Micro, Small And Medium Enterprises- The Heart Of Indian Economy

As per law (Micro, Small and Medium Enterprises Act, 2006), any incorporated entity would fall under micro, small or medium categories if their investment does not exceed 50 Crore Rupees or their turnover does not go beyond 250 Crore Rupees.[2] Just like, by giving the right amount of water, sunlight and manure to a plant we can grow it into a huge tree, similar is the case with these enterprises. Some of them have the potential to become the future Tatas’, Ambanis’, Birlas’, provided the state organs (be it Legislature, Executive or Judiciary) provide the right kind of atmosphere which would help them sustain and grow further.

One of the main problems which these budding enterprises face is the strict compliance of corporate laws. Many are demotivated just because of the sheer number of laws these enterprises need to comply with. The other demotivating factor is the fear of losing out their business to creditors because of the strict provisions of Insolvency and Bankruptcy Code (IBC), 2016. Sometimes, because of various reasons, these enterprises are unable to keep their business afloat and as a result of this the creditors to the enterprises swing into action. In order to counter such fears among MSME, the Legislature has relaxed some of the provisions under IBC for MSMEs.

The Legislature enacted the Insolvency and Bankruptcy (2^nd Amendment Act), 2018.[3] It added section 240A,[4] thereby curtailing the restrictions imposed on the promoters and guarantors of MSME corporate debtor/enterprises. Now, in case of MSME, the promoter/owner or the guarantors can also apply as Resolution Applicant and have the chance to again takeover the business, provided they are not wilful defaulters. Further, the amendment has allowed the central government to exempt or modify any other conditions relating to MSME. The main reason behind insertion of section 240A is that, in case of MSME, generally, only the promoters of the enterprise going for resolution are willing to bid as Resolution Applicant and no one else shows interest in these enterprises. The Supreme Court in Swiss Ribbon’s case[5] reiterated that the rationale for excluding such industries from the eligibility criteria laid down in section 29A (c) and (h)[6] is because qua such industries, other resolution applicants may not be forthcoming, which then will inevitably not lead to resolution, but liquidation.

In August, 2021 the Insolvency and Bankruptcy Code (Amendment) Act, 2021[7] came into force and it added Chapter 3A[8] to the Insolvency and Bankruptcy Code, 2016 (IBC). The amendment provides for a pre-packaged insolvency resolution process for MSME. It will help in achieving greater participation in the resolution process and make the process simpler for creditors and promoters as well.

Recently, Ministry of Corporate Affairs, Government of India, invited comments from the public on changes being considered to the Insolvency and Bankruptcy Code, 2016[9]. Some of the proposed changes which will be helpful to the MSME are-

Use of technology in the IBC ecosystem:

The institutions forming pillars of the Code, including the Ministry of Corporate Affairs, the Adjudicating Authority (“AA”), the Insolvency and Bankruptcy Board of India (“IBBI”), information utilities (“IUs”) and service providers, operate on separate technological platforms. However, there are challenges posed by the fragmented nature of this approach. It is being considered that a state-of-the-art electronic platform, which can handle several processes under the Code with minimum human interface may be developed which can provide for a case management system, automated processes to file applications with the AAs, delivery of notices, enabling interaction of Ips(Insolvency Professionals) with stakeholders, storage of records of CDs(Corporate Debtors) undergoing the process, and incentivising participation of other market players in the IBC ecosystem. It may also allow regulators and the AAs to exercise better oversight over their respective domains of functioning through the consolidated information available on the e-platform. This will surely motivate people to establish more and more MSME, transfer unorganised MSME to organised ones and the creditors to advance loans to MSME because of the simpler and efficient resolution process.

