Pre-Pack Insolvency in The Real Estate Sector – The Much-Needed Saviour

Largely the introduction of Pre-Pack insolvency resolution plans in India is a step forward to provide an effective and efficient mechanism for resolving the financial distress of corporate entities

The Central Government introduced the pre-packaged insolvency resolution process (“PPIRP or Pre-Pack”) for corporate persons classified as MSMEsby amending the Insolvency and Bankruptcy Code, 2016 (“Code”) and promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 on 4th April, 2021.

The Pre-Pack amendment was necessitated after COVID-19 pandemic and suspension of CIRP mechanism for a year-long period, which with the low consumer confidence and weak demand led to small businesses being stressed under various financial constraints. It is pertinent to note that PPIRP is specifically designed to assist a Corporate Debtor (“CD”) in resolving its debts and starting over by way of restructuring of liabilities of the company by way of an agreement between the corporate debtor, creditors and other stakeholders.

THE PPIRP MODEL: INTERPLAY OF DEBTOR IN POSSESSION AND CREDITOR IN CONTROL

The Pre-Pack insolvency model is a hybrid model that combines features of both the formal resolution process under the Code and informal restructuring mechanism. Additionally, Pre-pack includes an interplay of the debtor-in-possession and creditor-in-control approach as the debtor would continue to oversee business activities during PPIRP, the resolution professional (“RP”) is in charge of ensuring that the process is fair and transparent and in accordance with the law.

PPIRP allows for a quick and efficient resolution of the CDs financial problems, while also protecting the interests of its creditors against fraudulent and arbitrary conduct of the CD post initiation of PPIRP (Sections 67A and 77A of the Code). However, it is important to note that Pre-Pack is not a one-size-fits-all solution and must be carefully evaluated on a case-by-case basis.

ELIGIBILITY CRITEREA

A CD, classified as a MSME, in terms of sub-Section (1) of Section 7 of the Micro, Small and Medium Enterprises Development Act, 2006 read with relevant notification¹, qualifies to apply for the commencement of the PPIRP if it meets the following criteria:

a) default at least 10 lakh;

b) meets eligibility criteria under Section 29A² of the Code;

c) has not undergone the PPIRP 3 years prior to the initiation date;

d) has not completed the Corporate Insolvency Resolution Process (CIRP) 3 years prior to the initiation date;

e) is not undergoing a CIRP; and

f) has not been ordered for liquidation under Section 33³ of the Code.

CIRP vs. PPIRP

Unlike the CIRP model which follows the creditor in control approach, under the Pre-Pack model the management of the distressed company is allowed to retain control over the business operations, subject to supervision of an insolvency professional appointed by the creditors. This model is premised on the belief that the existing management of the distressed company has the best understanding of its operations and is, therefore, best placed to propose and implement a resolution plan that will maximize the value of its assets and preserve the interests of its stakeholders.

In order to ensure that the National Company Law Tribunal (NLCT) is not faced with a logjam between financial creditors in control versus debtor in control, the amendment by virtue of Section 11A⁴ obliges the NCLT to dispose-of a PPIRP application before considering any applications for CIRP except where the PPIRP is filed 14 days after a CIRP application. The NLCT Bench at Delhi has dealt with the nitty-gritties and importance of the Section in depth.⁵

PPIRP can be initiated either by the corporate debtor or by its financial creditors, followed by the appointment of an insolvency professional (IP) to manage the affairs of the company. The IP then examines the financial position of the company and evaluates the feasibility of a base resolution plan.

If the IP determines that a base resolution plan is feasible, the debtor can submit it to the creditors for approval. The creditors then consider the resolution plan and may approve it with a minimum voting threshold of 66% of the voting share of the financial creditors. After which the resolution plan is submitted for approval with the NCLT, and on approval it is implemented by the debtor and monitored by the IP.

BENEFITS OF PRE-PACK INSOLVENCY

CHALLENGES TO PPIRP IN THE REAL ESTATE SECTOR

The real estate sector in India has been facing significant challenges, with many companies struggling to complete projects due to issues such as liquidity crunch, regulatory compliances, legal disputes etc.

This has resulted in delays and uncertainties for homebuyers, who have invested their hard-earned money in these projects. In such a scenario, the introduction of Pre-Pack specifically for the real estate sector can bring about a ray of hope to the present state of affairs.

Given that the debtors are in control in a Pre-Pack insolvency resolution process, real estate developers can register themselves as MSMEs to file for a resolution with the NCLT.

