To strengthen the insolvency framework for medium, small and micro enterprises (MSMEs), a latest Insolvency and Bankruptcy Board of India (IBBI) study suggests that the government should permit clubbing of the claims by operational creditors (OCs) up to a limit of 10 claims. This proposal is aimed at improving the recovery of marginal suppliers/vendors during the insolvency process.
“Individually, many MSMEs do not hold claims large enough to justify the cost of initiating proceedings, even when non-payment is persistent and economically damaging. Aggregation would allow similarly placed OCs to collectively initiate proceedings, thereby improving access to the Insolvency and Bankruptcy Code (IBC) without lowering thresholds across the board,” the study said.
At present, the statutory threshold to submit claims and initiate bankruptcy proceedings for OCs requires a minimum default of Rs 1 crore.
The study, conducted by Management Development Institute (MDI) Gurgaon, has asked for a waiver of procedural and filing charges for smaller OCs post admission to the insolvency proceedings.
What was the purpose of the study?
A key job of the study was to identify the structural gaps in the current resolution auction design. To address this, it has proposed an auction model where the bidder offering the highest overall recovery is awarded. This has to be coupled with implementing a quasi-Absolute Priority Rule (quasi-APR) for the distribution of proceeds.
Under the quasi-APR, financial creditors’ priority will be fully recognised up to the firm’s liquidation value, and any value realised beyond liquidation will then be distributed proportionately across other creditor classes. “The quasi-APR with MSME orientation provides large OCs and MSMEs with recovery rates proportional to their claims,” the study noted.
Additionally, the study suggests that the National e-Governance Services (NeSL) should be mandated to record all accepted OC invoices of at least Rs 1 crore. NeSL is a central repository for financial information that enables OCs to submit and store data regarding debts, which acts as an evidence of default under the IBC.
“A systematic recording of claims would reduce informational frictions, speed up dispute resolution, and lower transaction costs at the pre-admission stage, particularly for MSMEs,” the study said.
Tailored specifically for MSMEs, the pre-packaged insolvency resolution process (PPIRP) has been sparsely used with just 14 cases filed under it so far. The study calls for interventions by eliminating the clause requiring that OCs suffer “no impairment” of their claims. Also, it calls for separating the main (pre-pack) resolution process from the investigation of avoidance transactions, with certain safeguards.
A brief history of the PPIRP package
Introduced in 2021, PPIRP offers faster and cost-effective method to restructure MSMEs wherein the existing promoter remains in control of the company, and works with financial creditors to revive the company.
“MSMEs have been found to avoid initiating PPIRP for fear of reputation risk that can lose them customers and vendors. MSMEs often operate in clusters where inter-connectedness is high in both business and personal relationships. Submitting to bankruptcy proceedings is still seen by some as a ‘stigma’, which they seek to avoid,” the study stated.
Further, it has recommended that IBBI should collect, standardise, and make available data and information on pre-admission settlements, recoveries and disposals since such data would allow policymakers to better understand why weaker firms eventually enter CIRP while stronger firms tend to settle earlier, and would enable a more accurate assessment of the IBC’s overall impact.
Experts said that the recommendations are aligned with the priorities of MSMEs. “It also aptly recognises that OCs claims to be paid without impairment is a non-starter and would lead to an anomalous situation of going against the spirit of IBC,” said Prateek Kumar, partner at Khaitan & Co.
“The report also appears to be slightly late since the new amendments have just now got promulgated. Going by the nature of suggestions contained in the report, implementing them through IBC regulatory regime will not be feasible,” said Abhishek Swaroop, partner at Saraf and Partners.