The Indian government has amended the Insolvency and Bankruptcy Code (IBC) through an Ordinance to provide for a so-called pre-pack resolution scheme for micro, small, and medium enterprises, amid growing perceptions that India’s three-year-old insolvency resolution system has been less than effective in saving businesses and assisting lenders in recovering their assets (MSMEs).
Following global best practices, the Union government moved an ordinance on Monday to introduce pre-packaged insolvency resolution options for micro, small, and medium enterprises (MSMEs).
The ordinance adds a new chapter to the Insolvency and Bankruptcy Code to allow medium and small businesses, or MSMEs, to participate in the pre-package scheme under the MSME Development Act. In addition to corporations, the scheme applies to businesses organised as partnerships.
The scheme is open to businesses that have not filed for bankruptcy in the previous three years or are facing liquidation orders.
Pre-packs are a type of restructuring in which creditors and debtors collaborate on an informal plan before submitting it for approval. Typically, the current management retains control until the final agreement is reached.
If the major shareholder is an undischarged insolvent or a wilful defaulter, the business cannot participate in the scheme. The most important feature is that, unlike general bankruptcy provisions, it allows the defaulting small business’s management to maintain control of operations.
In such schemes, keeping corporate debtors in possession is a global best practice. “Pre-pack provides you with a platform to conduct a resolution as a ‘debtor in possession’ rather than a ‘creditor in control’ under the supervision of a resolution professional. That’s the main difference. The company that is in the debtor’s possession is able to reach an agreement. The majority of the litigation in the IBC is brought by promoters, which creates roadblocks in the resolution process,” said Ajay Shaw, partner at DSK Legal.
The ordinance states that the increase in the minimum amount of default for initiation of the corporate insolvency resolution process to 1 crore, which was implemented last year, as well as the suspension of bankruptcy proceedings for a year in the event of defaults beginning March 25, 2020.
Businesses can apply for a pre-pack scheme voluntarily by adopting a special resolution by the board of directors or a resolution by three-fourths of the partners. The scheme states that, while management retains control, it must “make every endeavor to protect and preserve the value of the corporate debtor’s property, and manage operations as a going concern.”
During the pre-pack resolution process, the defaulting small business’s current management is allowed to remain in charge of the company’s affairs, as the chances of new investors lining up for small businesses are lower than for large companies.
