India has recently enacted the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (Ordinance), under which the pre-packaged insolvency process (“PPIP”) for MSMEs with a default of up to INR10,000,000 (Indian Rupees Ten Million) has been made effective.  Further, the Ministry of Corporate Affairs has notified the minimum amount of default to trigger the PPIP under the Ordinance as INR1,000,000 (Indian Rupees One Million).

Partner and Head of M&A, Rukshad Davar, assesses whether pre-packs will result in speedier distressed deals.

Background

Micro, Small and Medium Scale Enterprises (“MSMEs”) have faced a lot of hardships and financial stress during the Covid19 pandemic.  The Indian government has taken several measures to mitigate their distress, including increasing the limit of the minimum amount that constitutes a default for the initiation of the Corporate Insolvency Resolution Process (“CIRP”) and suspending the filing of fresh insolvency applications under the Insolvency and Bankruptcy Code, 2016 (the “Code”) for a year post March 25, 2020.

The government also constituted a sub-committee of the Insolvency Law Committee (the “Sub-committee”) to prepare the framework for pre-packaged debt resolution.  The Sub-committee submitted its draft report last October.

Based on the Sub-committee’s report, on April 4, 2021, the President of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (the “Ordinance”), under which the pre-packaged insolvency process (“PPIP”) for MSMEs with a default of up to INR10,000,000 (Indian Rupees Ten Million) was made effective.  Further, on April 9, 2021, the Ministry of Corporate Affairs notified the minimum amount of default to trigger the PPIP under the Ordinance as INR1,000,000 (Indian Rupees One Million).

PPIP under the Ordinance

The PPIP commences on the date of admission of an application by the National Company Law Tribunal (the “NCLT”) (the “Pre-packaged Insolvency Date”), and the maximum time frame provided under the Ordinance for completion of the entire process is one hundred and twenty (120) days from the Pre-packaged Insolvency Date.

A PPIP is initiated by the corporate debtor itself, and the decision to initiate a PPIP is typically arrived at after the corporate debtor and its creditors have arrived at an informal plan to resolve the corporate debtor’s outstanding debt obligations.

Within two (2) days of the Pre-packaged Insolvency Date, the corporate debtor is required to submit to the insolvency resolution professional (the “IRP”): (i) a base resolution plan; (ii) list of claims; and (iii) preliminary information memorandum containing all information relevant for formulating a resolution plan.  The IRP is, in turn, required to submit this to the committee of creditors (the “CoC”).  On the Pre-packaged Insolvency Date, a moratorium is imposed, and within ninety (90) days of the Pre-packaged Insolvency Date, the IRP is required to submit a resolution plan (approved by 66% of the voting share of the CoC) to the NCLT.  The NCLT is then responsible for passing an order approving or rejecting the resolution plan within thirty (30) days of submission of the resolution plan.

Under the PPIP, the following eligibility criteria have to be fulfilled before initiation of the process:

• The corporate debtor must not have undergone a PPIP or completed a CIRP for at least three (3) years prior to the initiation of the current PPIP;
• The corporate debtor must not currently be under a CIRP and/or no liquidation order must have been passed against the corporate debtor;
• The corporate debtor must be eligible to submit a resolution plan under Section 29A of the Code;
• The financial creditors (who are not related parties to the corporate debtor) must have proposed the name of the IRP and his/her appointment must have been approved by at least 66% (by value of debt) of such financial creditors;
• A majority of the directors or partners of the corporate debtor must have made a declaration to the NCLT stating: (i) that they will file an application for initiating the PPIP within ninety (90) days; (ii) that the PPIP is not being initiated to defraud any person; and (iii) the name of the IRP;
•  Members of the corporate debtor must have passed a special resolution, or 3/4thpartners of the corporate debtor must have filed a resolution approving the filing of the application to initiate PPIP.

Key changes under the pre-packaged regime

Shorter timelines

Under the CIRP, the resolution process is long-drawn and takes up to two hundred and seventy (270) days for resolution of stressed companies.  However, under the Ordinance, a PPIP must be completed in one hundred and twenty (120) days.  This shorter timeline will benefit MSMEs owing smaller debts and their creditors as a quick resolution can be achieved for such insolvent MSMEs.