Decriminalisation of Offences:

Section 235A[10] of the IBC provides the punishments to be imposed for contravention of the provisions of the Code or rules or regulations framed thereunder, for which no penalty or punishment is specifically provided under the Code. The punishment under this provision is administered by the Special Court, established under Chapter XXVIII of the Companies Act, 2013, through criminal proceedings. In furtherance of the Central Government’s policy to decriminalise offences in business law statutes wherever feasible, it is felt that section 235A should be converted into a civil penalty. Therefore, it is being considered that section 235A may be amended to empower the AA to impose penalties where any person fails to comply with the provisions of the Code or any rules or regulations made thereunder, where such compliance was required. Further, it is observed that several proceedings are maliciously instituted before the AA to delay the conduct of processes. Hence, it is being considered that the AA should also be empowered to impose a penalty where it believes that such a person has filed frivolous or vexatious applications. The move will encourage people to incorporate more and more MSME as the stigma of being prosecuted and sent to jail will be eliminated.

Expansion of the applicability of Pre-packaged Insolvency Resolution framework:

At present, the Pre-packaged Insolvency Resolution framework applies to only incorporated entities. But, the majority of MSME in India are unincorporated. The pre-packaged resolution process seeks to provide quicker, cost-effective, and value-maximising outcomes for all the stakeholders in a manner that is least disruptive to the continuity of their business and helps in preserving jobs. Accordingly, it is being considered that section 54A of IBC[11] be amended to provide that the framework shall apply to prescribed categories of CDs in addition to the MSMEs. Some of the developed countries already have such provisions in their concerned laws. For example-

United Kingdom- Their Individual Voluntary Arrangement (IVA) is a private negotiation between debtors and creditors wherein the debtors avoid the stigma of bankruptcy. While negotiations are outside of the court, they are supported by legal provisions embedded in the law. If the debtors and creditors can come up with an agreement on the composition of debts, then the court only plays a role in sanctioning the agreement. There is no bankruptcy in the case of an IVA since a plan of repayment is agreed upon before a debtor can be called ‘bankrupt’. An IVA is available to all individuals, sole traders or those in a business partnership who are experiencing financial difficulty.

Where an unincorporated/non-LLP partnership is insolvent and where a rescue of that partnership or business is possible, an administration may be appropriate. An Administrator is a licensed insolvency practitioner appointed by the partners of the business out of court, a floating charge holder (for example the holder of an agricultural charge) or by the court on application. An administration protects the partnership and its business from its creditors whilst proposals regarding its future are prepared. The Administrators deal with all classes of the creditor. The procedure is similar to that of Company administrations.[12]

United States- In the US, The US Bankruptcy Code provides for the resolution process. Chapter 13 of the Code provides a reorganisation plan to individuals who do not want to go through a bankruptcy. Individuals get an opportunity to reorganise their financial affairs while being under the protection of the Bankruptcy Court. Although an individual, who is operating a business as a sole proprietor or conducting a professional practice, can file a Chapter 13 petition as most Chapter 13 debtors are ‘consumer debtors’.[13]

Canada­­- In Canada, Division II ‘consumer’ proposal is used for micro businesses which is provided under the Bankruptcy and Insolvency Act, 1985 (BIA). These provisions are accessible to non-incorporated self-employed individuals and sole proprietors whose debts are less than 250,000 CAD, excluding a mortgage or hypothec on the individual’s principal residence.[14]

The PPIRP framework may involve a diverse range of FCs who will be required to approve its initiation at the pre-commencement stage by confirming the proposed RP under section 54A (2)(e)[15]. Thus, to facilitate quicker and more efficient decision-making at this stage, the sixty-six per cent threshold for unrelated FCs may be lowered to fifty-one per cent. Similarly, under section 54A(3)[16], the sixty-six per cent threshold for unrelated FCs may be replaced by an enabling provision for the IBBI to specify the appropriate threshold, not being less than fifty-one per cent of the unrelated FCs, for approving the filing of an application.

