Impact of insolvency and bankruptcy code on MSMEs

By Gautam Khurana and Sanjeev Ahuja, India Law Offices

Micro, small and medium enterprises (MSME) contribute 8% to GDP, employ 106 million, that is 40% of the workforce, produce 45% of manufacturing output and 40% of total exports. While MSMEs play a vital part in the economy, they are vulnerable and exposed, and need support. If this sector could be strengthened, MSMEs could become even greater drivers of growth and exports. Nowhere is such support needed as in the relationship between MSMEs and the Insolvency and Bankruptcy Code, 2016 (IBC).

Gautam Khurana India Law Offices Indian manufacturing
Gautam Khurana
Managing Partner
India Law Offices

When the IBC passed into law, it was applicable to all corporate bodies and LLPs equally. After that, a series of amendments was introduced following the experience of a number of major cases, and the saga of inequality began. The infamous amendment of section 29A, which listed situations under which the eligibility of resolution applicants had to be determined, prevented many existing promoters and owners from meeting the eligibility threshold. Most MSMEs were, and continue to be, family-owned, family-run units.

Promoters are the face of the organization and manage relationships with stakeholders. Making them ineligible at a stroke became a nightmare for resolution professionals who found it difficult to get a response from third party resolution applicants. This left liquidation as the only option. A limited amendment to section 29A applicability, introduced by section 240A, was intended to create an exemption for MSMEs, but had limited success. The impact of the IBC in general and the limited impact of the amendments on MSMEs in specific circumstances, regularly haunted policymakers. Questions were raised on the efficacy of the code, in the light of the peculiar structures of MSMEs.

The position of MSMEs as operational creditors is unsatisfactory. The operational creditors in any case have always felt left out of the insolvency process. After the initiation of the corporate insolvency resolution process (CIRP), which, like financial creditors, operational creditors too can initiate, they are usually not part of the process or accepted onto the committee of creditors (CoC). They do not take part in the approval of the resolution plan, thereby reducing their chances of recovery to the lowest. In the usual liquidation situation, they are too low in the recovery waterfall. Another amendment to the code made it mandatory for the resolution plans to accept the higher of what is being offered to an operational creditor against what the operational creditor would get in a liquidation. This amendment intended to create a support for the operational creditors but again met a limited success. The raising of the threshold for initiation of the CIRP from ₹100,000 to ₹10 million, ideally to support MSME as a corporate debtor, seems to be hurting MSMEs as operational creditors, as their rights to recover seem to have been curtailed.

Sanjeev Ahuja
Senior partner
India Law Offices

The recent report of a sub-committee of the Insolvency Law Committee recommends a pre-pack insolvency resolution process (PPIRP) within the current IBC framework. The main features include a hybrid of debtors in possession and creditors in control, where the RP would initially be an advisor to the corporate debtor and would eventually be the representative of the CoC. The timelines would be reduced to 90 days for the process, and there would be a default provision for the existing management or promoter to submit the plan if they are eligible under section 29A.

The said report mentions about the practice in France, in which a conciliation or mediation period of 45 days is available to the existing management to discuss with creditors, explore a settlement and resolve the situation, but unfortunately fails to make a recommendation in this regard. Authors strongly feel that this be the first option provided to MSMEs, in the Indian context and that too with the presence of a resolution professional. Further, there would have to be an exemption with regards to the applicability of section 29A for MSMEs, otherwise this provision can prove to be a non-starter. To maximize value or recovery, even the existing owners should be allowed to pitch in. Only where there has been diversion or syphoning, should the person responsible be debarred.

An independent third party could carry out the forensic or avoidance transaction assessment and a public price discovery through a Swiss challenge in the case of a resolution plan, and a public auction in the case of liquidation, be made standard practice. This would reduce over-dependence on the current valuation process.

These suggestions should help ease the way in which business is done.

Gautam Khurana is the managing partner and Sanjeev Ahuja is a senior partner at India Law Offices

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