By Mr. Sanjeev Pandey, CEO, AIPE
Executive Summary
Prepackaged insolvency was introduced in India in 2021 to offer Micro, Small, and Medium Enterprises (MSMEs) a quicker and more efficient resolution process under the Insolvency and Bankruptcy Code (IBC). Despite its promise, the framework has seen limited uptake. This article explores the reasons behind the lack of traction, analyses both structural and operational shortcomings, and suggests practical reforms drawn from global best practices. By addressing these issues with targeted legal, institutional, and procedural reforms, prepackaged insolvency could become a viable tool for timely business rescue in India.
1. Introduction: Legal Framework and Objective
India introduced the prepackaged insolvency framework through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, on April 4, 2021. It was designed to provide MSMEs with a streamlined process to resolve financial distress quickly, while minimising disruption to ongoing business operations. Unlike the standard Corporate Insolvency Resolution Process (CIRP), prepack insolvency aimed to balance creditor rights with the operational continuity of debtors through a debtor-in-possession model.
2. The Cost Burden of Traditional Insolvency Processes
Bankruptcy processes inherently carry both direct and indirect costs:
- Direct Costs: These include fees for insolvency professionals, lawyers, valuers, and accountants. A U.S. study estimates that Chapter 11 proceedings can cost 2–7% of debtor assets; similarly, Indian CIRP cases may cost 2–5%, often higher for smaller or asset-light companies.
- Indirect Costs: These are less visible but can be more damaging—loss of customer and employee confidence, disrupted operations, and foregone investment opportunities. These effects can erode 10–20% of a debtor’s value during CIRP.
In contrast, prepackaged insolvency was conceptualized to reduce such costs by avoiding public announcements, maintaining managerial control, and facilitating faster resolutions through pre-negotiated plans.
3. Key Features of the Prepack Framework
- Silent Process: No public announcement to limit reputational damage.
- Debtor-in-Possession: Promoters retain control, reducing internal disruption.
- Pre-Negotiated Resolution Plan: The Plan is discussed and voted on before formal NCLT proceedings begin.
- 120-Day Time Frame: Designed for efficiency but often undermined by judicial delays.
Despite these features, uptake has been extremely limited, prompting a closer examination.
4. Why Prepackaged Insolvency Failed to Take Off
A. For the Corporate Debtor
- Legal Complexity: MSMEs often lack the legal and financial sophistication to navigate detailed procedural requirements, such as multiple affidavits and transaction audits.
- Risk of Escalation to CIRP: Fear that any discrepancy may derail the prepack plan and trigger a full CIRP deters promoters.
B. For Creditors
- Information Asymmetry: Lenders often lack visibility on asset quality and cash flows due to limited third-party oversight during prepack.
- Perception of Bias: The debtor-led nature of prepacks raises concerns about promoter motivations and the risk of moral hazard.
- Limited Asset Valuation Confidence: Without transparent price discovery, recommending deep haircuts to sanctioning authorities becomes difficult.
C. Systemic and Judicial Limitations
- Judicial Delays: Despite the 120-day mandate, delays in NCLT admissions and interim applications diminish time value of assets.
- Lack of Pre-Moratorium Protection: Assets remain exposed to enforcement actions before admission, undermining resolution efforts.
5. Structural Flaws and Operational Inefficiencies
- Inadequate Role of RP: The resolution professional’s supervisory role did not generate sufficient trust among creditors.
- Limited Legal Safeguards: The absence of robust provisions to prevent undervalued or preferential transactions pre-admission adds uncertainty.
- Section 29A: Its broad applicability continues to restrict genuine promoters from participating in resolution plans.
6. Suggestions for Improvement
1. Simplify the Process:
- Introduce lighter procedural requirements.
- Enable fast-track hearings and reduce interim litigation.
2. Institutional Reforms:
- Establish dedicated NCLT benches for insolvency with commercially astute members.
- Provide continuous training on financial restructuring and commercial viability.
3. Policy Enhancements:
- Gradually extend the prepack framework to larger corporates.
- Modify Section 29A to create safe harbours for genuine promoters.
4. Promote Transparency and Credibility:
- Mandate third-party asset and cash flow audits during pre-negotiation.
- Encourage CoC participation from the early stages, even before formal filing.
5. Learn from Global Best Practices:
- USA: Use of pre-negotiated Chapter 11 to reduce costs.
- UK: Use of the Pre-Pack Pool to assess fairness of plans.
- Singapore: Simple, court-light insolvency for small firms.
7. Way Forward: A Calibrated Revival
Prepackaged insolvency can still be a powerful tool for business rescue, provided it undergoes thoughtful recalibration. It must evolve from a legalistic, form-driven process into a pragmatic resolution platform that inspires trust among all stakeholders—debtors, creditors, and adjudicating authorities.
India’s experience shows that innovation in law must be accompanied by investment in institutions, trust-building mechanisms, and pragmatic policy support. Prepacks were not a bad idea—they were simply rolled out in an ecosystem not yet ready to support them.
8. Conclusion
The prepackaged insolvency framework in India aimed to offer MSMEs a less disruptive path to recovery. However, it struggled under the weight of legal complexity, creditor mistrust, and systemic delays. With strategic reforms—such as simplified procedures, enhanced transparency, targeted legal changes, and lessons from global regimes—this framework can still be a cornerstone in India’s insolvency architecture.
The future of prepacks depends on how well we can balance legal discipline with commercial pragmatism.