Behind the lukewarm response to pre-pack insolvency

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India introduced the prepackaged insolvency resolution process (PPIRP) in April 2021 as an alternative resolution process for micro, small and medium-sized enterprises (SMEs). However, it has admitted only two cases so far. TBEN investigates the reasons.

What is the Insolvency and Bankruptcy Act?

The IBC was introduced in 2016 to simplify insolvency and bankruptcy procedures, protect the interests of all stakeholders (the company, employees, debtors and especially creditors) and resolve non-performing assets. It was a shift from a ‘debtor in possession’ regime to a ‘creditor in control’ regime. IBC provides a time-bound process for resolving bankruptcy. The Insolvency and Bankruptcy Board of India (IBBI) is the regulator that implements the code and oversees the functioning of stakeholders. The IBBI last week authorized the payment of performance-related incentives to resolution professionals.

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What are the distinguishing features of PPIRP?

On April 4, 2021, the government issued a regulation to allow the use of ‘pre-packs’ as an insolvency resolution mechanism for SMEs. Unlike the corporate insolvency process (CIRP), an informal agreement is reached with creditors before the application is filed. PPIRP starts only after 66% of financial creditors approve the proposal and the name of the resolution professional. Debt settlement agreement between financial creditor and a potential investor is concluded in consultation with the corporate debtor, for which approval of the settlement plan is then requested from the NCLT.

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What were the objectives behind the introduction of PPIRP?

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MSMEs are a major contributor to the economy and provide employment for a large segment of the population. The pandemic had a major impact on their operations. With this in mind, the unique nature of their business and a simpler corporate structure, an alternative insolvency resolution process was designed to ensure faster, cost-effective and value-maximizing results for everyone.

What is the progress in PPIRP so far?

Since the introduction of PPIRP, only two insolvency cases have been started: Loon Land Developers from Delhi and GCCL Infra-structure & Projects from Ahmedabad. The poor response is attributed to the hesitation of financial institutions. In the case of CIRP, the haircut involved is a last resort, as opposed to a voluntary one in the case of PPIRP. Data shows that between December 2016 and June 2022, a total of 5,636 CIRPs were started, of which 3,637 were closed.

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Does PPIRP Beat IBC’s Goal?

The purpose of the IBC is to facilitate the exit of failed units so that capital can be allocated to better ones. However, banks are not comfortable starting PPIRP due to voluntary haircuts. There are fears that such a decision will be examined at a later date. This means that capital remains locked in failed units, negating the purpose of IBC. Voluntary haircuts mean fewer resources from the liquidation process and more room for corrupt practices.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH

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