From UPSC perspective, the following things are important :
Prelims level : Pre-Packs, IBC
Mains level : Not Much
India introduced the pre-packaged insolvency resolution process (PPIRP) in April 2021, as an alternative resolution process for micro, small and medium enterprises (MSMEs). However, it has only two cases admitted under it so far.
What is the Insolvency and Bankruptcy Code (IBC)?
- The IBC was enacted in 2016 to simplify insolvency and bankruptcy proceedings, safeguard interests of all stakeholders (the firm, employees, debtors and especially creditors), and resolve non-performing assets.
- From a ‘debtor in possession’ regime, it was a shift to a ‘creditor in control’ one.
- IBC provides for a time-bound process for resolving insolvencies.
- The Insolvency and Bankruptcy Board of India (IBBI) is the regulator implementing the code and overseeing the functioning of stakeholders.
- The IBBI last week allowed payment of performance-linked incentives to resolution professionals.
What are Pre-packs?
- A pre-pack is the resolution of the debt of a distressed company through an agreement between secured creditors and investors instead of a public bidding process.
- This system of insolvency proceedings has become an increasingly popular mechanism for insolvency resolution in the UK and Europe over the past decade.
- Under the pre-pack system, financial creditors will agree to terms with a potential investor and seek approval of the resolution plan from the National Company Law Tribunal (NCLT).
- The approval of a minimum of 66 percent of financial creditors that are unrelated to the corporate debtor would be required before a resolution plan is submitted to the NCLT.
- Further NCLTs are also required to either accept or reject any application for a pre-pack insolvency proceeding before considering a petition for a corporate insolvency resolution process (CIRP).
How does it work?
- Unlike the CIRP, an informal understanding is reached with creditors before the application is filed.
- PPIRP begins only after 66% of financial creditors approve the proposal and the name of resolution professional.
- Debt resolution agreement between financial creditor and a potential investor is arrived at in consultation with the corporate debtor for which subsequent approval of the resolution plan is sought from the NCLT.
What were the objectives behind introducing PPIRP?
- MSMEs greatly contribute to the economy, and employ a wide section of the population.
- The pandemic severely impacted their operations.
- This alternative insolvency resolution process was designed to ensure quicker, cost-effective and value-maximizing outcomes for all.
What is the progress in PPIRP so far?
- Only two insolvency cases have been initiated under PPIRP since it was introduced.
- The poor response has been attributed to the hesitancy on the part of financial institutions.
- In the case of CIRP, the haircut involved is a last resort, against a voluntary one in case of PPIRP.
- Data shows that between December 2016 and June 2022, a total of 5,636 CIRPs commenced, of which 3,637 have been closed.
Does PPIRP defeat the purpose of IBC?
- The IBC’s objective is to facilitate exit from failed units so that capital can be reallocated to better ones.
- However, banks are not comfortable initiating PPIRP due to voluntary haircuts.
- There is a fear that such a decision might be scrutinized later.
- This means capital will remain locked up in failed units, defeating the purpose of IBC.
- Voluntary haircuts mean fewer resources from the winding-up process and greater scope for corrupt practices.