The central government has promulgated an ordinance allowing the use of pre-packs as an insolvency resolution mechanism for MSMEs with defaults up to Rs 1 crore, under the Insolvency and Bankruptcy Code.

Read till the end to know about the ‘Swiss Challenge’.

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 CIRP.

Benefits of pre-packs over the CIRP

• One of the key criticisms of the Corporate Insolvency Resolution Process (CIRP) has been the time taken for resolution.
• One of the key reasons behind delays in the CIRPs is prolonged litigations by erstwhile promoters and potential bidders.
• The pre-pack in contrast is limited to a maximum of 120 days with only 90 days available to the stakeholders to bring the resolution plan to the NCLT.
• The existing management retains control in the case of pre-packs while a resolution professional takes control of the debtor as a representative of creditors in the case of CIRP.
• This allows for minimal disruption of operations relative to a CIRP.

What is the key motivation behind the introduction of the pre-pack?

• Pre-packs are largely aimed at providing MSMEs with an opportunity to restructure their liabilities and start with a clean slate.
• It provides adequate protections so that the system is not misused by firms to avoid making payments to creditors.
• Pre-packs help corporate debtors to enter into consensual restructuring with lenders and address the entire liability side of the company.

How are creditors protected?

• The pre-pack also provides adequate protection to ensure the provisions were not misused by errant promoters.
• The pre-pack mechanism allows for a swiss challenge for any resolution plans which proved less than full recovery of dues for operational creditors.
• Under the swiss challenge mechanism, any third party would be permitted to submit a resolution plan for the distressed company and the original applicant would have to either match the improved resolution plan or forego the investment.
• Creditors are also permitted to seek resolution plans from any third party if they are not satisfied with the resolution plan put forth by the promoter.

Back2Basics: Swiss Challenge

• A Swiss Challenge is a method of bidding, often used in public projects, in which an interested party initiates a proposal for a contract or the bid for a project.
• The government then puts the details of the project out in the public and invites proposals from others interested in executing it.
• On the receipt of these bids, the original contractor gets an opportunity to match the best bid.
• In 2009, the Supreme Court approved this method for the award of contracts.
• This method can be applied to projects that are taken up on a PPP basis but can also be used to supplement PPP in sectors that are not covered under the PPP framework.

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