For decades, MSMEs (Micro, Small, and Medium Enterprises) have been an undeniably important part of the Indian economy. MSMEs are frequently referred to as the "power engines of the economy" due to their ability to create the most job opportunities at the lowest possible cost.

The Micro, Small, and Medium Enterprise Development Act divides MSMEs into two categories: service and manufacturing. Manufacturing enterprises produce or manufacture goods in any industry, whereas service enterprises provide support and services. MSMEs are essentially small-sized business units defined by their investment.

The Insolvency and Bankruptcy Code establishes a comprehensive framework for the timely resolution of insolvency and bankruptcy of corporate entities, LLP, Individuals, Partnerships, and sole Proprietorship firms in order to maximize asset value. The Code, on the other hand, doesn't offer any express or distinct resolution process for MSMEs.  Because most MSMEs are partnerships or sole proprietorships, they must use the standard Corporate Insolvency Resolution Process. These businesses, however, are exempt from the consequences 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 the Central Government’s nationwide lockdown has adversely affected businesses, particularly MSMEs. Following the disruption caused by Covid, the definition of MSMEs was revised with the interests of the Atmanirbhar Bharat Abhiyan in mind, and to ensure that benefits aimed at MSMEs had a broader reach. The following provisions in the Insolvency & Bankruptcy Law provide some respite to Micro, Small, and Medium Enterprises (MSMEs):

• Section 29A of IBC

Section 29A of the Code specifies who is or isn’t eligible to be a Resolution Applicant(s) and thus, serves as an important criterion of eligibility to submit a Resolution Plan. MSMEs have been given relief following the Insolvency and Bankruptcy Code (Second Amendment) Ordinance, by relaxing the applicability of the provisions of Section 29A regarding submission of a resolution plan in case of such entities, in their favour. The purpose of enacting this provision was to grant exemptions to corporate debtors  that 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 an MSME’s Resolution Plan.

The following classes of people are, thus, exempt under Section 29A and are eligible to submit a resolution plan in the case of MSME(s) -

  1. A person who, at the time of submission of the resolution plan,  has an account, or that of a corporate debtor, under his/her management or control, or is the promoter of an account that  has been classified as a non-performing asset by the RBI and at least a year from the date of such classification until the start of the Corporate Debtor CIRP. [Section 29A (c)]
  2. A person who has executed a guarantee in favour of a creditor with respect to a corporate debtor against which the creditor’s action for insolvency resolution has been admitted under the Code, and the guarantee has been invoked by the creditor but remains unpaid in full or part. [Section 29A (h)]

It is important to note, however, that promoters of MSME(s) may attempt  to take unfair advantage of the enacted legislation. To counteract the possibility of foul play, the following individuals are prohibited from submitting a Resolution Plan under the Code’s scheme, 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

Section 240A of the Insolvency & Bankruptcy code has emerged to be a much needed relief to the MSME segment, given the critical role they play in the economy. The Insolvency Law committee report from March 2018 states that Section 240A empowers the Central Government to notify any situation of non-application of the Code’s provisions to MSMEs. The provisions of Section 29A (c) to (h) are, thus, exempt from application to MSMEs. As stated by the Supreme Court in the case of Swiss Ribbons v. Union of India the Code is one of the essential pieces of legislation, containing dynamic and contemporary modifications. Industries that do not meet the  eligibility criteria set forth in Sections 29A(c) and 29A(h) may suffer liquidation. Section 240A gives a Resolution Applicant a viable choice while ensuring that the other prohibitions under Section 29A remain applicable  to all the corporate entities, thereby safeguarding  the sanctity & intent of the Section’s insertion to the Code.

Photo: MSME Data Bank

Analyzing Impact

MSMEs are important contributors to the nation's economy, as they are vital generators of employment, growth & financial inclusion. Under the resolution plan, MSMEs face difficulties recovering their full dues from corporate debtors (who will be referred to the IBC process)  From the perspective of an MSME, one might consider the prevalent IBC recovery process  to be  one-sided. After all, they get nothing if their buyer undergoes liquidation. Considering the amount of debt, the recovery rate, the time taken to realize the amount and the cost incurred in recovery proceedings, the IBC route is financially challenging for MSMEs.

MSMEs being the Corporate Debtors

Maximization of asset value to boost entrepreneurship, loan availability, and stakeholder balance is one of the IBC’s primary goals. Various financial assistance programmes are available to help an MSME expand its borrowing capacity. This reduces the chances of the MSME debtor facing insolvency.  Section 10 of the Act allows a corporate debtor to transfer a  loss-making business to a prospective resolution applicant in exchange for a resolution plan to revive the distressed enterprise. However, after the suspension of Section 10 of IBC, if a MSME debtor defaults during the period, no creditor will be able to initiate an insolvency proceeding.

If the MSME has reaped the benefits of the schemes (as described above), the chance of being declared insolvent (and facing insolvency procedures) is significantly lowered even after the Disruption period has ended. However, this undermines the IBC's primary goal of reviving rather than liquidating the company. The ordinance would not only deny the corporate debtor the opportunity to rehabilitate  the business, it also forces him to continue operating in distress or in a state of duress.  Not only would this decrease asset value rather than maximise it,  it would also result in the closure of a potentially viable business. There is, however, a difference in the case of a stressed MSME debtor who wishes to voluntarily commence a corporate insolvency resolution procedure.

MSMEs being the Operational Creditors

Despite the fact that government initiatives have an overall impact on MSMEs' funding and operations (via the MSME debtor), it is difficult to claim the same for MSME creditors. Given that, MSME creditors would be precluded from filing bankruptcy proceedings to recover their debts if Section 9 of the IBC was suspended. This, in turn, may alleviate the MSME's debtors' fear of insolvency procedures, and such debtors may be less likely to make payments to the distressed MSME. However, under the amended IBC framework, a corporation that heretofore feared the harsh consequences of insolvency proceedings, can ruthlessly bully smaller businesses by failing to pay their debts.

MSMED Act over IBC?

Despite the fact that the MSMED Act, 2006,  addresses the issue of delayed payment, the process has been questioned due to the enforceability of the council. The MSMED Act allows for quick resolution of pending concerns through the council. The IBC is not a mechanism for collecting debts, but rather for resolving disputes between parties.  MSMEs aren't always referred to as "Corporate Debtors," as is commonly understood. These MSMEs serve as the 'Operational Creditors' in a large number of insolvency proceedings. The IBC has a downside in that the debtor may be liquidated, and the Operational Creditor may get very little. With the suspension of sections 7, 9, and 10, causing financial stress in addition to the economic slowdown brought on  by the pandemic, the MSME’s can still leverage the power of the MSMED Act to  ensure that some form of debt recovery is attainable.

The Final Remark

Although the government attempted to amend the IBC’s provisions with the laudable intention of safeguarding MSMEs, we are forced to wonder if it has effectively worsened the situation. MSME insolvency is, and will continue to be a crucial feature  of the entire Insolvency regime, particularly  in countries like India where such enterprises are a major source of development. To avoid these hiccups and time-consuming procedures, effective electronic reporting and submission practices need to be implemented. In a press release, the Hon’ble Finance Minister stated  that under S. 240A of the  IBC, a unique insolvency framework, as well as other targeted actions, must be implemented. This hopefully would provide MSMEs a significant advantage when dealing with large corporations. To really foster the Indian dream of self-reliance, the focus needs to be on the future and regeneration prospects of the industry a corporate debtor operates in during an insolvency process rather than mere procedural consequences.

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

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