Pre-Packaged Insolvency Resolution Process- A critical analysis

Updated: May 12, 2021

CHAPTER III-A had got introduced in to the Insolvency and Bankruptcy Code, 2016 through an Ordinance and the same came into effect with effect from 04th April, 2021. The Pre Packaged Insolvency Resolution Process(PPIRP) is basically intended to resolve the financial stress on Corporate Persons which can be classified as as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006. The PPIRP is envisioned as an “Out of Court” process in contrast to the Corporate Insolvency Process (CIRP) which is more litigative in nature and heavily expensive.

A. The process of filing application for PPIRP.

In order to file an application under PPIRP, the Corporate Debtor (Company or LLP) should be classified as an MSME under relevant Act and the said Corporate Debtor(CD) should have committed “Default” within the meaning of the Code. Furthermore as a precondition, the Corporate Person should not have undergone the process of PPIRP or CIRP, or had not completed CIRP in three years preceding the initiation date or no liquidation proceedings order has been issued against the CD. In order to be qualified as an Applicant, the Corporate debtor should not be disqualified under Section 29A of the Code.


If the Corporate Debtor had committed a Default within the meaning of Section 4 of the Code, and intending to move the application for PPIRP, the Board of Directors or partners, as the case may be, shall have to make a declaration stating that the corporate debtor shall file an application for initiating pre-packaged insolvency resolution process within a definite time period not exceeding ninety days. If the Corporate Debtor had committed a Default within the meaning of Section 4 of the Code, then the Board of Directors have to proceed to call a General Meeting of the shareholders or its partners to obtain their approval to submit the application for undergoing PPIRP.


Further to the above, the Board of Directors have to prepare a ‘Base Resolution Plan’ which conforms to the requirements referred to in section 54K of the Code. Once the above three factors, viz Declaration, Special Resolution and Base Plan is ready, then the Corporate Debtor have to approach the Financial Creditors(lenders) for obtaining their concurrence for submitting the application under CIRP. The Financial Creditors who are having not less than sixty-six per cent. in value of the financial debt approve the same. On their approval the Corporate Debtor can move the application for initiating pre-packaged insolvency resolution process


Pitfalls spotted in filing process!

The Sections are beautifully drafted and many of the loopholes are properly addressed at the drafting stage itself. But following pitfalls are evident in the entire process, which can hamper the same during the actual scenario.

  1. “Default” means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be. Corporate Debtor (CD) who commits a default of minimum amount of Rs 10 lakhs as specified by Central Government vied Notification released by MCA on April 9, 2021.

  2. If there is a Default, the Creditors to whom deby is owed by the Corporate Debtor have the right to move an application under Section 7 or 9 of the IBC.(For this purpose default amount should be Rs 1 CR or more) If an application is filed before NCLT(Adjudicating Authority) under the said Sections, AA is bound to admit the same within 14 days provided everything in application is proper and in place. So, can the CD file the application under PPIRP before the Adjudicating Authority after completing all the given formalises such as Declaration, Special Resolution, preparation of the Base Plan and approval of the financial creditors before some other creditor approaches the NCLT? If not, the application filed under Section 7 or 9 shall get admitted and the Corporate Debtor shall get disqualified from filing the application for commencement of PPIRP! Is that shall becoming a vicious circle?

  3. A Financial creditor’s primary intention is to recover their dues before it starts reflecting as “default” in their books. It is pertinent to note that the process of PPIRP shall start rolling only after the occurrence of default. Will a Financial Creditor, privileged under SARFAESI, have the legal and financial bandwidth to permit the CD to convene the General meeting and prepare the base plan as part of debt resolution? If they move an application under Section 7 and the same got admitted, then can the CD file an application for PPIRP? The answer is a big NO as non existence of CIRP is a precondition to commence PPIRP! If the application filed under Section 7 or 9 pending for admission, then there is a leeway for the CD to move the application for PPIRP.

B. Application to initiate pre-packaged insolvency resolution process.

If the above mentioned conditions are duly satisfied, the Corporate Debtor can submit an application to the Adjudicating Authority (AA) along with the copy of the declaration and the copy of the special resolution. Along with the said documents, the name and consent letter of the Resolution Professional nominated and approved by the Financial Creditors also to be attached. Another document to be attached is the declaration regarding the existence of any transactions of the corporate debtor that may be within the scope of provisions in respect of avoidance of transactions. If the said documents are proper, then the AA shall admit the same or reject the same. In case of rejection, the CD will be given with 7 day’s time period to rectify the same.


Pitfalls Spotted in admission process!

  1. The declaration regarding the existence of any transactions of the corporate debtor that may be within the scope of provisions in respect of avoidance of transactions under Chapter III or fraudulent or wrongful trading under Chapter VI is a self-declaration. Is that a practical one? Will any Corporate Debtor who had carried out avoidance transactions will give a true and fair disclosure like that? What is the sanctity of that?

  2. If the said declaration can be replaced with a certificate from an Independent forensic auditor appointed by Financial Creditors , that is more logical and sensible.

C. Period of PPIRP

The Period of PPRIP is 120 days. As per Section 54D,the Resolution Professional shall submit the resolution plan, as approved by the committee of creditors, to the Adjudicating Authority under sub-section (4) or sub-section (12), as the case may be, of section 54K, within a period of ninety days from the pre-packaged insolvency commencement date. Where no resolution plan is approved by the committee of creditors within the time period of ninety days, the resolution professional shall, on the day after the expiry of such time period, file an application with the Adjudicating Authority for termination of the pre-packaged insolvency resolution process in such form and manner as may be specified.


