Insolvency resolution: Why corporate MSMEs deserve special treatment

Special treatment for Indian MSMEs
MSMEs contribute around 28% of the country’s GDP and around 45% of its manufacturing output.

By Anubha Agarwal

India’s gross domestic product had a great fall in the first quarter of 2020-21, pushing the economy into deep uncertainty. The sharp contraction of the economy made a huge dent on the prospects of the country recovering from the impact of the Covid-19 pandemic and the stringent measures taken by the government to contain the dreaded viral infection. The measures announced by the government will play a key role in providing stimulus to help the economy tide over the unprecedented crisis.

Micro, Small, and Medium Enterprises is a crucial sector of the Indian economy. MSMEs contribute around 28% of the country’s GDP and around 45% of its manufacturing output, apart from providing employment to more than 11 crore people. To achieve self-reliance and improve ease of doing business, the government has proposed the following measures:

  • To increase the threshold to initiate insolvency proceedings to Rs 1 crore from Rs 1 lakh, largely to insulate MSMEs (March 2020).
  • The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, was promulgated in June 2020. It suspended the initiation of insolvency proceedings against corporate debtors in respect of any default arising during the COVID-19 period. This period began on March 25 when the first phase of the national lockdown was announced and continues for six months or such further period not exceeding one year as the government may decide depending on the situation on the ground.

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In addition to the above, the government proposed to notify a special insolvency resolution framework for MSMEs under Section 240A of the IBC Code. The special insolvency resolution framework will allow the Union government to direct that any of the provisions of the IBC Code shall not apply to MSMEs or apply to them with certain modifications. The distinctive and uncommon characteristics of MSMEs call for a special resolution framework for MSMEs under the IBC Code. It may be noted that though the special resolution framework needs to be expedited in view of COVID-19, it could serve as a special framework under Section 240A of the IBC Code for MSMEs beyond COVID-19.

As per the ministry of corporate affairs database, there are 5,03,324 companies in micro category, 1,06,672 companies in small category and 13,799 companies in medium category, as per the modified definition of MSMEs.

MSMEs face issues such as scarcity of working capital, higher interest rates and larger collateral requirements, which make raising finance difficult, especially in situations of financial distress. There is an increasing recognition that addressing the distress of MSMEs is critical for economic growth.

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There exist very few specialised legal regimes for MSME insolvency. Most jurisdictions treat MSME insolvencies as the same as in case of other corporate entities, or conversely, natural persons, despite the unique attributes of MSMEs. The Insolvency Law Committee, in its Report of March 2018, took note of the suggestions in a World Bank Report to provide relief to MSMEs by way of exemption or relaxation of certain provisions of the normal insolvency process, as done in various other jurisdictions like France, Japan and the US. In the US, the Small Business Reorganisation Act, 2019 provides for reorganisation of small companies and allows only the debtor to submit the resolution plan that too within a period of 90 days. The plan filed thereafter is approved by the court.

Section 240A of the IBC Code gives power to the central Government to notify any non-application of provisions of the Code to MSMEs. By virtue of such power, the promoters of MSMEs have been allowed to bid for their own companies even if they fall in the category of a non-performing asset. This facilitates exemption of MSMEs from the restrictions imposed by Section 29 A (c) to (h) of the IBC Code.

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It is imperative that the existing management, directors and promotors of MSMEs should have more flexibility to participate in the resolution process while keeping the corporate debtor as a going concern because most MSMEs do not attract much interest from third parties and due to the unique nature of business of MSMEs. In most cases, the existing management alone would be interested in continuing with the business of the corporate debtor.

IBBI (Fast-track Insolvency Resolution Process for Corporate Persons) Regulations, 2017 provide that fast-track CIRP process can only apply to the following corporate debtors — a small company under Section 2 of the Companies Act, 2013, or a start-up (other than the partnership firm), an unlisted company whose total assets do not exceed Rs 1 crore in the immediately preceding financial year. Further the definition of the fast-track process period provides that the process of resolution must be completed within 90 days from the date on which the process commences.

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The Report of the Insolvency Law Committee, February 2020, recommended that operational creditors should be allowed to have recourse to the CIRP under the IBC Code on a minimum default of Rs 5 lakh only, and appropriate actions may be taken to revise the threshold accordingly.

The suggestions of the Insolvency Law Committee and IBBI (Fast-track Insolvency Resolution Process for Corporate Persons) Regulations, 2017 focus on a time-bound resolution of insolvency process and financial claims of the creditors of a corporate debtor. MSMEs have a special position in the Indian economy, as key drivers of employment, growth and financial inclusion and form a major part of operational creditors along with employees and trade creditors.

These measures by the government could, therefore, go a long way in giving an impetus to a much drained and stressed asset economy and will not only serve as a tool to improve current situation, but could be a historic measure in carving an alcove for the MSME sector. As we await the notification on the specific provisions of the special resolution framework for MSMEs, we do recognise the efforts of IBBI and the government to carve out a special procedure for a niche sector of MSMEs.

(Anubha Agarwal is a Senior Associate at Corporate Law Group, a New Delhi-based law firm)

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