Catalyzing MSMEs through A Facilitative Distress Resolution Process
Mathew Jacob
LLM-IBL, NALSAR University of Law & Indian Institute of Corporate Affairs
Introduction
Micro, Small, and Medium Enterprises (MSMEs) form the backbone of the Indian economy, playing a pivotal role in fostering economic growth, creating employment opportunities, and contributing significantly to exports and GDP. As per government statistics, the MSME sector contributes approximately 33% to India’s GDP and accounts for nearly 42% of total exports, showcasing its indispensable role in driving economic self-reliance. Furthermore, with over 63 million MSMEs operating across the country, this sector is a critical pillar for employment generation, providing jobs to over 120 million individuals.[1]
Despite their importance, MSMEs are highly vulnerable to financial and operational stresses. Challenges such as limited access to credit, burdensome compliance requirements, technological obsolescence, and market volatility have been compounded in recent years by external shocks like the COVID-19 pandemic and global supply chain disruptions. Such stresses not only threaten the survival of individual enterprises but also pose systemic risks to the economy, given the interconnected nature of MSMEs with larger businesses and industries.
The introduction of the Insolvency and Bankruptcy Code, 2016, (IBC) marked a paradigm shift in India’s approach to distress resolution. While initially designed for larger corporates, the framework has been progressively adapted to suit the unique needs of MSMEs. Particularly, the inclusion of the Pre-Pack Insolvency Resolution Process (PPIRP) as a personalized mechanism for MSMEs has provided a much-needed avenue for resolving stress efficiently. However, the uptake of PPIRP in India has been limited due to various challenges, requiring a deeper analysis of its framework, implementation, and alignment with international best practices.
Key Provisions in IBC for MSMEs
Section 240A
Section 240A of the IBC provides certain exemptions to MSMEs from the applicability of clauses (c) & (h) of Section 29A, which deals with the eligibility criteria for resolution applicants. It allows promoters of MSMEs, who may be classified as NPAs, to bid for their enterprises during insolvency proceedings, facilitating their potential revival. The Supreme Court, in the case of Hari Babu Thota[2], addressed the eligibility of promoters to submit resolution plans under Section 240A. The Court held that even if MSME registration was obtained post-commencement of the Corporate Insolvency Resolution Process (CIRP), the corporate debtor’s promoter remains eligible to submit a resolution plan. This judgment further emphasizes the flexibility provided to MSMEs in distress, enabling promoters to regain control and facilitate revival.
PPIRP
Introduced in 2021 under chapter III-A of the IBC, the PPIRP is a hybrid mechanism combining informal negotiations with formal proceedings. It combines informal, out-of-court restructuring efforts with formal insolvency proceedings, aiming to expedite the resolution process while minimizing disruptions to business operations. The PPIRP emphasizes the debtor-in-possession model, allowing existing management to retain control during the process, which is crucial for the preservation of business value in MSMEs.
Understanding PPIRP
PPIRP is a hybrid mechanism combining informal negotiations with formal insolvency proceedings. The process involves pre-filing negotiations, preparation of a base resolution plan, and creditor approval before submission to the National Company Law Tribunal (NCLT). The statutory timeline for completion is 120 days, with limited judicial intervention to ensure efficiency.
PPIRP also allows the corporate debtor’s management to retain control during the resolution process, preserving the value of the enterprise. This debtor-in-possession model is particularly suited for MSMEs, which often rely on the expertise and networks of their promoters.
The PPIRP framework involves the following key steps:
- Initiation: The corporate debtor initiates the process by obtaining approval from financial creditors representing at least 66% of the financial debt, as mandated under Section 54A(2)(e) of the IBC.
- Base Resolution Plan: The debtor, with creditor input, prepares a base resolution plan for consideration, as outlined in Section 54A(4)(c) of the IBC.
- NCLT Submission: The base plan and required documents are submitted to the NCLT for review and admission, as specified under Section 54C of the IBC.
- Moratorium: Upon admission, a moratorium is declared to prevent creditor action, ensuring continuity of operations, as provided under Section 14 of the IBC.
- CoC Evaluation: The Committee of Creditors (CoC) assesses and votes on the resolution plan, as governed by Section 30(4) of the IBC.
- Implementation: Following CoC and NCLT approval, the plan is implemented to resolve the debtor’s financial distress, as outlined in Section 31 of the IBC.
Challenges Hindering PPIRP’s Success
Despite its potential benefits, the implementation of PPIRP has encountered several challenges that have hindered its widespread adoption and effectiveness. Since its inception, the adoption of PPIRP has been notably low. Over a two-year period, only eight cases were filed, with just one reaching a resolution. This minimal engagement suggests that the process has not gained the anticipated traction among MSMEs. Factors contributing to this limited uptake include a lack of awareness about the process, apprehensions regarding its efficacy, and the availability of alternative informal restructuring methods that businesses may prefer.
The success of PPIRP heavily relies on the cooperation and trust between debtors and creditors. However, in the Indian context, there is often a deficit of trust, particularly towards promoters of distressed companies. This skepticism is exacerbated by past instances of wilful defaults and mismanagement. Consequently, creditors may be reluctant to approve resolution plans proposed by existing management, fearing potential biases or unfavourable terms. This lack of trust undermines the collaborative spirit essential for the success of PPIRP.
