Overview of the Position of MSMEs as Corporate Debtors and as Operational Creditors under the IBC – By Mr. Rajrishi Ramaswamy

Overview of the Position of MSMEs as Corporate Debtors and as Operational Creditors under the IBC

– By Mr. Rajrishi Ramaswamy
Second Year B.B.A. LLB Student, Symbiosis Law School, Hyderabad

Introduction

In an Order dated 20^th April, 2021 in K. Sateesh Babu Rajesh v. Mr. George Varkey (2021) ibclaw.in 61 NCLT, the Kochi Bench of the National Company Law Tribunal (hereinafter “NCLT”) disposed of an application made by a promoter to an MSME, after asking him to file an Expression of Interest  (EoI) in his own capacity and to then register the Corporate Debtor as an MSME through the newly initiated “Udhyam” process.

Through this Order, the NCLT has very succinctly reiterated the position of MSMEs under the Indian insolvency law. In light of the same, it would be pertinent to analyze the relevant legislative provisions and key judicial pronouncements which deal with MSMEs not just as Corporate Debtors (hereinafter “CD”) but also as Operational Creditors (hereinafter “OC”).

MSMEs as CDs

In India, the classification of MSMEs and measures for their promotions, among other aspects, are provided for under the MSME Development Act of 2006. However, this legislation neither provides for their reconstruction during insolvency, nor for their liquidation. This warranted inclusion of a provision for insolvency of MSMEs, under the Insolvency and Bankruptcy Code, 2016 (hereinafter “IBC”).

The most relevant provision is Section 240A read with Section 29A. Pertinently, other provisions of the IBC have also been extended to MSMEs through the decisions of the NCLT, NCLAT, the High Courts and the Supreme Court.

Section 240A(1) exempts the applicability of clauses (c) and (h) of Section 29A to MSMEs. Section 29A lays down restrictions for who is eligible to submit a resolution plan as the Corporate Insolvency Resolution Process (hereinafter “CIRP”) is in progress. Clause (c) of this Section disqualifies a promoter of the corporate debtor whose accounts are classified as non-performing assets as per the Banking Regulation Act, 1949. Clause (h) disqualifies a guarantor to the Corporate Debtor from submitting a resolution plan. Hence, Section 240A empowers both these persons to submit resolution plans when the Corporate Debtor is an MSME. Pertinently, both these provisions were inserted in the IBC by way of the (Second) 2018 Amendment Act. Furthermore, by way of an Ordinance dated 4^th April, 2021, the applicability of Section 29A was also excluded in cases of pre-packaged insolvency processes of MSMEs. Through this Ordinance, MSMEs as debtors have now been put in control of their CIRPs, as opposed to the conventional model in which creditors (more specifically, FCs) control the CIRP.

Another pertinent provision was exempted from being applicable to MSMEs through the decision of the NCLAT in Saravana Global Holdings Ltd. & Anr. vs. Bafna Pharmaceuticals Ltd. & Ors. (2019) ibclaw.in 38 SC, where the Tribunal held that the Committee of Creditors (hereinafter “CoC”) need not abide by all the procedures relating to CIRP when the Corporate Debtor is an MSME. One such procedure was regarding withdrawal of the application under Sections 7, 9, or 10, which is provided under Section 12A.

Therefore, MSMEs have a secured position as CDs, due to the legislature taking cognizance of the shortcomings they have faced under the IBC and also the judiciary interpreting the IBC to their advantage.

MSMEs as OCs

Generally, OCs under the IBC are not as protected as the Financial Creditors (hereinafter “FCs”). The justification for this differential treatment has been provided in various decisions of the Courts and Tribunals. For instance, in Committee of Creditors of Essar Steel vs. Satish Kumar Gupta [2019] ibclaw.in 07 SC, the Supreme Court held that OCs and FCs are not to be treated equally under the IBC. Furthermore, OCs are not entitled to claim unfair or inequitable treatment with respect to funds distributed under the Resolution Plan, as was ruled by the NCLAT in Pratap Technocrats Pvt. Ltd. & Ors. v. Monitoring Committee of Reliance Infratel Ltd. & Anr. (2021) ibclaw.in 02 NCLAT. This is especially true when the OCs had been taken into consideration while the Resolution Plan had been made.

From the abovementioned judgements, it is clear that OCs cannot demand to be treated as equals to FCs and further that if it can be shown that their needs have been taken into consideration when the Resolution Plan was prepared, they cannot demand allocations be made to them.

The plight of OCs with respect to equal treatment under the IBC also extends to MSMEs. Additionally, MSMEs as OCs also face a higher risk component, as non-return of the debt by the CD may mean substantial losses for MSMEs. They however have recourse to an extent under the MSMED Act, which they also cannot avail due to the effect of Section 238 of the IBC. Section 238 as a non-obstante clause, provides that the provisions of the IBC would prevail when inconsistencies exist with other legislations. Since the IBC was enacted after the MSMED Act, the law laid down by the Supreme Court in an array of judgements such as Duncancs Industries Ltd. v. A.J. Agrochem [2019] ibclaw.in 18 SC, dictates that the provisions of the IBC would take effect. This would then mean that MSME creditors would fall within OCs and the amount of money they would be receiving, would be left to the Resolution Applicants, the plans they submit and the final decision of the CoC.

Ultimately, MSMEs are subject to the same treatment OCs are given under the IBC. However, given the level of importance accorded to these enterprises by the legislature and the judiciary, it would be a reasonable ask to enable MSME creditors to secure a guaranteed return in the CIRP, as opposed to the OCs.

In order to enable MSMEs to approach the MSMED Facilitation Council under the MSMED Act, the Central Government would have to exercise its powers under Section 240A(2) of the IBC. Clause (a) of Section 240A(2) empowers the Central Government to exempt a provision from applying to MSMEs and Clause (b) empowers it  to make provisions applicable, after modifying them in a manner it deems necessary. Exercising its powers under Section 240(2)(b), the Central Government can make modifications to Section 238 and give precedence to the provisions of the MSMED Act, to the extent of MSME creditors being able to avail recourse under the MSMED Act. However, they should not be barred from seeking recourse under the IBC, if the MSMED Act fails them.

Conclusion

MSME s have been considered the “backbone of India’s economy” and various initiatives have been taken by the legislature to the benefit of these enterprises, particularly during the COVID-19 pandemic. It was in the context of the pandemic that pre-packaged insolvencies were exempted from the scope of Section 29A, so that failing MSMEs would have assured buyers before the CIRP commences. Based on the provisions discussed above and the recent steps that have been taken by the Central Government, it is clear that MSMEs which are CDs are not subject to as much risk as their creditor counterparts are. This scenario needs to see change in order to give better effect to the legislature’s intent with respect to MSMEs.

Arguably, the changes suggested above could result in OCs becoming more apprehensive of their returns, which are already not guaranteed. These apprehensions can only be resolved by undertaking to research on viable ways to better the position of OCs; studying foreign insolvency and bankruptcy laws; revisiting recommendations made in the reports of committees including the Insolvency and Bankruptcy Law Committee; and lastly, entering into regular communications with all involved stakeholders and taking in suggestions, to obtain better clarity whilst making amendments to the law.