Micro, Small, and Medium Enterprises (MSMEs) have been an undeniably important part of the Indian economy for decades. MSMEs are often referred to as the 'power engines of the economy', for generating the largest employment opportunities at comparatively lower costs. The Micro, Small & Medium Enterprises Development Act, classifies MSMEs into two classes, namely, Service and Manufacturing. Manufacturing enterprises engage in the production or manufacture of goods in any industry while service enterprises are engaged in providing support & services. MSMEs are basically small-sized business units defined in terms of their investment.

The Insolvency and Bankruptcy Code provides a comprehensive framework for Resolution of Insolvency and Bankruptcy of Corporate persons, LLP, Individuals, Partnerships, and Sole Proprietorship Firms in a time-bound manner for maximization of value of assets. The Code however, doesn't offer any express or distinct resolution process for MSMEs. Most MSMEs by virtue of being partnership or proprietorship firms, have to resort to the standard Corporate Insolvency Resolution Process. However, these enterprises are excluded from the implications imposed by section 29A of the code.

MSME Legal Safeguards and Provisions, Photo: AMLEGALS

MSMEs under Insolvency and Bankruptcy Code, 2016

It is no secret that the onset of COVID-19 and a nationwide lockdown imposed by the Central Government has adversely affected the businesses, and more so in the case of MSMEs. The definition of MSMEs was revised keeping in mind the interests of Atmanirbhar Bharat Abhiyan, and to ensure that benefits aimed at MSMEs had a wider reach following the disruption caused by Covid. The following provisions on the Insolvency & Bankruptcy Law provide some respite to Micro, Small, and Medium Enterprises (MSMEs):

• Section 29A of IBC

Section 29A of the Code provides for the persons who are ineligible to be Resolution Applicant(s) and thus, forms an important criterion of eligibility to submit a Resolution Plan. After the Insolvency and Bankruptcy Code (Second Amendment) Ordinance, MSMEs have been given relief, by relaxing the applicability of the provisions of Section 29A regarding submission of a resolution plan in case of such entities in their favor. The intention behind the enactment of this provision was to grant exemptions to corporate debtors which are MSME(s), by permitting a promoter who is not a willful defaulter or covered under any other specific disqualification as provided under Section 29A, to bid for the Resolution Plan of an MSME.

As per the above mentioned amendment, the following classes of people are exempted under Section 29A and hence, they are eligible to submit a resolution plan in case of MSME(s)-

  1. A person who at the time of submission of the resolution plan has an account or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter which is classified as non-performing asset in by the RBI and at least a period of 1 year has lapsed from the date of such classification till the date of commencement of CIRP of Corporate Debtor. [Section 29A (c)]
  2. A person who has executed a guarantee in favour of a creditor in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under the Code and such guarantee has been invoked by the creditor and remains unpaid in full or part. [Section 29A (h)]

However, it is important to note that Promoters of MSME(s) may try to take undue advantage of the enacted legislation. Therefore the following persons are prohibited from submitting a Resolution Plan under the Scheme of the Code, including, MSME(s):

  1. Any person, who is declared an insolvent[Section 29A(a)].
  2. Any person who is a willful defaulter in terms of the RBI Guidelines issued under the Banking Regulation Act, 1949[Section 29A(b)].
  3. Any person who has been convicted for any offence punishable with imprisonment for two years or more under specified Acts; or for seven years or more under any law for time being in force[Section 29A(d)].
  4. Any person who is disqualified to act as a director under the Companies Act, 2013[Section 29A(e)].
  5. Any person who is prohibited by the Securities and Exchange Board of India (SEBI) from trading in securities or accessing the securities market[Section 29A(f)].
  6. Any person, who has been in the management, control or promoter of a Corporate Debtor in which a preferential transaction, undervalued transaction, extortionate credit transaction or fraudulent transaction has taken place and in respect of which an order has been made by the Adjudicating Authority under the Code. [Section 29A(g)].
  7. Any person who, comes within the purview of a connected person[Section 29A(j)].

• Section 240A of IBC

The Insolvency and Bankruptcy Code, provides relaxations to MSMEs, vide section 240A. The Insolvency Law Committee Report of March 2018 had recommended the grant of certain concessions to MSMEs due to their vital role in the economy.  Section 240A gives power to the Central Government to notify any non application of provisions of the Code to MSMEs and by virtue of such power the provisions of Section 29A (c) to (h) have been exempted from being applicable to MSMEs.

In the case of Swiss Ribbons v. Union of India, it was observed by the Supreme Court that the Code is one of the most important legislations consisting of dynamic and contemporary changes. Thus, the industries, excluded from the eligibility criteria laid down in Section 29A(c) and 29A(h) will face potential liquidation. Section 240A provides a legitimate opportunity to a Resolution Applicant while making sure that the other prohibitions under Section 29A would continue to apply to all the corporate entities, thereby protecting the sanctity & intent behind the insertion of the Section, and the Code as an extension. This is the exact reason why limited exemptions have been granted under Section 240A in a purely contextual purpose of the Code, and the sustenance of MSME(s) in the Indian economic paradigm.

