretion to choose the resolution bid offered in the best of their interest.

Some of the comments and suggestions mentioned in the above paragraphs may also hold true for the CIRP process as well but it should be specifically implemented to the PRIRP. This is because, firstly, PRIRP involves a small amount of default limit, i.e. Rs. 1 Crore, in comparison with CIRP where the default can be 100 times of the maximum limit under PRIRP; Secondly, according to international practices, the PRIRP is supposed to be more informal and flexible which is not the case with CIRP. Further, the above suggestions such as more independence to COC and limiting restrictions under 29A would help in achieving the real objective of PRIRP in the international aspect.

Curbing ‘Pheonixing’

The above suggestions may drive through a common argument that limiting the restrictions first under Section 240A and then under Section 29A could lead to the adoption of illegal practices, by MSME corporate debtors, such as ‘phoenixing’. For a better understanding, ‘Pheonixing’ is a process where the management of the business deliberately puts the business under restructuring/ liquidation with the sole objective of buying back the same into a ‘phoenix’ company which is managed by an almost identical management and uses a similar name as that of the previous one.

In order to curb the menace of abusive ‘phoenixing’ practice, the Indian Insolvency law can amend provisions to adopt a process similar to that of pre-pack pool in the UK, where an independent body of business experts conducts individual scrutiny of sales involving connected parties. However, the same should be voluntary and be conducted at the request of the majority of members forming part of COC. This method will not only curb the fraudulent restructuring of businesses but will also help in the speedy disposal of insolvency resolution cases.

The above arguments should be considered in line with the fact that in some cases existing promoters or the connected parties may be willing to pay much higher than the other resolution bids received. Further, a committee like the pre-pack pool can analyze the whole transaction and help the COC to figure out if there is something shady in it.

Conclusion

It is no doubt that the recent amendment has brought in a significant revolution in the Indian insolvency regime by introducing an alternative mechanism of insolvency resolution for MSME, which in coming times will most likely be extended to other corporations as well. The PRIRP process due to its hybrid nature is more effective, less time-consuming, and inexpensive compared to the existing CIRP process. However, though a well thought and well-implemented plan, it is shrouded in excessive statutory obligations which need to be revisited for maximum productivity of PRIRP process.

Taking into consideration the implementation of a Pre-packaged scheme under insolvency law of foreign countries, the pre-packaged resolution process should be less formal and highly volatile, with less interference of statutory obligations. However, the same is not the case with the Indian pre-package scheme, as it provides strict statutory barriers to preclude the promoters/ connected parties from becoming prospective resolution applicants. This is clearly a departure from international practice where the corporate debtors and promoters are allowed to submit a prospective resolution plan to compete against  other plans.

It’s high time now that the government considers establishing a middle ground that allows the promoters/related parties a chance to regain control over their firm, but at the same time ensures that the gets the maximum output of the whole process. The same can be best achieved through independent scrutiny by a body of business experts of the promoter’s resolution plan, at the request of COC.

These suggestive measures will help both the creditors as well as debtors. The creditors will be able to accept the bid of the debtors/promoters who may be willing to pay more than the other bids received and debtors/promoters will be able to regain control over their businesses which may have to face the insolvency resolution process due to the unprecedented economic distress caused due to disruption in demand or production caused due to the COVID crisis.

[i] The Insolvency and Bankruptcy Code, No. 31 of 2016, India Code (2016), Sec. 54K(5).

[ii] Id., Sec. 54L(4).

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(Pulkit is currently a law undergraduate at Rajiv Gandhi National University of Law, Punjab. The author may be contacted via mail at pulkitgera@rgnul.ac.in)

Cite as: Pulkit Gera, ‘PRIRP for MSME Sector: Revisiting the scope of resolution applicants Under Section 29A’ (The RMLNLU Law Review Blog, 1 April 2021) <https://rmlnlulawreview.com/2021/06/01/prirp-for-msme-sector-revisiting-the-scope-of-resolution-applicants-under-section-29a/> date of access