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Introduction Of Pre-Packs In MSME Sector: The Right Time

A legitimate way to phoenix an insolvent company
Micro, small and medium enterprises (MSME) is considered to be a vital industry and a strong backbone of the Indian economy. This sector employs about 11.1 crore people, and contributes to approximately 28 per cent of India's GDP. Due to the holding of this significant position by the MSMEs, the Government and by extension the legislations formed by the Government should have a duty of care for the protection of the rights of MSMEs.

The Insolvency and Bankruptcy Code, 2016 (IBC), is one such important piece of legislation which has consolidated all the previous laws relating to insolvency and bankruptcy for every company, business, startup and individual. In layman's term, this piece of legislation helps in either the revival or liquidation of an enterprise. Even though this code has proved to be really helpful and is a massive improvement over its predecessors, it has its own problems, many of which affect the MSMEs at a greater scale. For instance, the time and cost incurred in the insolvency proceedings is of considerable value.

Formal insolvency proceedings consist of both direct and indirect costs. The direct costs include payment of court fees, engaging with third party advisors such as lawyers, accountants etc. The indirect costs include the costs of disruption of business such as those resulting from the refusal of counterparties to continue their relationship with the debtor, loss of goodwill, etc. These costs become a question of problem in case of MSMEs.

Further, keeping in mind the current state of the Indian economy, the revival process of companies and entities has come out to be very imperative as frequent cases of liquidation may not prove to be a viable and feasible option for the welfare of the economy. This problem worsens in case of MSMEs due to a lack of investor interest in their assets during the Corporate Insolvency Resolution Process (CIRP). This is where the importance of the introduction of Pre-Packaged Insolvency comes into place.

Now, before going further into why we need Pre-Packaged Insolvency and what is its importance, it is necessary to understand the definition and meaning of both MSME and Pre-Packaged Insolvency.

MSME

MSME are Micro, small and medium enterprises which have been defined under the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 according to the investment in plant and machinery or equipment. However, the Union Cabinet revised the basis of this definition on 1st June, 2020, changing the criteria to classify MSMEs from “investment in plant and machinery or equipment” to “annual turnover”.[1]
Existing MSME Classification
Criteria: Investment in plant and machinery or equipment
Classification Micro Small Medium
Investment in plant and machinery Up to 25 lakh Up to 5 crore Up to 10 crore
Investment in equipment Up to 10 lakh Up to 2 crore Up to 5 crore
 
New and revised MSME Classification
Criteria: Investment and annual turnover
Classification Micro Small Medium
Investment Up to 1 crore Up to 10 crore Up to 50 crore
Annual turnover Up to 5 crore Up to 50 crore Up to 250 crore

The table above shows the change in definition. This definition has further eliminated the difference between manufacturing and service enterprises in relation to investments.

Pre-Packaged Insolvency

Also commonly known as pre-packs, they are defined as arrangements under which the sale of all or part of a company's business or assets is negotiated with a purchaser prior to the appointment of a resolution professional, and the resolution professional affects the sale immediately on, or shortly after, his appointment.[2]

In simple words, a pre-pack is an agreement between the financially distressed company (including its creditors) and the buyer regarding its sale prior to the initiation of the insolvency proceedings.

Need for Pre-Pack in MSMEs

The practice of Pre-Pack has been in existence in developed countries like the US and the UK for many years and has turned out to be quite a success. A Pre-Pack is considered to be very advantageous in terms of speed, cost, risk, efficiency, and confidentiality.

These advantages are most helpful and needed in MSMEs. In general, a promoter of an MSME is the one who is the most interested in the business of an MSME as compared to other resolution applicants. Therefore, based on this rationale, rather than making the firm to go through an expensive and time-consuming CIRP, a pre-pack insolvency regime can be introduced, where the debts and payment of the firm can be restructured in such a way that, it is able to revive itself along with certain operational restructuring.

Further, for introduction of Pre-Packs, it would be safe to initially enable it for small debtors (such as micro and small enterprises), or debtors who do not have complicated debt structures. In INSOL International publication[3].

The relevance of pre-packed insolvency in relation to England and Wales was stated as follows:

From practical experience, the pre-pack sale has become the procedure of choice when trying to save the business of an MSME.

Conclusion
As per the data available till December 2019, it took, on an average, 394 days to successfully resolve 190 cases of insolvency, which far exceeds the timeline of 330 days provided in the IBC.[4] Delays in resolution can cause serious detriment to the going concern value of the debtor by significantly impacting the realizable value of its assets. Further, due to the ongoing Covid-19 crisis, several enterprises are facing financial distress and hardships out of which the worst hit are the MSMEs.

Even though; certain reliefs are provided by the Finance Minister of India for MSMEs in relation to insolvency proceedings, a blanket ban on all insolvency proceedings would lead to a dead-end for those resolutions that may be acceptable for both the debtor and the creditor.

The need of the hour is the introduction of pre-packaged insolvency in India whilst taking notes from the international experience on pre-packs. This should be done in a phased manner, initiating with small and micro companies as they tend to have a small number of financial creditors.[5]

There is an all the more need for the introduction of Pre-Packs in India for adherence of the stringent timelines provided in the insolvency and bankruptcy code, while also cutting down costs of litigation and administration, and helping in decongesting the overburdened NCLTs.

End-Notes:
  1. https://economictimes.indiatimes.com/small-biz/sme-sector/cabinet-approves-new-definition-of-msme-turnover-for-medium-enterprise-increased-to-rs-250-crore/articleshow/76132935.cms
  2. Lorraine Conway, ‘Pre-pack Administrations, House of Commons Library, Briefing Paper Number CBP5035' (2017) House of Commons Library
  3. Insol International-restructuring options for MSMEs and proposals for reforms; https://www.insol.org/_files/Special%20Report/MSME%20report.pdf
  4. Insolvency and Bankruptcy Board of India, Insolvency and Bankruptcy News (The Quarterly Newsletter of the Insolvency and Bankruptcy Board of India, Vol. 13, 2019)
  5. Ministry of Finance, Interim Report of The Bankruptcy Law Reforms Committee (2015) para 8.3; https://www.finmin.nic.in/sites/default/files/Interim_Report_BLRC_0.pdf

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