Although PPIRP aims to minimize judicial intervention, in practice, courts have often been involved in various stages of the process. Such interventions can lead to delays, defeating the purpose of a time-bound resolution mechanism. For instance, the statutory timeline of 120 days for completing the PPIRP is frequently exceeded due to legal challenges and procedural bottlenecks.
The U.S. Pre-Pack Framework
The United States’ pre-packaged bankruptcy process, commonly known as a “pre-pack,” is a streamlined approach under Chapter 11 of the Bankruptcy Code[3]. It allows financially distressed companies to negotiate and solicit acceptance of a reorganization plan from creditors prior to filing for bankruptcy. This method addresses several challenges inherent in traditional bankruptcy proceedings, offering a more efficient path to financial restructuring.
One of the primary advantages of the U.S. pre-pack process is its expedited timeline. By securing creditor approval before filing, companies can significantly reduce the duration of court proceedings. In some instances, companies have emerged from bankruptcy in as little as one day. For example, Belk Inc.[4], a department store chain, filed for bankruptcy under Chapter 11 and the entire process was completed approximately 12 hours later.
Traditional Chapter 11 cases can be costly due to prolonged court involvement and associated legal fees. The pre-pack process mitigates these expenses by shortening the bankruptcy timeline, thereby reducing administrative costs and conserving resources for the company’s rehabilitation. This cost efficiency is particularly beneficial for companies seeking to restructure without depleting their assets through extended legal battles.
The swift resolution inherent in pre-packs helps maintain market confidence. Companies can continue operations with minimal disruption, reassuring customers, suppliers, and employees.
Lessons to be learnt
- Pre-Filing Negotiations and Approval: The U.S. pre-pack process emphasizes reaching a consensus on the reorganization plan with creditors before filing for bankruptcy, ensuring a smoother and expedited court process. India can adapt the same by: –
- Mandating pre-filing negotiation meetings between debtors and creditors in PPIRP to finalize a draft resolution plan.
- Amending the IBC to allow the debtor to officially present the negotiated resolution plan as a pre-agreed document upon filing, thereby reducing the time needed for CoC deliberations.
- Introducing legal recognition for pre-filing agreements between creditors and debtors, ensuring that commitments made during these negotiations are enforceable.
- Strict Timelines with Flexibility for Genuine Extensions: The U.S. pre-pack system is designed for rapid resolutions, often concluding within a matter of weeks. The same can be adapted in India by: –
- Maintaining the current 120-day timeline while implementing strict penalties for delays caused by procedural lapses or frivolous objections.
- Allowing limited, case-specific extensions (e.g., up to 30 days) if the debtor demonstrates that the delay is due to extraordinary circumstances beyond their control.
- Reducing Judicial Intervention: The U.S. process minimizes court involvement, focusing on pre-negotiated settlements. India can adapt the same by:
- Empowering resolution professionals to handle disputes during the PPIRP process, limiting judicial involvement to cases of fraud or gross misconduct.
- Amending the IBC to streamline the role of the NCLT, focusing its oversight on plan approval rather than procedural details.
- Enhanced Public Awareness and Education: The U.S. has a mature insolvency ecosystem with widespread awareness among businesses and creditors. The same can be adapted in India by:
- Conducting national awareness campaigns to educate MSMEs about the benefits and procedural aspects of PPIRP.
- Introducing training modules for financial creditors, particularly those in rural and semi-urban areas, to ensure they understand the framework and its advantages.
- Partnering with industry associations (e.g., CII, FICCI) to disseminate knowledge about PPIRP among MSMEs.
Conclusion
The PPIRP offers a promising framework tailored to the unique challenges faced by MSMEs in India. By incorporating a debtor-in-possession model, streamlining timelines, and minimizing disruptions, PPIRP aims to preserve business continuity while facilitating a resolution process that is both efficient and equitable. However, the limited adoption of PPIRP highlights critical gaps in awareness, trust, and operational execution.
India can draw valuable lessons from international frameworks, such as the U.S. pre-packaged bankruptcy system, to enhance the efficacy of PPIRP. By mandating pre-filing negotiations, reducing judicial intervention, and fostering trust among stakeholders, the PPIRP can evolve into a robust mechanism for MSME distress resolution. Also, targeted reforms such as bridge financing, standardized documentation, and awareness campaigns are essential to address the systemic challenges hindering MSME participation.
Ultimately, MSMEs are the backbone of India’s economic growth, and their sustainability is imperative for the country’s long-term resilience. A well-implemented PPIRP, fortified by legislative refinements and collaborative efforts from policymakers and industry stakeholders, can ensure that distressed MSMEs find a pathway to revival. By building a framework that balances expediency, inclusivity, and fairness, India can pave the way for a more resilient and self-reliant MSME ecosystem.
References:
[1] Nikita Tambe, MSME Statistics and Trends, Forbes Advisor India (Feb. 6, 2024), https://www.forbes.com/advisor/in/business/msme-statistics/#:~:text=MSMEs%20in%20India&text=In%20India%2C%20over%2099%25%20of,of%200.01%25%20of%20all%20MSMEs.
[3] Bankruptcy Code, 11 U.S.C. ch. 11 (2018 & Supp. V 2024).
[4] In re Belk, Inc., Case No. 21-30630 (MI) (Bankr. S.D. Tex. 2021).
