MSME’s and Insolvency Bankruptcy Code

MSME’s and Insolvency Bankruptcy Code
18 May 2020

MSME’s and Insolvency Bankruptcy Code

MSMEs form the foundation of the Indian economy and are key providers of employment, production, economic growth, entrepreneurship, and financial inclusion. Micro, Small and Medium Enterprises (MSMEs) are small-sized business units defined as per the terms of their investment. Section 7 of the Micro, Small & Medium Enterprises Development (MSMED) Act, 2006 (hereinafter referred to as 'Act') classifies MSME into two classes, namely, manufacturing and service. For manufacturing units, those units having investment not more than Rs. 25 lakhs will be termed as Micro, units having investment ranging between Rs. 25 lakhs but not more than Rs. 5 crores will be termed as Small and for those enterprises having investment between Rs. 5 crores to Rs. 10 crores will be termed as Medium enterprises. Similarly, for Service units, enterprises with investment not exceeding Rs. 10 lakhs will be termed as Micro, enterprises with investment more than Rs. 10 lakhs but not exceeding Rs. 2 crores will be termed as Small and for enterprises with investment ranging between Rs. 2 crores to Rs. 5 crores will be termed as Medium.

MSMEs form the foundation of the Indian economy and are key providers of employment, production, economic growth, entrepreneurship, and financial inclusion. As per the report of the World Bank on the Treatment of MSME Insolvency, it suggested that the approach to provide relief to MSME's is to exempt or relax certain provisions from the regular insolvency process.

As per the Corporate Insolvency Resolution Process, the MSME suppliers are categorized as 'operational creditors'. The unfortunate fallout of the anomaly is that not only the corporate NPAs but a plethora of MSME NPAs could also emerge.

In a bid to encourage entrepreneurs to enter into a business and to encourage sustainable growth of the credit market in India, the Injeti Srinivas Committee in 2018, made certain recommendations in the Insolvency and Bankruptcy Code, 2016 (hereinafter referred to as "Code"). The recommendations qua MSME's have been detailed hereinbelow:

  1. to exempt MSMEs from the application of Section 29A of the Code, since usually, only promoters of an MSME are likely to be interested in acquiring it,
  2. to empower the Central Government to exempt or vary the application of provisions of the Code by way of a notification for a certain class or classes of companies, including for MSMEs as defined in Section 7 of the Act.
  3. to provide relief to MSMEs from the provision of the Code by inserting Section 240A in the Code, which specifically exempts resolution applicants for MSMEs that are undergoing CIRP from all eligibility criteria stated in Section 29A except the requirement that they should not be classified as wilful defaulters. Further, to clarify that provisions of the Code shall apply to MSMEs in such modified form as the Central Government may notify in terms of Section 240A of the Code. Additionally, a provision may be inserted to enable the Government to, by way of a notification, exempt or modify the application of certain provisions of the Code to MSMEs as defined in the Act.
  4. by recognizing the need of the hour to help MSME sector in not succumbing to the rigors of the strict provisions of the capital market, even the Reserve Bank of India ('RBI') vide a Circular dated 01.01.2019 on Restructuring of Advances – Micro, Small and Medium Enterprises ('MSME Circular'), permitted a one-time restructuring of existing loans to MSME's, classified as 'standard' without downgrading their the asset classification, provided the total fund and non-fund based exposure to such a borrower does not exceed Rs. 25 crores.

Additionally, even the Hon'ble Supreme Court of India in Swiss Ribbons Pvt. Ltd. vs. Union of India and Ors. [Writ Petition (Civil) No. 99 of 2012, judgment dated 25 January 2019] while recognizing the importance of adding MSME friendly provisions in the Code, found no fault in the exemption of MSME under Section 29A of the Code. The Court further perceived the business of an MSME to attract interest from a promoter of an MSME and may not be of interest to other resolution applicants. Therefore, if MSMEs aren't exempted, then other resolution applicants may not come forward and it would lead to a liquidation of the MSME instead of resolution.

The amendment to dispense with the application of Section 29A (clause c and h) of the Code, will now permit the promoters of such MSME (if they do not suffer from other disqualifications of Section 29A) to bid for their Company, as most MSMEs are unlikely to attract resolution applicants apart from their promoters, as rightly held by the Hon'ble Supreme Court in the judgment of Swiss Ribbons (Supra). Accordingly, to avoid liquidation of these MSMEs, not only the promoters of MSMEs have been allowed to bid for their own companies even though they had become NPA or are guarantors, but also any bidder for MSMEs who is otherwise disqualified on account of its account being NPA can also bid for such MSMEs.

Under the MSMED Act, medium, small and micro-manufacturing enterprises are defined based on their investments in plant and machinery; for a medium enterprise, the threshold is up to Rs. 10 crore, while for a small unit it is Rs. 5 crore.

Many MSMEs fail to meet this low threshold and, hence, are unable to qualify for relief under Section 29A.