In practice, it is observed that the MSME CDs face challenges in furnishing a declaration regarding avoidance transactions or improper trading under section 54C (3)(c)[17]. Such transactions or trading may not be easy to identify as it is often not the nature of the transaction or trading but the zone of insolvency, which renders transactions or trading suspect. Further, in the case of larger companies too, this may be a cumbersome requirement. Such a requirement should not discourage bona fide CDs from utilising the PPIRP for insolvency resolution. Accordingly, it is being considered to omit section 54C(3)(c).

Turning Liquidation back to CIRP:

The liquidation process under the Code commences after the CIRP, and the CD is dissolved after its assets are completely liquidated. The liquidator may carry on the CD’s business during the liquidation process if he/she considers it necessary for its beneficial liquidation. In some limited situations, due to the change in market conditions, it may be possible for the CD to be resolved while the liquidator is running the CD’s business. Therefore, it is being considered that the Code may enable reinstatement of the CIRP during the liquidation process, where the liquidator continues to carry on the CD’s business, and it is possible to revive the CD as determined by the CoC. This will incentivise the promoters of the MSME to make their businesses viable again by submitting a good resolution plan.

Improving recoveries for operational creditors in liquidation:

Most of the MSME are in the form of supply chain network for large companies. Given the huge competition in MSME sector and disadvantageous position in relation to large companies, they often agree to supply large companies with goods and services in advance without securing the payment for such goods or services. Therefore, they act as ‘Operational Creditors’(OCs) to these large companies. But, the recoveries made by OCs under liquidation are seemingly inadequate, even compared to unsecured FCs. Thus, to improve their position in the priorities for distribution under a plan or in liquidation, it is being considered that all unsecured creditors (FCs, OCs and any government or authority) other than the workmen and employees shall be treated equally for distribution under section 53[18]. The order of priority for the secured creditors, workmen and employees shall be retained as stipulated under section 53.

Incentivising interim finance providers:

Interim finance is a crucial aspect of the CIRP, which is often used to cover the costs involved in running the process and may also be used to support the CD’s operations. Creditors providing interim finance during the CIRP are given priority as it forms a part of the CIRP costs. However, the interim finance provider has no right to participate in the CoC meetings to oversee the conduct of the CIRP and remains largely unaware. Therefore, it is being considered that to incentivise the interim finance providers, they may be allowed to participate in the meetings of the CoC as non-voting members to keep themselves informed about the proceedings under the Code. This will help MSME secure the much-needed financial help during resolution process as the creditors will now be assured of their participation in CoC meetings.

Clearly, for India to thrive economically, its MSMEs’ are to be nurtured. Acknowledging the share it has in Indian economy, every effort should be made to promote them and help them grow sustainably. Many of our laws are in favour of these MSMEs’ and the abovementioned proposed amendments also point at this direction. Overall, the MSME sector has a significant role to play in the economic progress of the country, and its continued growth and development must be a priority for policymakers and stakeholders alike.

The author is an Advocate practising at High Court of Himachal Pradesh.Views are personal.

Endnotes:

1. https://www.pib.gov.in/PressReleasePage.aspx?PRID=1744032
2. https://msme.gov.in/sites/default/files/MSME_gazette_of_india.pdf
3. https://ibbi.gov.in//webadmin/pdf/legalframwork/2018/Aug/The%20Insolvency%20and%20Bankruptcy%20Code%20(Second%20Amendment)%20Act,%202018_2018-08-18%2018:40:34.pdf
4. Section 240A. (1) Notwithstanding anything to the contrary contained in this Code, the provisions of clauses (c) and (h) of section 29A shall not apply to the resolution applicant in respect of corporate insolvency resolution process of any micro, small and medium enterprises.

(2) Subject to sub-section (1), the Central Government may, in the public interest, by notification, direct that any of the provisions of this Code shall— (a) not apply to micro, small and medium enterprises; or (b) apply to micro, small and medium enterprises, with such modifications as may be specified in the notification.

