The Importance of Incentives in the Pre-pack Resolution Route - A Key Consideration

Introduction:

The Insolvency and Bankruptcy Code (IBC) has recently undergone an amendment that introduces the concept of a pre-packaged insolvency resolution process (PIRP) for micro, small, and medium enterprises (MSMEs). This development comes as a response to the financial strain faced by MSMEs due to the COVID-19 pandemic. The PIRP aims to provide a hybrid mechanism for negotiated debt restructuring, which, upon approval by the National Company Law Tribunal (NCLT), becomes binding on all stakeholders. However, to ensure the effectiveness of the PIRP, it is crucial to incentivize MSMEs to utilize this route.

Background:

MSMEs play a significant role in the Indian economy, accounting for approximately 30% of the gross domestic product and employing over 110 million individuals. These enterprises often lack formal corporate structures and rely on the personal assets of their founders for debt funding. The informal nature of their organization and the dependence on founder management make MSMEs hesitant to engage in an insolvency resolution process that could potentially displace their founders. Additionally, the complexity of the process, high costs involved, and the social stigma associated with personal insolvency further discourage MSMEs from accessing available mechanisms.

The Pre-Pack Resolution Route:

The PIRP aims to minimize disruption to business operations and ensure job preservation by allowing the existing management of the MSME to retain control during the process. Unlike the corporate insolvency resolution process (CIRP), the PIRP requires certain fundamental decisions to be approved by the Committee of Creditors (CoC) and is monitored by a resolution professional (RP). In cases where the existing management mismanages the affairs of the MSME or commits fraud, the management can be handed over to the RP, subject to the approval of the CoC and the NCLT.

Challenges and Considerations:

While the PIRP is a well-intentioned initiative, its success in resolving stress on corporate debtors in the MSME sector depends on addressing implementation challenges and potentially revisiting its design. The ambitious timeline for completing the PIRP could prove to be a significant challenge, considering the delays experienced in the CIRP process. Potential delays in inviting and considering resolution plans, as well as the approval process by the CoC, cannot be overlooked. Moreover, the requirement for duplicate information from the MSME and the RP could also lead to additional delays.

The Need for Incentives:

To encourage MSMEs to opt for the PIRP route, it is essential to provide them with incentives. These incentives could include reduced costs, a simplified process, alleviating the fear of losing one's business, and relaxing eligibility conditions for submitting the base resolution plan. Currently, the design of the PIRP closely resembles that of the CIRP, albeit with truncated timelines. While it is crucial to have appropriate checks and balances, an over-prescriptive approach could deter MSMEs from exploring the PIRP route.

Conclusion:

In conclusion, the introduction of the PIRP in the IBC for MSMEs is a significant step towards addressing financial distress caused by the pandemic. However, the success of this resolution process depends on ironing out implementation challenges and providing the necessary incentives to encourage MSMEs to utilize the route. By striking the right balance between regulatory oversight and practical considerations, the PIRP can effectively contribute to the recovery and growth of the MSME sector in India.