Photo: MSME Data Bank

Analyzing Impact

MSMEs are considered as the key drivers of employment, growth & financial inclusion contributing significantly to the economy of the nation. MSMEs face difficulties recovering their full dues from the corporate debtor (being referred to the IBC process) under the resolution plan. MSMEs find the prevalent recovery process under IBC, as one-sided process(as they get nothing if their buyer undergoes liquidation). Considering the amount of debt, the recovery rate as well as the time taken to realize the amount and, the cost incurred in recovery proceedings, the IBC route presents itself quite challenging for MSMEs.

MSMEs being the Corporate Debtors

One of the objectives IBC has is maximization of the value of assets, to promote entrepreneurship, availability of credit and to balance the interests of the stakeholders. Various schemes provide financial support, to increase the borrowing appetite of an MSME. This keeps the risk of insolvency proceedings for the MSME debtor at bay . Section 10 of the Act, facilitates an exit route to a corporate debtor wherein the loss-making business is transferred to a prospective resolution applicant based on a resolution plan to revive the sick enterprise. However, after the suspension of Section 10 of IBC, if a MSME debtor defaults during the disruption period, it will not be possible for any creditor to initiate the insolvency proceedings.

Even after the Disruption period, if the MSME has gained the benefits under  the  schemes (as  above),  the risk  of being declared insolvent is greatly reduced. This defeats the core objective of the IBC to revive and not to liquidate the enterprise. Suspension of the section would lead to a slow death of the business enterprises which could have been revived with a prospective plan. The ordinance would not only deprive the corporate debtor of rehabilitating the business but also force him to continue the distressed business. Therefore, this would not only deplete the value of assets rather than maximizing them but also lead to the winding-up of a potentially viable business, though the position may not be the same for a stressed MSME debtor who intends to voluntarily initiate corporate insolvency resolution process.

MSMEs being the Operational Creditors

Though, MSME debtors stand in a beneficial position, it is difficult to say the same for MSME creditors, despite the government schemes having an overall impact on the financing and operations of the MSMEs. With the suspension of Section 9 of IBC, MSMEs creditors would  be debarred from initiating insolvency proceedings for the recovery of their dues. This, indirectly, could relieve the debtors of the MSME from the fear of insolvency  proceedings and such debtors may tend to deter in making payments to the distressed MSMEs. However, under the garb of the amended IBC framework, a corporate who earlier feared the harsh consequences of insolvency proceedings would now fearlessly strong-arm the smaller firms by defaulting the repayment of their dues.

MSMED Act over IBC?

Although the MSMED Act addresses the issue of delayed payment, the said process has been highly questionable owing to the enforceability of the awards passed by the council. The MSMED Act provides speedy recourse through the council to resolve pending issues. The IBC is not a mechanism for the recovery of dues but for the resolution of disputes between the parties. MSMEs aren't in every case the 'Corporate Debtors' as is often wrongly assumed. In a vast number of insolvency cases, these MSMEs act as the 'Operational Creditors'. There is a disadvantage associated with the IBC whereby the debtor may undergo liquidation and as per the waterfall mechanism, the Operational Creditor may receive close to nothing. With the suspension of sections 7, 9, and 10, causing financial stress apart from the economic slowdown caused by the pandemic, the MSME’s can still avail the benefits of the MSMED Act to assure that some amount of recourse is provided by way of debt recovery.

The Final Remark

Though the government has tried to modify the provisions of the IBC with a bonafide intention to safeguard the MSMEs, today we are left asking ourselves if it has ended up worsening the situation for them. MSME insolvency is and will be a crucial aspect of the entire Insolvency regime especially in countries like India where development is majorly backed by such enterprises. To mitigate these teething troubles, it’s important that the hectic procedure and formalities be scrapped or replaced with more efficient electronic noticing and submission practices. The Hon’ble Finance Minister mentioned in her press note that, a special insolvency framework needs to be introduced under S. 240A of IBC accompanied with other focused initiatives. This would only provide a huge leverage to MSMEs going up against  powerful corporates. Further, during an insolvency proceeding, it’s extremely important to lay emphasis on the future  and revival prospects of the industry. A corporate debtor operates in rather than just procedural ramifications to truly uphold the Indian ambition of self-reliance.

To know more about Section 29A, Debt recovery & Insolvency, we recommend you read

•  Section 29A of Insolvency and Bankruptcy Code - Resolution over liquidation?

•  Unravelling IBC Ordinance 2020

About SignalX's 29A Eligibility Automation Solution.

SignalX's 29A Eligibility Check Automation solution is custom built to help Insolvency Professionals analyze RA's, discover connected parties, establish CD/RA independence and analyze CDs. Take a tour of our 29A solution by booking a free live demo today.

Click here to book a Demo