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MSME Sector: the torch bearer of the Indian Economy
MSMEs are the sinews of the nation’s economy and are often referred to as the power engines of the economy. Over the last five decades, MSMEs have emerged as a vibrant and dynamic sector of the Indian economy and today is the second largest employment generating sector after agriculture providing employment to around 120 million persons in India [1]. It is believed that by 2025, MSMEs will contribute 50% to India’s GDP up from 30% currently and their contribution to exports will rise to 60% from 49% currently [2].
However, despite contributing significantly to employment and GDP, failures and bankruptcy are all too frequent in the MSME sector. The most notable constraints are delayed payments, lack of timely credit, technological backwardness, non-procurement of raw materials at a competitive cost, inadequate infrastructure facilities, lack of skilled manpower.
Indubitably, COVID-19 pandemic and the ensuing nationwide lockdowns suddenly threw everything out of gear and adversely affected businesses, particularly for MSMEs.
IBC Code: The harbinger of change for the MSME sector
While it is welcome that the Government of India in its endeavour to create a conducive environment for the growth of MSME sector has enacted various legislations and schemes in order to provide the necessary impetus to the MSME’s, including the amendment in the provisions of the Insolvency & Bankruptcy Code in order to make it more conducive for the MSME’s to avail its benefits.
Arguably, the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 brought much needed relief to the MSMEs through Section 240A by relaxing the applicability of the provisions of Section 29A (c) and (h) of the Code. The object for relaxation under the said provision is to grant exemptions to MSME corporate debtor/promoter, not being willful defaulter or covered under any other specific disqualification provided under the said Section 29A, to bid for an MSME’s Resolution Plan.
Notably, on August 11, 2021, the Central Government enacted the Insolvency and Bankruptcy Code (Amendment) Act, 2021 which was deemed to have come into force on April 4, 2021 by introducing the Pre-packaged Insolvency Resolution Process (“PPIRP”) for corporate MSMEs with INR 10 lakh as the de minimus threshold under Chapter III-A, S.54A to S.54P of the Code prescribing the manner and form of making application to initiate PPIRP. Further, IBBI notified the IBBI (Pre-packaged Insolvency Resolution Process) Regulations, 2021 along with the Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Rules, 2021.
In the Act, ‘Pre-Packaged’ refers to the preparation of a re-organization plan by the MSME corporate debtor after negotiations with creditors prior to the fling of an insolvency petition to the Adjudicating Authority (“AA”) and hence it can be said that the case is ‘pre-cooked’ one.
Significantly, the new provisions have been introduced for only corporate persons classified as MSMEs with the overarching theme to provide a quick and value-maximizing option for resolving insolvency with minimum disruption to business operations of an MSME than what is possible under the traditional CIRP route.
The Pre-Requisites to initiate PPIRP are:
- The corporate debtor may prove its MSME status by submitting its ‘Udyam’ registration details or information about investment in plant and machinery/equipment and turnover in terms of new criteria of defining MSMEs as laid out in notification issued by the MSME Ministry on June 26, 2020. Additionally, corporate debtors that would be disqualified under section 29A to submit a resolution plan subject to section 240A which carves out certain exceptions for MSME promoters are not permitted to initiate a PPIRP. After ensuring that the above criteria is duly met, PPRIP, inter alia, envisages the completion of certain actions by corporate debtor prior to formally filing an application to NCLT for commencement of PPRIP which are set out as under:
- The members of the corporate debtor are required to pass a special resolution by at least 75% of the total number of Members of the corporate debtor, or 3/4th of the total number of Partners, as the case may be approving the initiation of the process.
- Under this new regime, corporate debtors eligible for the PPIRP are required to negotiate a “base resolution plan” with their creditors. A meeting of the unrelated financial creditors is required to convened by the corporate debtor and not less than 66% in value of the unrelated financial creditors should approve the filing of the Application.
Thereafter, the Pre-Pack process would typically pass through the following stages:
- The RP is required to constitute the committee of creditors (“CoC”) within a period of 7 (seven) days of the admission of the process and submit to it the list of claims of the corporate debtor.