Pitfalls spotted in base plan submission process!

The approval of base plan by the Financial Creditors is a precondition for filing the application for commencement of PPIRP. Approval of Base Plan by Financial Creditor is a precondition for filing the application before Adjudicating Authority. The Base plan (Plan submitted by the CD) will get approved in first instance only if meet some specific criteria. In that case, how there is circumstance of “No Resolution Plan approved by the CoC” will arouse?


D. Interest of Operational Creditors are protected?

Under CIRP, operational creditors are trashed and corned due to the super supremacy of the Financial Creditors in the Committee of Creditors. However, under PPIRP, the said lacunae is addressed to an extent.


As per Section 54K(4) the committee of creditors may approve the base resolution plan for submission to the Adjudicating Authority if it does not impair any claims owed by the corporate debtor to the operational creditors. If the CoC does not approves the Base Resolution Plan or the base resolution plan impairs any claims owed by the corporate debtor to the operational creditors, then the Resolution Professional shall invite prospective resolution applicants to submit a resolution plan or plans, to compete with the base resolution plan.


Pitfalls Spotted!

The above section is very plain and does not have any ambiguity. Prima facie it is largely in favour of the “Operational Creditors”. Operational Creditors debt cannot be impaired in the base resolution plan. “Impair” means “Weaken or Damage”. So practically, the CD have to pay the full amount owed to Operational Creditors, failing of which the Base plan shall be rejected by the CoC. Fair Enough. What next? There is a catch!


On rejection of the Base Plan, the Resolution Professional shall invite others to submit fresh resolution plan. The resolution applicants submitting such resolution plans shall fulfil such criteria as may be laid down by the resolution professional with the approval of the committee of creditors, having regard to the complexity and scale of operations of the business of the corporate debtor. On receipt of such plan, the committee of creditors decides approves the resolution plan which is significantly better than the base resolution plan, such resolution plan may be selected for approval. Significantly better in relation to resolution plan, means that the score of the resolution plan is higher than that of another resolution plan by a certain number or percentage, as approved by the committee and disclosed in the invitation for resolution plans. But that doesn’t insist for non impairment of facts as a crucial factor.


While considering the feasibility and viability of a resolution plan, where the resolution plan submitted by the corporate debtor provides for impairment of any claims owed by the corporate debtor, the committee of creditors may require the promoters of the corporate debtor to dilute their shareholding or voting or control rights in the corporate debtor. What if the promoters are not ready to dilute ? In case the resolution plan does not provide for such dilution, the committee of creditors shall prior to the approval of such resolution plan record reasons for its approval!!.


That means, by simply recording the “Reasons for Non dilution” the Committee of Creditors can approve the Plan even if there is an impairment of debts owed to “any creditors”. So practically, does it protects the interest of Operational Creditors? My answer to that is a NO. Ultimately it does not protect the interest of any creditors other than Financial Creditors. It should have been much better, if all the Creditors were given proportional representation in the Committee, so that they can at least voice against the "impairment or "reason for non dilution".


E. Role of Resolution Professional

Section 54F details the duties and responsibilities of the Resolution Professional. The RP is nominated and appointed by the Financial Creditors and hence he is independent of the Corporate Debtor. But is he really independent?


It is mentioned in the section that the resolution professional shall conduct the pre-packaged insolvency resolution process of a corporate debtor during the pre-packaged insolvency resolution process period. But as per section 54H the management of the affairs of the corporate debtor shall continue to vest in the Board of Directors or the partners, as the case may be, of the corporate debtor. The Board of Directors or the partners, as the case may be, of the corporate debtor, shall make every endeavour to protect and preserve the value of the property of the corporate debtor, and manage its operations as a going concern. However the Section cast the duty to “monitor” the affairs of the Corporate Debtor of the shoulders of RP. How far that is practical is a question only time can prove. Though the Section 54F gives amble powers to the Resolution professional to interfere in the affairs of the company, he will be facing lot of practical issues in the given situation. The said will open by a pandoro box of litigations and rift between the CD and RP.


If the affairs of the corporate debtor have been conducted in a fraudulent manner or there has been gross mismanagement of the affairs of the corporate debtor the Adjudicating Authority on recommendation of the CoC have the power to pass an order vesting the management of the corporate debtor with the resolution professional. But to prove the mismanagement and fraudulent conduct, the RP have to sweat a lot, especially when his fees and litigation expenses are being borne by the same “fraudulent party”!


F. Approval of resolution plan.

If the Adjudicating Authority is satisfied that the resolution plan as approved by the committee of creditors it shall within thirty days of the receipt of such resolution plan, by order approve the resolution plan. The Adjudicating Authority shall ensure the compliance under section 30 and section 54K before approval of the plan, which shall be binding of all


Conclusion

Though the intention behind the legislation is good, it contains many ambiguous clauses which can lead to endless litigations. The interest of the operational creditors may again get adversely affected due to the loose drafting of the clauses. It is a known fact that, the last person to accept the incapacity to pay their debts, shall be the defaulter himself/herself/ itself. So it is remote for Corporate Debtor to adopt the PPIRP route for resolving their debts. Lastly, the MSME segment is notorious for poor data management and flimsy accounting systems. So it is too much to expect from them the level of compliance that is expected under the PPIRP. As mentioned before, let the time to prove the strength of the metal in it.


Bijoy P Pulipra





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