What explains the delay in implementing pre-pack restructuring for stressed MSME loans under IBC?
Rating agencies and expert committees could play a role in enhancing the banks’ decision-making in pre-packs
- Aug 8, 2023,
- Updated Aug 8, 2023 12:12 PM IST
Two years ago, when the outbreak of the Covid-19 pandemic dealt a body blow to micro, small, and medium enterprises (MSMEs), the government introduced a simpler pre-packaged insolvency. Unlike the court-driven IBC process, lenders were allowed to restructure the stressed loans of a MSME and obtain the National Company Law Tribunal’s (NCLT’s) approval within 90 days. But pre-packs have been a complete non-starter.
Currently, there are only four MSMEs that have opted for this process—GCCL Infrastructure & Projects, Loonland Developers, Enn Tee International, and Amrit India.
Misha, a Partner at Shardul Amarchand Mangaldas & Co, says the design of pre-pack seems counterintuitive due to its complexity, involving multiple procedural steps and the NCLT at the admission stage.
First, the trigger for pre-packs requires the consent of 66 per cent of lenders. Under the legal provisions, any haircut must be duly recorded. However, bankers are apprehensive about putting their signatures on such records.
“Pre-packs haven’t taken off because of lack of decision-making capabilities at the bank level. There is also unease in financial institutions, particularly with public sector banks because in the past (pre-IBC), commercial decisions have been scrutinised,” says Mani Gupta, Partner at Sarthak Associates. There is a bank bureaucracy that takes its own time to process or take a call on the resolution or haircut.
Promoters of stressed firms also fear that a pre-pack could be converted into a full-fledged insolvency process. For instance, if the lenders detect fraud, the company defaults, or the enterprise value is lower than the liquidation value, the financial creditors would call for a bid on the company.
Aashit Shah from JSA Solicitors describes the promoters’ concerns about the Swiss challenge clause, which comes into effect when a resolution plan proposes a haircut for operational creditors. He describes the pre-pack model as complex because it necessitates providing operational creditors with the full value under the pre-pack plan to avoid going through a bidding process.
Under the Swiss challenge mechanism, bidding will be allowed to encourage new players to come in with a better resolution plan. “Why will a promoter change himself by getting into prepacks If the promoter has the slightest doubt or hint that he is going to get replaced?” asked a consultant.
Bhrugesh Amin, Partner at BDO Restructuring Advisory LLP, explains that promoters might delay the early recognition of stress and the initiation of a pre-pack due to their apprehension about losing control.
The pre-pack regulations were drafted with the objective of putting the debtor in control as opposed to IBC, where creditors are in control. According to Regulation 50, creditors can impose limitations on specific value transactions in pre-packs. “The committee of creditors (COC) holds the authority to impose such restrictions,” says Amin.
The key lies in enhancing the decision-making capacity of bankers. One potential solution could involve incorporating the concept of rating agencies or forming an independent committee of external experts to evaluate and endorse the commercial viability of the resolution solution under the pre-pack process.
“The comfort has to be given by the government of the day, perhaps the RBI, that if you restructure, which is within the commercial framework, and commercially justifiable, nobody is going to question the commercial wisdom of officers who have signed on to it. If that is done, then perhaps there is some kind of hope for prepacks,” says Gupta of Sarthak Associates.
Two years ago, when the outbreak of the Covid-19 pandemic dealt a body blow to micro, small, and medium enterprises (MSMEs), the government introduced a simpler pre-packaged insolvency. Unlike the court-driven IBC process, lenders were allowed to restructure the stressed loans of a MSME and obtain the National Company Law Tribunal’s (NCLT’s) approval within 90 days. But pre-packs have been a complete non-starter.
Currently, there are only four MSMEs that have opted for this process—GCCL Infrastructure & Projects, Loonland Developers, Enn Tee International, and Amrit India.
Misha, a Partner at Shardul Amarchand Mangaldas & Co, says the design of pre-pack seems counterintuitive due to its complexity, involving multiple procedural steps and the NCLT at the admission stage.
First, the trigger for pre-packs requires the consent of 66 per cent of lenders. Under the legal provisions, any haircut must be duly recorded. However, bankers are apprehensive about putting their signatures on such records.
“Pre-packs haven’t taken off because of lack of decision-making capabilities at the bank level. There is also unease in financial institutions, particularly with public sector banks because in the past (pre-IBC), commercial decisions have been scrutinised,” says Mani Gupta, Partner at Sarthak Associates. There is a bank bureaucracy that takes its own time to process or take a call on the resolution or haircut.
Promoters of stressed firms also fear that a pre-pack could be converted into a full-fledged insolvency process. For instance, if the lenders detect fraud, the company defaults, or the enterprise value is lower than the liquidation value, the financial creditors would call for a bid on the company.
Aashit Shah from JSA Solicitors describes the promoters’ concerns about the Swiss challenge clause, which comes into effect when a resolution plan proposes a haircut for operational creditors. He describes the pre-pack model as complex because it necessitates providing operational creditors with the full value under the pre-pack plan to avoid going through a bidding process.
Under the Swiss challenge mechanism, bidding will be allowed to encourage new players to come in with a better resolution plan. “Why will a promoter change himself by getting into prepacks If the promoter has the slightest doubt or hint that he is going to get replaced?” asked a consultant.
Bhrugesh Amin, Partner at BDO Restructuring Advisory LLP, explains that promoters might delay the early recognition of stress and the initiation of a pre-pack due to their apprehension about losing control.
The pre-pack regulations were drafted with the objective of putting the debtor in control as opposed to IBC, where creditors are in control. According to Regulation 50, creditors can impose limitations on specific value transactions in pre-packs. “The committee of creditors (COC) holds the authority to impose such restrictions,” says Amin.
The key lies in enhancing the decision-making capacity of bankers. One potential solution could involve incorporating the concept of rating agencies or forming an independent committee of external experts to evaluate and endorse the commercial viability of the resolution solution under the pre-pack process.
“The comfort has to be given by the government of the day, perhaps the RBI, that if you restructure, which is within the commercial framework, and commercially justifiable, nobody is going to question the commercial wisdom of officers who have signed on to it. If that is done, then perhaps there is some kind of hope for prepacks,” says Gupta of Sarthak Associates.