The Goods and Services Tax (GST) regime led to some initial teething troubles and subsequently things were settling down for the Micro, Small and Medium Enterprises (MSMEs). But the COVID-19 imposed country-wide lockdown in March 2020 left the MSME sector scrambling for finances to stay afloat.
To battle the economic depression, the Reserve Bank of India (RBI) injected liquidity and extended credit lines by way of a special relief package, including a moratorium on loans with a view to protect businesses from drowning in a quagmire of unquantifiable uncertainty, debt and litigation. With the moratorium clearly being a half-baked solution, additional measures were required to help distressed MSMEs — that employ a sizeable population and contribute over 30 percent to India’s GDP.
In view of the existing recovery gap, the government promulgated an ordinance allowing the use of pre-packs as an insolvency resolution mechanism for the MSMEs with defaults up to Rs 1 crore, under the Insolvency and Bankruptcy Code, 2016 (IB Code). This move comes soon after the end of a one-year suspension of insolvency initiation imposed by the government on the pretext of the COVID-19 pandemic, wherein the minimum default threshold for insolvency proceedings was increased from Rs 1 lakh to Rs 1 crore.
With the increase in threshold to Rs 1 crore, numerous operational creditors, especially MSMEs, were deprived of remedies under the code. Therefore, it appears that the ordinance has been meticulously formulated to soothe distressed MSMEs while placing the pause button on frivolous litigation emanating from losses occurred during the pandemic.
The pre-packaged insolvency framework across jurisdictions is known to plug this wide recovery gap. In fact, pre-pack resolution plans are likely to facilitate adherence to the timelines prescribed under the IB Code. The MSMEs have suffered the most during the pandemic and placing a strict timeline of 120 days by virtue of the pre-pack model is likely to support ailing MSMEs. As a result, the ordinance is likely to provide a cost-effective and faster resolution process for the MSMEs under the debtor in possession model, unlike the normal Corporate Insolvency Resolution Process (CIRP) where it is the resolution professional (RP) in possession.
Simply put, under the pre-pack insolvency framework for the MSMEs, the debtor shall continue to control and run the company till resolution takes place, whereas in the normal CIRP, the RP waltzes in and takes over the debtor company on the day of admission itself. This model shall provide tremendous flexibility and a free hand to existing promoters of the MSMES as well.
Further, the pre-pack model will help distressed companies-corporate debtors to enter into consensual restructuring with lenders and address the liabilities of the company. In addition to this, several procedural requirements on issues, such as claims of creditors may be simplified to make the entire process less rigorous under the MSME framework.
With the ever-evolving nature of the IB Code and insolvency professionals still adapting to the varying levels of power entrusted in them, it will be interesting to see how the debtor companies shall manage to address their liabilities in consonance with this ordinance. Under the debtor-in-possession model, there lies further scope for strengthening both the financial and operational position of the MSMEs, importantly under prevailing COVID-19 crises.
Therefore, in view of the changing dynamics, it is pertinent for debtor companies have to be aware of their own self-worth before undergoing the pre-pack insolvency route to truly salvage the status of such debtor company and revive the business again without resorting to desperate acts of litigation.