- The RP is required to finalise the information memorandum and submit to members of the CoC within 14 (fourteen) days of its admission.
- The management of the corporate debtor shall remain vested with the Board of Directors of the Corporate Debtor as per the provisions of Section 54H, subject to action under Section 54J of the Code.
- The corporate debtor is required to submit the Base Resolution Plan to the RP within a period of 2 (two) days of admission. The CoC may consider and approve the Base Resolution Plan does not impair the claims owed to the operational creditors, the CoC may approve it for further submission to the AA. Otherwise the resolution professional will initiate the process for inviting resolution plans for competition with the base resolution plan.
Alas, the wows of MSMEs still continue
The growth of MSME sector holds the key to growth in Indian GDP, on that there is no dispute. However, the sum and substance of the measures and changes brought about in the Code for MSMEs is that they have not yielded the desired results thus far for them to be tagged as a game changer. Here’s are some possible answers. The increase of threshold limit from Rs. 1 Lakh to Rs. 1 Crore is supportive of MSMEs who are corporate debtors, but not of MSMEs who are Operational Creditors. Also, the pre-pack insolvency process only covers the MSMEs who are corporate debtors, whereas, most of the MSMEs in India are unincorporated. What emerges from this is that they are not eligible to claim benefits of the Pre-pack process. Moreover, only a hand few of cases have been filed with the NCLT for MSME insolvency under PPIRP. The IBC also makes it mandatory to complete PPIRP within the period of 120 days, but none of the cases under PPIRP have been disposed of within due time.
What lies Ahead…
That said, what are the steps that must be ushered in to obviate MSME stress? Well that, the limit was hiked ostensibly to help the MSMEs, nonetheless, the higher limit prevented MSMEs to file for insolvency against large corporates despite having overdue balance. Accordingly, the first step could be to revise the notification of March 2020 that raised the default amount to Rs. 1 crore for filing of an insolvency application to bring it down to a lower figure, say, Rs. 50 Lacs, at least when the Operational Creditor is an MSME. Further, many of the MSMEs operating in the country are either individuals or sole proprietorship firms and are not incorporated and putatively outside the ambit of the PIRP provisions of the Code as of now. Thus the term ‘Corporate Debtor’ as provided for in the context of Section 54A of the Code, so far as the MSME’s are concerned, requires to be amended to include Sole Proprietorship and Partnerships as well, since Section 7 sub-section (1) of the Micro, Small and Medium Enterprises Development Act, 2006, includes Sole Proprietorships, HUF, Association of Persons, Co-operative Society, Partnership Firms alongwith Companies and Undertakings and therefore till the provisions of IBC are notified with respect to the Sole Proprietorships and Partnerships, to exclude any category of MSME from the purview of IBC is detrimental to its interest.
Another step could be to bring in changes so that such MSMEs can also gain from the benign objective of the Code. Perhaps, another step could be to grant priority to MSMEs in the waterfall mechanism in the Code by bringing them above the unsecured financial Creditors, i.e., immediately after the dues of the secured Financial Creditors are settled, which is also presently being contemplated by the Government of India.
While PPIRP definitely provides for a boost in terms of revival or resolution of the stressed assets of the MSME’S and is anticipated to be more cost effective and speedier process as compared to any other mechanism, however there are challenges in relation to the delays which may be caused in the adjudication process and the objections that may be filed by the Objectors to cause delay. However, with changes being brought about in Code to reflect the market realities, perhaps there may be light at the end of the tunnel!
Authors:
Shweta Bharti, Senior Partner & Sumit Jay Malhotra, Principal Associate, Hammurabi & Solomon Partners
[1] <https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1747403> accessed on 22 October 2022
[2] <https://www.business-standard.com/article/economy-policy/govt-aims-to-create-50-mn-jobs-in-5-years-in-msme-sector-says-gadkari-120090901888_1.html> accessed on 22 October 2022