We see certain challenges with the process and few of them are as under:

1. No clarity on status of MSME of a real estate company: Since there are no prescribed guidelines for real estate/ project companies, this has created a conundrum for the real estate companies and the NCLT, if the companies actually qualify for resolution under Pre-Pack mechanism. A more structured approach with some guidelines will help resolving the issue since it is not uncommon in the close-knit real estate sector for developers to collaborate for resolving the other with some reliefs and concessions in case of a distress. Such a resolution is a win-win situation for all the stakeholders including the homebuyers.

2. Lack of Consensus: Section 54A(e)⁶ of the Code requires CD to obtain mandatory approval from financial creditors, not being related parties, representing not less than 66% within 90 days, which is practically an arduous task in real estate projects, owing to the lack of trust among homebuyers. This aspect also needs to be addressed by the government since it is the most crucial aspect of Pre-Pack of a real estate company.

3. Appointment of IRP: The role of the IRP is a significant area of concern in the implementation of a PPIRP. In a CIRP, the IRP is appointed as soon as the application is admitted. However, in a Pre-Pack scheme even though an IRP is involved by the creditors, the IRP is formally appointed by the NCLT only after the scheme has been finalized, presented before the NCLT and has received its approval. This delay in the appointment of the IRP could result in a lack of supervision and transparency during the Pre-Pack process. The absence of the IRP may raise concerns about the fairness of negotiations, the protection of the interests of all stakeholders, and the credibility of the entire process.

4. Plain sailing Termination of PPIRP: By virtue of Section 54N(4)⁷, if due to fraudulent and preferential act of CD, the CoC decides to vest the control of CD with the RP, the PPIRP will immediately terminate, in which case company shall go for liquidation.

5. Lack of Clarity on applications for initiation of CIRP once Pre-Pack resolution has been initiated: Section 11A of the Code does not envisage a scenario in which the CD is in the process of availing the sanction from the financial creditors and one of the financial creditors files for CIRP to obstruct the application of PPIRP. However, NCLT Jaipur has shown some guidance in the matter of Shree Rajasthan Syntex Ltd. v. SBI &Ors.⁸, and allowed an application for PPIRP, even though filed after 14 days of the application of CIRP under Section 7, and noted that preserving the corporate debtor as a going concern, while ensuring maximum recovery for all creditors is the prime objective of the Code.⁹

The major concern around the process involves absence of the shield of moratorium which is generally available under CIRP. This absence means that creditors may enforce their rights and remedies while the company is negotiating for a Pre-Pack scheme. This could create significant hurdles for the successful implementation of the PPIRP, besides the aspects highlighted hereinabove.

CONCLUSION

Largely the introduction of Pre-Pack insolvency resolution plans in India is a step forward to provide an effective and efficient mechanism for resolving the financial distress of corporate entities. By empowering the existing management to propose and implement a resolution plan, subject to the monitoring by an insolvency professional, the Pre-Pack model seeks to balance the interests of the company, its creditors, and other stakeholders and facilitate a successful outcome for all parties involved. It is expected that the Pre-Pack model will continue to gain popularity in India, as it provides a more streamlined and collaborative approach to resolving financial distress with flexibility of deliberations between CD and its financial creditors and the post-initiation which phase is aimed at value maximisation.

Pre-Pack insolvency can be a beneficial option for real estate developers in India by providing a faster and cost-effective process for resolving insolvency, as it can help preserve the value of the company’s assets, protect the interests of stakeholders and enable the real estate developer to continue operating its business. Further, it provides a much-needed mechanism for fast-tracking the resolution process, and its success will depend on the cooperation and collaboration of all stakeholders involved.

To ensure the success of the PPIRP, the government must take steps to address the underlying issues faced by the real estate sector, including ensuring timely financing. Additionally, the legal system must be prepared to implement the PPIRP in a timely and efficient manner, more so with the proposed expansion to apply PPIRP on a broader range of CDs, as on January 18, 2023. Hence, sector specific regulations for real estate be also notified to streamline the process.

The recent proposal by the Ministry of Corporate Affairs to include a project-wise as well as reverse CIRP insolvency scheme for real estate projects can definitely be seen as a significant step in the right direction towards addressing the unique challenges posed by the behaviour of homebuyers, as compared to traditional financial creditors. This proposal is also a way forward towards acknowledging the judicial evolution of the two significant concepts that were laid down in the case of Flat Buyers Association Winter Hills-77, Gurgaon v Umang Realtech Private Ltd through IRP & Ors.¹⁰ Moreover it also acknowledges the widely recognized fact that a uniform approach cannot effectively tackle the complexities of insolvency in the real estate sector, where each case requires individual attention. However, whether the concept of project-wise and reverse CIRP would also be applicable in the PPIRP proceedings, is still a grey area.

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