(3) A draft of every notification proposed to be issued under sub-section (2), shall be laid before each House of Parliament, while it is in session, for a total period of thirty days which may be comprised in one session or in two or more successive sessions.

(4) If both Houses agree in disapproving the issue of notification or both Houses agree in making any modification in the notification, the notification shall not be issued or shall be issued only in such modified form as may be agreed upon by both the Houses, as the case may be.

(5) The period of thirty days referred to in sub-section (3) shall not include any period during which the House referred to in sub-section (4) is prorogued or adjourned for more than four consecutive days.

(6) Every notification issued under this section shall be laid, as soon as may be after it is issued, before each House of Parliament.

Explanation—For the purposes of this section, the expression "micro, small and medium enterprises" means any class or classes of enterprises classified as such under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006.

5. Swiss Ribbons Pvt. Ltd. and Anr. v. Union of India and Ors, (2019) 4 SCC 17
6. Section 29A. Person not eligible to be resolution applicant. —A person shall not be eligible to submit a resolution plan, if such person, or any other person acting jointly or in concert with such person­­­­-

(c) 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, classified as non-performing asset in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949, or the guidelines of a financial sector regulator issued under any other law for the time being in force, and at least a period of one year has lapsed from the date of such classification till the date of commencement of the corporate insolvency resolution process of the corporate debtor: Provided that the person shall be eligible to submit a resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to non-performing asset accounts before submission of resolution plan;

Provided further that nothing in this clause shall apply to a resolution applicant where such applicant is a financial entity and is not a related party to the corporate debtor.

Explanation I.—For the purposes of this proviso, the expression “related party” shall not include a financial entity, regulated by a financial sector regulator, if it is a financial creditor of the corporate debtor and is a related party of the corporate debtor solely on account of conversion or substitution of debt into equity shares or instruments convertible into equity shares or completion of such transactions as may be prescribed, prior to the insolvency commencement date.

Explanation II.—For the purposes of this clause, where a resolution applicant 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, classified as non-performing asset and such account was acquired pursuant to a prior resolution plan approved under this Code, then, the provisions of this clause shall not apply to such resolution applicant for a period of three years from the date of approval of such resolution plan by the Adjudicating Authority under this Code;

(h) 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 this Code and such guarantee has been invoked by the creditor and remains unpaid in full or part;

7. https://ibbi.gov.in//uploads/legalframwork/0150ec26cf05f06e66bd82b2ec4f6296.pdf
8. Ibid
9. https://www.mca.gov.in/content/dam/mca/pdf/IBC-2016-20230118.pdf
10. Section 235A. Punishment where no specific penalty or punishment is provided.—If any person contravenes any of the provisions of this Code or the rules or regulations made thereunder for which no penalty or punishment is provided in this Code, such person shall be punishable with fine which shall not be less than one lakh rupees but which may extend to two crore rupees.
11. Section 54A. Corporate debtors eligible for pre-packaged insolvency resolution process.—

(1) An application for initiating pre-packaged insolvency resolution process may be made in respect of a corporate debtor classified as a micro, small or medium enterprise under sub-section (1) of section 7 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006).

(2) Without prejudice to sub-section (1), an application for initiating pre-packaged insolvency resolution process may be made in respect of a corporate debtor, who commits a default referred to in section 4, subject to the following conditions, that—

(a) it has not undergone pre-packaged insolvency resolution process or completed corporate insolvency resolution process, as the case may be, during the period of three years preceding the initiation date;

(b) it is not undergoing a corporate insolvency resolution process;

(c) no order requiring it to be liquidated is passed under section 33;

(d) it is eligible to submit a resolution plan under section 29A;

(e) the financial creditors of the corporate debtor, not being its related parties, representing such number and in such manner as may be specified, have proposed the name of the insolvency professional to be appointed as resolution professional for conducting the pre-packaged insolvency resolution process of the corporate debtor, and the financial creditors of the corporate debtor, not being its related parties, representing not less than sixty-six per cent. in value of the financial debt due to such creditors, have approved such proposal in such form as may be specified:

