Context

The central government has promulgated an ordinance that allows the pre-packs to be used as an insolvency resolution mechanism for Micro, Small and Medium Enterprises (MSMEs) having defaults up to Rs 1 crore under the Insolvency and Bankruptcy Code.

About

• What are pre-packs?
• A pre-pack is theprocess of debt resolutionof a distressed company by an agreement between secured creditors and investors instead ofa public bidding process.
• Under this resolution, the company’s business is negotiated with a buyer before the appointment of an insolvency professional. 
• Pre-pack is a corporate rescue method with both informal (out-of-court) and formal (judicial) insolvency proceedings.
• It is a hybrid framework, as it empowers stakeholders to resolve the debt issue with the minimum assistance of the State.
• Under this system, the financial creditors seek approval from the National Company Law Tribunal (NCLT) regarding the resolution plan.
• NCLT may accept or reject any application
• The plan has to be approved by a minimum of 66 percent of unrelated financial creditors to the corporate is required before a plan is sent to NCLT.
• The pre-pack mechanism permits the Swiss challenge for any resolution plans which proved less than full recovery of dues for operational creditors.
• It will be implemented in parallel to the Corporate Insolvency Resolution Process (CIRP).
• This system of insolvency proceedings is a popular mechanism for insolvency resolution in the UK and Europe.

What was the earlier process?

• Corporate Insolvency Resolution Process (CIRP) is a recovery mechanism for creditors under the IBC, 2016.
• If a corporation becomes insolvent, in this case,a financial creditor, an operational creditor, or the corporate itself may initiate CIRP.

Benefits of pre-packs over the Corporate Insolvency Resolution Process (CIRP)

• CIRP is said to be a time taking resolution process. In the majority of the cases the threshold of 270-days has been crossed.
• The prolonged litigations by promoters and potential bidders are said to be the key reason behind the delays.
• On the other hand, the limit for a pre-pack is 120 days with 90 days available to the stakeholder in bringing the resolution plan to the NCLT.
• Under the CIRP, a resolution professional takes control of the debtor. On the other hand, the in case of pre-pack the management retains control.

What is the need for the pre-pack plan?

• Due to the Covid-19 pandemic, the government had suspended the insolvency act. Now as the one-year suspension had come to an end, the government has initiated a pre-pack solution for the debt resolution.
• The pre-packs will provide MSMEs an opportunity to restructure their liability and to start afresh.
• It will incorporate the consensual restructuring of debt with lenders.
• It also ensures adequate protection by errant promoters.