Debtor in possession

The CIRP follows a model of IRP in possession and creditor in control, whereas the PPIP provides for a debtor in possession and creditor in control model.  It means that under the CIRP, the IRP takes over business of the corporate debtor, but under the PPIP, the debtor remains in the driving seat and runs the company until the resolution plan is finalized.  At the same time, to protect the interest of creditors, the CoC can also pass a resolution, with at least 66% of the voting share, to direct the promoters to hand over the management of the corporate debtor to the IRP.  Practically speaking, this move to allow the debtor to be in possession will ensure that the MSME has a higher chance of continuing to operate as a going concern.  Moreover, this model is likely to incentivize promoters to seek the initiation of PPIPs to resolve their insolvency.  Further, this model may ensure a reduction in the litigation as a majority of the litigation in insolvency cases is initiated by ousted promoters.

Freedom with the debtor to negotiate with potential investors

As the PPIP envisions the immediate submission of a base resolution plan, a corporate debtor can negotiate with potential investors or buyers, and creditors for the sale of a stake in the debtor company or other revival structures.  At the same time, to protect the interests of the creditors, the PPIP also provides for a swiss challenge mechanism, under which the IRP can invite resolution plans to compete with the base resolution plan if the base resolution plan is not approved by the CoC.  Given this, a PPIP incentivizes the corporate debtor to resolve debt obligations promptly so as to ensure continuity of the business.

Conclusions

The PPIP is very popular in several countries, including the UK, the USA, and international experience has shown that the PPIP has helped in preserving the value of the business or debtor entity.  However, in India, the pre-packaged insolvency regime may face certain challenges.

First, adhering strictly to timelines for disposal of issues is going to be a major challenge for the insolvency tribunals and courts, because even basic issues and settled positions seem to get litigated.  In our experience with the Code thus far, the CIRP generally takes longer due to procedural issues and other complexities, thereby defeating the very purpose of a time-bound insolvency process.  As such, the onus will be on the insolvency tribunals to make sure that the parties involved in the PPIP adhere to the timelines mentioned in the Ordinance.

Second, in the PPIP, certain issues may be raised with respect to the transparency of the entire process as promoters will be in charge of keeping the corporate debtor afloat. Operational creditors, although protected, may, nevertheless, be at the receiving end of proposed resolutions.  There may also be legal issues alleging the honesty of the entire process.  Therefore, the insolvency tribunals and courts will have to strike a balance between managing these challenges without compromising the intent of the Ordinance.

Having said that, the Ordinance is a good first step in India towards creating a PPIP jurisprudence, which will evolve over time just like the Code did.

India has recently enacted the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (Ordinance), under which the pre-packaged insolvency process (“PPIP”) for MSMEs with a default of up to INR10,000,000 (Indian Rupees Ten Million) has been made effective.  Further, the Ministry of Corporate Affairs has notified the minimum amount of default to trigger the PPIP under the Ordinance as INR1,000,000 (Indian Rupees One Million).

Partner and Head of M&A, Rukshad Davar, assesses whether pre-packs will result in speedier distressed deals.

Background

Micro, Small and Medium Scale Enterprises (“MSMEs”) have faced a lot of hardships and financial stress during the Covid19 pandemic.  The Indian government has taken several measures to mitigate their distress, including increasing the limit of the minimum amount that constitutes a default for the initiation of the Corporate Insolvency Resolution Process (“CIRP”) and suspending the filing of fresh insolvency applications under the Insolvency and Bankruptcy Code, 2016 (the “Code”) for a year post March 25, 2020.

The government also constituted a sub-committee of the Insolvency Law Committee (the “Sub-committee”) to prepare the framework for pre-packaged debt resolution.  The Sub-committee submitted its draft report last October.

Based on the Sub-committee’s report, on April 4, 2021, the President of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2021 (the “Ordinance”), under which the pre-packaged insolvency process (“PPIP”) for MSMEs with a default of up to INR10,000,000 (Indian Rupees Ten Million) was made effective.  Further, on April 9, 2021, the Ministry of Corporate Affairs notified the minimum amount of default to trigger the PPIP under the Ordinance as INR1,000,000 (Indian Rupees One Million).

PPIP under the Ordinance

The PPIP commences on the date of admission of an application by the National Company Law Tribunal (the “NCLT”) (the “Pre-packaged Insolvency Date”), and the maximum time frame provided under the Ordinance for completion of the entire process is one hundred and twenty (120) days from the Pre-packaged Insolvency Date.

A PPIP is initiated by the corporate debtor itself, and the decision to initiate a PPIP is typically arrived at after the corporate debtor and its creditors have arrived at an informal plan to resolve the corporate debtor’s outstanding debt obligations.

