Corporate Laws Newsletter: Pre-Packaged Insolvency Resolution Process – May 2021

The COVID-19 pandemic halted the resolution process for small businesses classified under the MSME sector due to the suspension of the Insolvency and Bankruptcy Code (“IBC”) in March 2020. The Government of India has amended the IBC to introduce Pre-Packaged Insolvency Resolution Process1 (“PPIP”). The amendments are applicable to Micro, Small & Medium Enterprises (“MSMEs”) and aim for a speedy and inexpensive insolvency resolution process. Under PPIP, the threshold limits for admission are between Rs.10 Lakhs and Rs.1 Crore and the resolution process is to be completed within a period of 120 days as against the CIRP route which takes up to 330 days. The most remarkable feature of PPIP is that the management can continue to control the distressed business unlike the general bankruptcy procedure where there is a shift of control in hands of creditors.

The debtor gets the opportunity to retain the control and management of the affairs of its business and also to prepare a resolution plan for the revival of the corporate debtor, thereby reducing creditor’s control over debtor’s activities. The application for initiating PPIP can be filed by corporate applicant only if the eligibility criteria as per the latest amendments to IBC are met2 which consists of an entity which has neither undergone Pre-Packaged Insolvency Resolution process or completed CIRP during the preceding 3 (Three) years nor is undergoing a CIRP or liquidation process currently. Applicant is inter alia required to get approval from at least 66% financial creditors before submitting the resolution plan before the NCLT. If the Applicant does not have financial creditors, approval from their directors or partners is sufficient. The adjudicating authority would accept or reject the application within 14 days from the receipt of application. In case of rejection, a 7 days’ notice for rectification of defects must be given to the applicant. Moratorium period available under Section 14 of IBC applies to PPIP.

The amendments introduced in the IBC by way of the PPIP provide a separate framework for MSMEs which facilitates quicker and cost-effective resolution of insolvency proceedings. The introduction of PPIP will help to alleviate the distress to various stakeholders due to the disruption in business activities on account of the pandemic and related restrictions on conducting business. Impact of Change in Control provisions on Employee Stock Options Plan (ESOP) of companies Employee stock options (“ESOPs”) provide employees an opportunity to acquire a share in the wealth that they have helped create for the company by having an option to purchase shares of the company at a concessional rate. Companies implement the ESOP mechanism as a tool to retain and reward their star performers, retain talent, and incentivize potential employees to be associated with the company.

A company may undergo a corporate restructuring event resulting in change of control such as merger, amalgamation, demerger, acquisition, etc. at any time. When a company which has issued ESOPs to its employees is being acquired by another company (“Change in Control Event”), the acquirer may want to replace the ESOPs issued by the target with options of the acquirer entity. Typically, a Change in Control Event may trigger concerns in relation to integration of human resources and alterations to the employment terms of the employees. Considering the commercial and legal implications of ESOPs and apprehensions of employees, structuring the treatment of existing ESOPs issued by the target company is one of the key considerations in an acquisition. In any Change in Control Event of a company, the ESOPs granted to employees may be: (a) unvested; (b) vested and exercised; (c) vested but not exercised.

What happens to unvested ESOPs in case of a Change in Control Event?

In case of any unvested options, the company may either: – accelerate the unvested ESOPs and provide an option to the employees to exercise such ESOPs within a defined exercise period else options will lapse.

– where the ESOP plan does not provide for accelerated vesting, the acquirer may choose to cash out the ESOPs held by the employees of the target in lieu of the employees exercising the options and being issued shares. Cashing out of the ESOPs would involve termination of the ESOPs and payment of a sum equal to the fair market value of the shares of the target company or the price at which the equity shares are being acquired by the acquirer less the agreed exercise price and tax to be deducted at source; or

– make the employees to surrender the unvested ESOPs and replace it with options of the acquirer post the merger / acquisition of the target company. This option would be available only in the case of employees who continue to be employed with the target even after the acquisition.

In the event the acquirer is an Indian resident entity of a listed entity, the acquirer is required to ensure compliance with the Companies Act and SEBI (Share Based Employee Benefits) Regulations, 2014 for issuance of ESOPs to the employees of the entity being acquired. If the acquirer is a foreign entity, the acquirer will need to ensure compliance with Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004, issued by Reserve Bank of India for the issuance of ESOPs to employees or directors of the Indian target. The terms of surrender will need to be mutually agreed by the target company and the employee. Instead of causing employees to surrender the ESOPs, the company may also choose to terminate the unvested ESOPs pursuant to the ESOP plan and the grant agreements. Varying the terms of the ESOP plan to provide for termination of unvested ESOPs may be construed to be a variation prejudicial to the interest of the employees and thus may be a challenging task.

Further, issue of new ESOPs under an entirely new plan of the acquirer may result in new vesting periods, exercise price and even performance linked conditions. All the employees of the target company who were option holders may not even be considered eligible to receive options under the ESOP plan of the acquirer. Therefore, acquirers may face resistance from employees in the case of a requirement to surrender the options they hold.

What happens to vested and exercised ESOPs in case of a Change in Control Event?

For the employee of the target company who has exercised their vested ESOPs and converted them into equity shares, the acquirer will need to purchase the shares held by such employees along with the remaining shareholders of the target company to ensure that it has complete control over the company. The equity shares held by existing employees of the target can be purchased by the acquirer at the same value at which the acquirer is purchasing the remaining equity shares to incentivize the employees to sell their equity shares.

What happens to vested and unexercised ESOPs in case of a Change in Control Event?

If there are any options are vested, the same will have to be exercised by the option holder on or before the expiry of the exercise period as per the ESOP plan and grant agreement, else they will lapse.