Moneycontrol Pro Panorama | Are pre-packs for MSMEs a magic wand for stressed asset resolution?

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After a year’s hiatus, the Insolvency and Bankruptcy Code (IBC) got back in action in the last days of March. Now, the government has tweaked it to introduced a so-called ‘pre-packaged’ resolution process for micro, small, and medium enterprises (MSMEs).

This mechanism, pre-packs for short, is a way to shrink the 270-day period for the regular corporate insolvency resolution process into a 90-day period.

In a pre-pack, a defaulting company strikes a deal to sell all or some of its assets to a buyer, after getting its lenders on board, before declaring insolvency. It then files this resolution plan with the National Company Law Tribunal for approval. In essence, a defaulter can have its cake and eat it too – it gets to find a buyer or arrive at a settlement before declaring insolvency and gets the benefits of the IBC such as exemption from certain SEBI norms and a court’s stamp of approval.

The most important thing perhaps is that a resolution can be arrived at when a defaulter is still a going concern. If the insolvency process drags on for too long, the value of assets can deteriorate fast and lenders too will have to sacrifice a larger portion of their loans.

And clearly, the insolvency process as it stands now, is not without delays. As of December 31, 1481 out of 1717 companies (86 percent) undergoing resolution have seen their cases stretch past 270 days.

There is also a striking difference from the rest of the bankruptcy code. The cornerstone of the IBC  - and the reason why it is largely praised – is that it took assets away from defaulters. Throughout the insolvency resolution process, creditors exercised control over the stressed asset through a so-called resolution professional. The fear of losing control over their company meant that promoters could no longer get away with default and improved the credit culture.

But in a pre-pack, we are back to a debtor-in-possession model where the defaulting promoter or management can bid. This could reverse the improvements in credit culture seen recently, feel critics.

But then, pre-packs have been introduced only for MSMEs. Unlike bigger firms, MSMEs don’t have the same kind of bidding for stressed assets. They are also exempt from Section 29 A of the IBC which prevents defaulting promoters from bidding for their own assets.

The real problems could arise when this scheme is extended for bigger firms. Will lenders still be okay with the debtor-in-possession model? If that is allowed, we are back to square one of bad asset resolutions – back to the days of promoter entrenchment. Note that one of the key drawbacks of pre-packs is that they are prone to abuse through sweetheart deals. Establishing transparency will be a key factor or it will end up in just adding to litigation, whether it be an MSME or a large company.

In any case, even in MSME pre-packs, the key concern will still be around timelines. According to lawyers dealing with insolvencies, the two main reasons for delays in the corporate insolvency resolution process are creditors dragging their feet on timely approvals of resolution plans and delays at the tribunal.

The first, perhaps, won’t be a factor since MSMEs would likely have fewer creditors. (A related point is that operational creditors also account for a large portion of MSME dues and their voice should be heard; this is a feature in countries like the UK, but the ordinance just says that resolution plans should not impair the claims of operational creditors).

The second factor could still be an issue as there is insufficient infrastructure at the NCLT. At the end of the day, the simplest solution to improve the IBC’s efficiency might be to add more benches and judges to the tribunal.

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Ravi Krishnan

Moneycontrol Pro