Within two (2) days of the Pre-packaged Insolvency Date, the corporate debtor is required to submit to the insolvency resolution professional (the “IRP”): (i) a base resolution plan; (ii) list of claims; and (iii) preliminary information memorandum containing all information relevant for formulating a resolution plan.  The IRP is, in turn, required to submit this to the committee of creditors (the “CoC”).  On the Pre-packaged Insolvency Date, a moratorium is imposed, and within ninety (90) days of the Pre-packaged Insolvency Date, the IRP is required to submit a resolution plan (approved by 66% of the voting share of the CoC) to the NCLT.  The NCLT is then responsible for passing an order approving or rejecting the resolution plan within thirty (30) days of submission of the resolution plan.

Under the PPIP, the following eligibility criteria have to be fulfilled before initiation of the process:

The corporate debtor must not have undergone a PPIP or completed a CIRP for at least three (3) years prior to the initiation of the current PPIP;

The corporate debtor must not currently be under a CIRP and/or no liquidation order must have been passed against the corporate debtor;

The corporate debtor must be eligible to submit a resolution plan under Section 29A of the Code;

The financial creditors (who are not related parties to the corporate debtor) must have proposed the name of the IRP and his/her appointment must have been approved by at least 66% (by value of debt) of such financial creditors;

A majority of the directors or partners of the corporate debtor must have made a declaration to the NCLT stating: (i) that they will file an application for initiating the PPIP within ninety (90) days; (ii) that the PPIP is not being initiated to defraud any person; and (iii) the name of the IRP;

 Members of the corporate debtor must have passed a special resolution, or 3/4thpartners of the corporate debtor must have filed a resolution approving the filing of the application to initiate PPIP.

Key changes under the pre-packaged regime

Shorter timelines

Under the CIRP, the resolution process is long-drawn and takes up to two hundred and seventy (270) days for resolution of stressed companies.  However, under the Ordinance, a PPIP must be completed in one hundred and twenty (120) days.  This shorter timeline will benefit MSMEs owing smaller debts and their creditors as a quick resolution can be achieved for such insolvent MSMEs.

Debtor in possession

The CIRP follows a model of IRP in possession and creditor in control, whereas the PPIP provides for a debtor in possession and creditor in control model.  It means that under the CIRP, the IRP takes over business of the corporate debtor, but under the PPIP, the debtor remains in the driving seat and runs the company until the resolution plan is finalized.  At the same time, to protect the interest of creditors, the CoC can also pass a resolution, with at least 66% of the voting share, to direct the promoters to hand over the management of the corporate debtor to the IRP.  Practically speaking, this move to allow the debtor to be in possession will ensure that the MSME has a higher chance of continuing to operate as a going concern.  Moreover, this model is likely to incentivize promoters to seek the initiation of PPIPs to resolve their insolvency.  Further, this model may ensure a reduction in the litigation as a majority of the litigation in insolvency cases is initiated by ousted promoters.

Freedom with the debtor to negotiate with potential investors

As the PPIP envisions the immediate submission of a base resolution plan, a corporate debtor can negotiate with potential investors or buyers, and creditors for the sale of a stake in the debtor company or other revival structures.  At the same time, to protect the interests of the creditors, the PPIP also provides for a swiss challenge mechanism, under which the IRP can invite resolution plans to compete with the base resolution plan if the base resolution plan is not approved by the CoC.  Given this, a PPIP incentivizes the corporate debtor to resolve debt obligations promptly so as to ensure continuity of the business.

Conclusions

The PPIP is very popular in several countries, including the UK, the USA, and international experience has shown that the PPIP has helped in preserving the value of the business or debtor entity.  However, in India, the pre-packaged insolvency regime may face certain challenges.

First, adhering strictly to timelines for disposal of issues is going to be a major challenge for the insolvency tribunals and courts, because even basic issues and settled positions seem to get litigated.  In our experience with the Code thus far, the CIRP generally takes longer due to procedural issues and other complexities, thereby defeating the very purpose of a time-bound insolvency process.  As such, the onus will be on the insolvency tribunals to make sure that the parties involved in the PPIP adhere to the timelines mentioned in the Ordinance.

Second, in the PPIP, certain issues may be raised with respect to the transparency of the entire process as promoters will be in charge of keeping the corporate debtor afloat. Operational creditors, although protected, may, nevertheless, be at the receiving end of proposed resolutions.  There may also be legal issues alleging the honesty of the entire process.  Therefore, the insolvency tribunals and courts will have to strike a balance between managing these challenges without compromising the intent of the Ordinance.

Having said that, the Ordinance is a good first step in India towards creating a PPIP jurisprudence, which will evolve over time just like the Code did.