Provided that where a corporate debtor does not have any financial creditors, not being its related parties, the proposal and approval under this clause shall be provided by such persons as may be specified;

(f) the majority of the directors or partners of the corporate debtor, as the case may be, have made a declaration, in such form as may be specified, stating, inter alia, that—

(i) the corporate debtor shall file an application for initiating pre-packaged insolvency resolution process within a definite time period not exceeding ninety days;

(ii) the pre-packaged insolvency resolution process is not being initiated to defraud any person; and

(iii) the name of the insolvency professional proposed and approved to be appointed as resolution professional under clause (e);

(g) the members of the corporate debtor have passed a special resolution, or at least three-fourth of the total number of partners, as the case may be, of the corporate debtor have passed a resolution, approving the filing of an application for initiating pre-packaged insolvency resolution process.

(3) The corporate debtor shall obtain an approval from its financial creditors, not being its related parties, representing not less than sixty-six per cent. in value of the financial debt due to such creditors, for the filing of an application for initiating pre-packaged insolvency resolution process, in such form as may be specified: Provided that where a corporate debtor does not have any financial creditors, not being its related parties, the approval under this sub-section shall be provided by such persons as may be specified.

(4) Prior to seeking approval from financial creditors under sub-section (3), the corporate debtor shall provide such financial creditors with—

(a) the declaration referred to in clause (f) of sub-section (2);

(b) the special resolution or resolution referred to in clause (g) of sub-section (2);

(c) a base resolution plan which conforms to the requirements referred to in section 54K, and such other conditions as may be specified; and (d) such other information and documents as may be specified.

2. https://ibbi.gov.in/uploads/resources/b7dfd3332bc133fde5783cf70b9371a1.pdf, Pages 9-11
3. Ibid
4. Ibid
5. Section 54A, supra, note 11
6. Ibid
7. Ibid
8. Section 53. Distribution of assets.—(1) Notwithstanding anything to the contrary contained in any law enacted by the Parliament or any State Legislature for the time being in force, the proceeds from the sale of the liquidation assets shall be distributed in the following order of priority and within such period and in such manner as may be specified, namely:—

(a) the insolvency resolution process costs and the liquidation costs paid in full;

(b) the following debts which shall rank equally between and among the following:—

(i) workmen’s dues for the period of twenty-four months preceding the liquidation commencement date; and

(ii) debts owed to a secured creditor in the event such secured creditor has relinquished security in the manner set out in section 52;

(c) wages and any unpaid dues owed to employees other than workmen for the period of twelve months preceding the liquidation commencement date;

(d) financial debts owed to unsecured creditors;

(e) the following dues shall rank equally between and among the following:—

(i) any amount due to the Central Government and the State Government including the amount to be received on account of the Consolidated Fund of India and the Consolidated Fund of a State, if any, in respect of the whole or any part of the period of two years preceding the liquidation commencement date;

(ii) debts owed to a secured creditor for any amount unpaid following the enforcement of security interest;

(f) any remaining debts and dues;

(g) preference shareholders, if any; and

(h) equity shareholders or partners, as the case may be.

(2) Any contractual arrangements between recipients under sub-section (1) with equal ranking, if disrupting the order of priority under that sub-section shall be disregarded by the liquidator.

(3) The fees payable to the liquidator shall be deducted proportionately from the proceeds payable to each class of recipients under sub-section (1), and the proceeds to the relevant recipient shall be distributed after such deduction.

Explanation.—For the purpose of this section—

• it is hereby clarified that at each stage of the distribution of proceeds in respect of a class of recipients that rank equally, each of the debts will either be paid in full, or will be paid in equal proportion within the same class of recipients, if the proceeds are insufficient to meet the debts in full; and
• (ii)(ii) the term “workmen’s dues” shall have the same meaning as assigned to it in section 326 of the Companies Act, 2013