‘Insolvency framework shouldn’t only solve proceeding issues but also save MSMEs from being dragged to it’

• By Harish Kumar & Itee Singhal

Ease of Doing Business for MSMEs: The drive to revamp the Micro Small and Medium Enterprises (MSMEs) is more evident in present times than ever, perhaps, owing to a reason that MSMEs may provide a big push to the Government’s much-decorated vision of “Atmanirbhar Bharat”. The recent entry to the reforms, which India may witness, is a special insolvency framework for MSMEs. The present framework under the Insolvency and Bankruptcy Code, 2016 (“Code”) treats MSMEs at par with other big corporate entities, without regard to their unique attributes and inherent challenges. India seems to have addressed the insolvency concerns peculiar to MSMEs by introducing an entirely new insolvency framework for MSMEs, an approach which only a few countries like Japan and Korea have followed so far, while most of the countries have only tailored their existing general insolvency provisions to address certain MSME asks.

Reportedly, the new insolvency framework will follow the ‘debtor in possession’ model for insolvency proceedings contrary to the ordinary insolvency resolution process which follows ‘creditor in control’ system. To this end, apparently, the revised framework proposes to allow the promoters of the MSMEs to continue to manage the operations even after the commencement of the insolvency process, instead of transferring the control to the resolution professional. This mechanism would certainly avoid disruption in the business operations as the promoters are already well aware of the business nuances as compared to the resolution professionals, who generally do not possess the business acumen. This coupled with the proposed reduction in the timeline to 90 days for MSME insolvency, similar to the present regime for fast track insolvency, would also prevent deterioration of assets of the MSMEs.

The framework further proposes to permit only the MSMEs, and not the financial and operational creditors, to apply for the initiation of insolvency proceedings. The purpose of this feature is not clear. Notably, the promoters of MSMEs are exempted from ineligibility norms stipulated under Section 29A of the Code, on the pretext that not enough resolution applicants may participate in the bidding process for MSME, given their nature of business. In such a scenario, the question arises as to who would be the driving force for initiating insolvency proceedings against MSMEs.

The most practicable answer seems to be that MSMEs would use the insolvency proceedings to restructure and negotiate their debts with the creditors. While this to an extent would provide temporary relief to the MSMEs by reducing their debt burden, however, it has the effect of defeating the underlying objectives of insolvency legislation i.e. balance of interest of all stakeholders (as it fails to take care of the interest of creditors). In fact, the MSMEs would be more inclined to initiate insolvency proceedings when they are confident that no resolution applicant(s), other than the promoters, would come forward and, therefore, the promoters would be in a better-off position to negotiate with the creditors. As the biggest challenge for MSMEs is the availability of credit, this unequal treatment is likely to make the lenders more averse to provide credit support to MSMEs.

Also read: Rs 3 lakh cr ECLGS: Nearly 33% of amount disbursed so far; this many MSME loan accounts credited

Another relevant aspect to consider is generally the MSMEs promoters extend their personal guarantees to secure the loan/financial assistance to MSMEs. Failure of business may doom the promoters to a lifetime of outstanding debt. Thus, the proposed framework should also contain safeguards to ensure that the provisions related to insolvency proceedings against personal guarantors, which provisions have already been notified in December 2019, do not extend to these MSMEs promoters. Further, over 97 per cent of the MSMR sector comprises proprietorship and partnership firms, and private and public limited companies comprise merely 0.8 per cent. Thus, a special insolvency framework for MSMEs, without corresponding enactment of the long-pending insolvency framework for partnership firms, proprietorship and individuals may leave some gaps and may lack wider reach.

The highlighted discussions so far related to the proposed framework, have been focused, on the treatment of MSMEs as debtor without much accreditation to the challenges, which the MSMEs face as creditors. The MSMEs are operational creditors to many large corporates. If such large businesses go into insolvency, then, the liquidation value that is guaranteed to MSMEs is negligible. This may be corrected by providing priority to MSMEs dues in the waterfall mechanism or making MSMEs dues as part of the CIRP cost. Further, Section 14 (2A) of the Code, inserted through 2020 Amendment, provides for non-termination of the supply of ‘essential’ goods or services during the moratorium, if the resolution professional believes such supplies to be critical to protecting the business of the corporate debtor, except where the corporate debtor has not paid dues arising of such supplies during the moratorium.

Though, Regulation 32 of the CIRP Regulations, limits ‘essential’ goods and services to mean only electricity, water, telecommunications, and information technology. This extended ambit of Section 14 (2A) would lead to the inclusion of wide arrays of supplies, including those offered by MSMEs, as essentials. It is inevitable to exempt MSMEs from this over aching provision as it obligates MSMEs to provide uninterrupted supplies to insolvent corporate debtor despite having a risk of default, which may make MSME suppliers themselves insolvent.

The expectations from the proposed framework center not only on resolving the issues once insolvency proceedings are initiated against MSMEs but also to protect the MSMEs from being dragged to insolvency in the first place. Further, as the majority of MSMEs consist of proprietorship firms and partnerships, the proposed framework should inevitably provide for due safeguards to protect their interests.

Harish Kumar is the Partner and Itee Singhal is the Senior Associate at L&L Partners. Views expressed are the author’s own.