Implication of Section 29A on Pre-Packaged Insolvency – Need for Clarity?
Recently, in the case of K. Satheesh Babu Rajesh v. Mr. George Varkey (2021) ibclaw.in 61 NCLT, the Kochi Bench of National Company Law Tribunal held that a Promoter of a Micro, Small and Medium Enterprises (MSMEs) Corporate Debtor will be eligible to submit an Expression of Interest/ Resolution Plan in his individual capacity. This Order clears the position of law regarding Section 240A of Insolvency and Bankruptcy Code, 2016 (IBC), which states that the eligibility criteria laid down in Section 29A(c) and 29A(h) of IBC will not be applicable to insolvency of MSMEs. Hence, hitherto the law was clear regarding the eligibility of Resolution Applicants to submit Resolution Plans during insolvency of MSMEs. However, a query now arises due to the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 (Ordinance) which makes Section 29A applicable to Pre-Packaged Insolvency for MSMEs.
Applicability of Section 29A to MSMEs
Section 29A of the IBC, which was added to the IBC by the Insolvency and Bankruptcy Code (Amendment) Act, 2017, provides a list of disqualifications criteria for Resolution Applicants from submitting a Resolution Plan during Corporate Insolvency Resolution Process (CIRP). This Section was included not only to ensure disqualification of persons due to whose mismanagement the corporate debtor is facing CIRP, but also to prevent undischarged insolvents from participating in the resolution process and to ensure maximization of assets. The two sub-clauses that impacted the MSMEs are sub-clauses (c) and (h) as they disqualified the Promoters of the MSMEs from submitting a Resolution Plan. Section 29A(c) of the IBC states that a person shall be ineligible to submit a Resolution Plan, if, at the time of submission of the Resolution Plan, he has an account or an account of Corporate Debtor under his control, which has been classified as a Non-Performing Asset by the RBI, before at least one year from the date of commencement of CIRP. On the other hand, 29A(h) states that a person shall be ineligible from submitting a Resolution Plan if he has executed a guarantee in favour of a creditor in respect of the Corporate Debtor against whom CIRP has been initiated.
Initially, the entire Section 29A was made applicable to Resolution Applicants submitting Resolution Plans for MSMEs. However, the Insolvency Law Committee submitted a Report in 2018, stating that since MSMEs form the foundation of Indian economy, certain relaxations must be provided to them. They suggested that a Promoter who is not a wilful defaulter must be permitted to bid for an MSME in insolvency because an MSME attracts mainly the interests of its Promoters and disqualifying them might hinder the efficiency of the Resolution Process of an MSME. Based on these recommendations, Section 240A was inserted via the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018. This Section provides that Section 29A (c) and 29A (h) will not apply to any Resolution Applicant submitting a Resolution Plan for MSMEs. Additionally, it explains that “the expression ‘micro, small and medium enterprises’ would mean any class or classes of enterprises classified under Section 7 (1) of the Micro, Small and Medium Enterprises Development Act, 2006.”
Effect of Section 29A on Pre-Packaged Insolvency
Due to the increasing distress caused by the pandemic on the MSMEs, the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021 was promulgated by the President to include the Pre-Packaged Insolvency Resolution Process for corporate persons classified as MSME with default upto INR 1 Crore. Pre-Packaged Insolvency refers to an arrangement between the Corporate Debtor, buyer and creditors of the Corporate Debtor, wherein the resolution of the Corporate Debtor’s business is negotiated between the buyer and the creditors before the appointment of an Insolvency Professional.[i] It can be considered as a viable alternative to the formal and standard CIRP.
It is pertinent to note that Section 54A of IBC, which has been incorporated through the Ordinance, provides the various conditions that has to be fulfilled before initiating the Pre-Package Insolvency. According to Section 54A(2)(d), an application to initiate Pre-Packaged Insolvency can be made only if the eligibility requirement provided under Section 29A of IBC is fulfilled. This sub-clause creates a confusion as to whether all the disqualifications enumerated under Section 29A would be applicable to Pre-Packaged Insolvency or whether Section 54A must be read with Section 240A of the IBC in order to exempt applicability of sub-clauses (c) and (h) of Section 29A to Pre-Packaged Insolvency.
On one hand, the 2020 Report by the Insolvency Law Committee, based on which the Ordinance was promulgated, recommended that all the conditions enumerated under Section 29A must be fulfilled prior to filing an application for initiation of the Pre-Packaged Insolvency. On the other hand, the judicial pronouncements prior to the Ordinance emphasized the importance of diluting certain disqualifications provided under Section 29A to Insolvency of MSMEs. In the case of Swiss Ribbons Pvt. Ltd. & Anr. v. Union of India & Ors.  ibclaw.in 03 SC, the Hon’ble Supreme Court held that the rationale for excluding MSMEs from the eligibility criteria laid down under Section 29A(c) and 29A(h) is due to the business model of MSMEs. It stated that in these types of businesses, there might not be any other forthcoming Resolution Applicant other than the Promoter and this in turn, may lead to inevitable liquidation of the Corporate Debtor, which is against the object of the IBC.
The law pertaining to applicability of Section 29A to CIRP is well settled and evolved over the course of years. However, the same cannot be concluded for applicability of Section 29A to Pre-Packaged Insolvency of MSMEs. Lack of clarity on this issue might lead to the Ordinance becoming a mere dead letter. The main purpose of the Ordinance is to promote continuity of the businesses, and ensure cost effective and timely resolution of the MSMEs. However, the said objective cannot be achieved if the Promoters, who in most cases are the sole guarantors for the loans taken by Corporate Debtor and who are mostly the sole stakeholders of the businesses, are not permitted to provide Resolution Plans. Since, the Pre-Packaged Insolvency Process is at its nascent stage, it is important for the Legislature to take note of this confusion and provide clarity on the effect of Section 29A to Pre-Packaged Insolvency Process. It is suggested that the afore-mentioned confusion can be solved by merely introducing an Amendment to the Ordinance by making Section 240A of IBC applicable to Chapter III-A.
[i] Tushar Kumar, Applicability of Section 29A to Pre-Packaged Insolvency Resolution of MSMEs, https://indiacorplaw.in/2021/04/applicability-of-section-29a-to-pre-packaged-insolvency-resolution-of-msmes.html