Insolvency Law: Government Allows Pre-Packs For MSMEs

Micro, small and medium enterprises will now be able to opt for a pre-packaged insolvency resolution under the Insolvency and Bankruptcy Code. The government has promulgated an ordinance making way for pre-packs for MSME defaults of up to Rs 1 crore. While a pre-pack process is underway, no insolvency proceedings can be initiated against the MSME.

While there is no specific statutory definition, a pre-pack process will allow the creditor and the debtor to informally work on a resolution plan. The plan, if the parties agree, can be presented to the adjudicating authority for approval.

The Ordinance makes available the pre-packaged route to genuine and viable cases, to ensure least business disruption. While modelled on debtor-in-possession approach, it vests significant consent rights to the financial creditors, such that the mechanism cannot be misused by errant promoters, Soumitra Majumdar, partner, J Sagar Associates, said. “Further, adopting plan evaluation process akin to Swiss Challenge, it retains competitive tension such that promoters propose plans with least impairment to rights and claims of creditors,” he said.

According to the ordinance, here are the key features of the pre-pack option:

Pre-Pack Initiation

• A pre-pack can be initiated if members of the MSME have approved the proposal via a special resolution. And 66% of unrelated financial creditors by value have agreed to a pre-pack resolution.
• The MSME can propose a plan if it is Section 29A compliant. This section prohibits promoters of non-performing assets, willful defaulters and certain other class of persons from submitting a resolution plan for a corporate debtor.
• There will a penalty applicable if a pre-pack process is initiated with an intent to defraud. And if any officer of the MSME manages the affairs to defraud the creditors while the pre-pack process is on.

Pre-Pack Process

• A moratorium will apply when a pre-pack process is underway. The process must be completed within 120 days.
• During the pre-pack process, the management and control will continue with the promoters and directors of the MSME. The resolution professional will monitor the management of affairs of the company. The committee of creditors, by a 66% vote, can vest the management with the resolution professional after seeking court approval.
• The MSME, if eligible under the Section 29A, will have to submit a base resolution plan to the resolution professional. The plan should fulfil the conditions specified under the Section 30. Specifically, provide for payments as per creditor hierarchy specified under insolvency code and allow the corporate debtor to participate in the CoC meetings in which the plan is being considered.

Pre-Pack Approval

• If the plan proposed by the MSME is rejected by the CoC or where operation creditors’ dues are impaired, the resolution professional can invite prospective applicants to submit a competing plan. These applicants will have to be Section 29A compliant as well. Such applicants will get the benefit of the Section 32A, that is they can’t be held liable for actions of previous management
• 66% of financial creditors by value can approve such a plan after considering its feasibility and viability. The CoC will also have to consider the manner of distribution proposed, taking into account the order of priority among creditors, including the priority and value of the security interest of a secured creditor etc. The CoC may require the promoters of the corporate debtor to dilute their shareholding or voting or control rights.
• After checking for effective implementation, the plan can be approved the court within 30 days.
• At any point during before the approval of the pre-pack plan, 66% of CoC by vote share can initiate an insolvency application against the MSME.

Most provisions are along the lines of the pre-pack committee recommendations. Experts had earlier told BloombergQuint that complete exclusion of promoters — those that get hit by the Section 29A — may not bode well for the pre-pack process.

Misha, partner at Shardul Amarchand Mangaldas & Co., had said there is commercial justification for diluting the mandate of the Section 29A for pre-packs. The insolvency process has become highly litigious because of direct confrontation between the promoters and creditors’ interests. “Pre-packs are intended to be less formal and not a strict, statutory platform to resolve pre-insolvency,” she had said.

Abizer Diwanji, partner and national leader for financial services at EY, had agreed. If the applicability of the Section 29A is modified to only include established frauds, promoters will become eligible to enable the framework, he had said. He had also warned that if promoters are entirely debarred, every pre-pack will become a situation of hostile M&A.