A Critique of the Pre-Packaged Insolvency: A Flawed Framework
Pre-Packaged Insolvency Resolution Process (‘PPIRP’) was recently introduced within Chapter III of the Insolvency and Bankruptcy Code, 2016 (‘Code). It was promulgated in light of the global economic recession caused by the pandemic induced lockdowns. The recession has led to a rise in corporate insolvencies. A total of 283 companies in India had been admitted to the Corporate Insolvency Resolution Process (‘CIRP’) in the second half of the past year.
The objective behind invoking PPIRP is to preserve the business of the defaulters and balance the interest of the debtors and the creditors. It becomes particularly important in the event of the debtor being a Medium Small and Micro Enterprise (‘MSME’). These enterprises are promoter driven and are largely dependent on them, for operational and financial requirements. Therefore, vesting management to a resolution professional as per Section 35 of Code would entail the impossibility of revival of the company.
This article provides a critique of the PPIRP framework by emphasising on the problematic provisions related to the Debtor-in-Possession (‘DIP’) approach, examining the role of operational creditors and analysing the absence of a calm period. The author also provides an analysis of the impact of such drawbacks and further explores the possibility of restructuring of the framework, in order to address the aforementioned problems.
PPIRP: An Overview
The PPIRP framework is based on the report of the sub-committee headed by M.S Sahoo (‘Sub-committee’). As per the provisions of Section 54A of the amended Code, a corporate debtor classified as a MSME, who is also eligible to submit a resolution plan under Section 29A, can submit the application for PPIRP. This follows, provided a declaration has been made in this regard by majority of the partners and approved by creditors representing 66% of the value of amount due.
Further, Section 54D espouses that the PPIRP shall be concluded within a period of 120 days. This is in contrast to the existing framework that espouses a 270-day period for the completion of process, with the option to extend it by 90 days.
A significant alteration is the alteration of the role of the resolution professionals. Unlike CIRP, wherein the professional manages the company as a going concern, within the new framework, the management is vested with the existing board of directors. The distinction in roles of the resolution professional marks the shift from the creditors-in-control approach in India. The existing approach entailed a shift in effective control of the company from the promoter to the creditors. A change in such an approach would signify the reduced authority of the creditor over the debtor, as the debtor retains the managerial authority. It also signifies the reduction in responsibilities entrusted upon the resolution professional. Nevertheless, the resolution professional still commands significant authority, including apropos the completion of the PPIRP.
Misnomer of DIP
A significant change comes in with the introduction of the DIP approach, which provides the board of directors of the defaulting company with the authority to manage the affairs. The inclusion of the model has led to apparent inconsistency within the framework. While it may seem that the Code has adopted the DIP model, a perusal of the relevant provisions evidences the control of the creditors over the resolution process. The is because Section 54J(xii) gives the creditor the power to shift the management of the company from the board to the resolution professional. The provision can be invoked by the Committee of Creditors (‘CoC’), by filing an application when they are satisfied that the affairs of the company have been conducted in a fraudulent manner. While the Sub-committee advised the inclusion of such provision to prevent the promoters from siphoning the assets of the company, it creates the possibility of frustrating the process if the promoters do not agree with the opinion of the creditors. The creditors can thwart the insolvency process by filing frivolous applications that would consume a significant amount of time of the resolution process.
Further, the CoC has also availed the right to initiate the CIRP against the debtor, by initiating resolution after obtaining 66% of vote share. This would pre-emptively terminate the PPIRP. It has been codified under Section 54-O of the Code. This provision further emphasises the misnomer of the DIP model that the amendment seeks to introduce. Therefore, the resolution process and the management rights of the company are skewed towards the creditors.
Exclusion of Operational Creditors
The operational creditors are precluded from the PPIRP. The Code has inter alia historically excluded the operational creditors from any participation within the CoC, however, it did provide them with the right to initiate the CIRP against the debtor. The amendment excludes such rights of the operational creditors, as only the debtor can initiate PPIRP. The CoC constituted therein is identical to that under CIRP and excludes the operational creditors from any participation.
The reasoning for exclusion given by the Apex Court in the Swiss Ribbons case is based on the flawed distinction that the financial creditors have the expertise to evaluate the viability of the resolution plan, while the operational creditors are merely concerned with the recovery of the value of goods and services. The rational is tenacious as it is made on the assumption that the creditors shall approve the plan on the basis of viability and not on the basis of their interest in maximising their asset recovery. This is also in contrast to the practices in other jurisdiction such as the United States, wherein a committee of unsecured creditors is formed to protect the interest of such creditors who may not be given adequate consideration. Similarly, in the United Kingdom, any company under resolution shall require the approval of such creditors, representing 75% of value of each class of creditors.
The exclusion is also prejudicial to the interest of the MSMEs as they themselves are considered as operational creditors. Thus, any future framework of PPIRP for bigger corporates would certainly become prejudicial to the MSMEs themselves, given that they would not have a vote or opinion on the matter.
Absence of Calm Period
The existing CIPR process includes within its provisions, a ‘calm period’ during which the resolution professional seeks to revive the operational prospects of the company without the undue involvement of the CoC. It gives the professional the time to seek approval of a resolution plan that would potentially offer a viable alternative to the insolvency of the company.
The perusal of the framework signifies that the benefit of calm period is not available under PRIRP, since the CoC can interfere with the management and resolution by forcing their decisions on the Board. Failure to adhere could result in the termination of PPIRP by the CoC. The problem apparently arises since the resolution plan is submitted by the corporate debtor instead of the interim professional. The inspiration for this exclusion can be found in the report of the Bankruptcy Law Reform Committee (BLRC) that espouses the removal of the calm period. The rationale being that an interim resolution professional does not possess decisive control over the debtor, leading to a loss in the value. The BLRC thereby preferred a greater role of CoC to protect the intrinsic value of the debtor. The recommendation is from the perspective of creditors and disregards the protection of enterprise value of the debtor. Additionally, the interference of the CoC in the decision making of the company along with the inherent right to initiate the CIPR would prevent the preservation of business and certainly does not balance the interest of the promoters vis-à-vis the creditors.
The PPIRP revamps the insolvency regime in India on a positive note. The revamp would aid in the early resolution as well as the preservation of the business of the MSME corporate debtor. While the framework is certainly appreciated, the faults within the provisions cannot be ignored. There is a need to take into confidence the opinion of the operational creditor while approving the resolution plan. The inclusion of such creditors would be beneficial for the MSMEs as it would result in their participation within the CoC, post a full-scale rollout of the PPIPR. Nevertheless, the undue authority entrusted upon the creditors is contrary to the DIP model as well as the objective of the framework, to balance the interest of either party. If the PPIRP model seeks to introduce a DIP approach, it needs to inculcate a more positive attitude towards the defaulters. The existing framework can potentially enable the CoC to thwart the resolution process by constant interference. Alternatively, this can be derailed by threatening to abdicate the PPIRP through filing an application for CIRP, if the management of the company does not adhere to its views. Nonetheless, the legislative intent highlighted in the Sub-committee report is to evolve the framework in an experimental manner, thereby rekindling the hope that the existing concerns shall be addressed soon.
Anwesh Patnaik is a sophomore year law student at NLIU Bhopal with a keen interest in the field of corporate law specifically related to insolvency, mergers and acquisitions, and commercial dispute resolution. He is open to discussions pertaining to the content of the article and can be contacted via mail- firstname.lastname@example.org.