The bankruptcy board is planning to review the waterfall mechanism under the Insolvency and Bankruptcy Code (IBC), 2016, to assign a higher priority to micro, small and medium enterprises (MSMEs) during the distribution of proceeds from the sale of the liquidation of assets.
“The idea to prioritise MSME dues under IBC has been around for quite some time but the government is finally moving forward with a study that will make for a stronger case to classify MSME dues at par with secured creditors,” said an official.
The timeline for such a market study is yet to be decided by the Insolvency and Bankruptcy Board of India (IBBI), the official added.
Current Subordination of MSMEs
Section 53 of IBC puts MSMEs in the operational creditors category, which is the lowest level in the hierarchy of claims, during liquidation.
The constitutionality of the waterfall mechanism distinguishing financial and operational creditors was upheld by the Supreme Court in the Swiss Ribbons case in January 2019.
Till then, the operational creditors were usually paid before the financial creditors under the resolution plan, and also the initial recovery of what was owed to the operational creditors was slightly higher than what was owed to the financial creditors. Since then, circumstances have changed significantly with recoveries now being heavily skewed in favour of financial creditors.
A recent parliamentary panel report suggested to the Ministry of Corporate Affairs (MCA) to expedite the review of the waterfall mechanism’s impact on vulnerable stakeholder groups, particularly MSMEs and operational creditors.
“Despite several amendments in IBC over the years, the support towards MSME remains abysmal both as creditors and debtors. The pre-packaged insolvency scheme which was designed for MSMEs has not taken off as well due to trust deficit between borrowers and lenders. The amendments to section 53 is long overdue which will help safeguard the interests of MSMEs,” the official said.
Low Recovery Rates
Experts said that even after the likely amendments, recoveries for MSMEs would improve marginally given that the IBC recovery rates stand at just 32.44% as on September 2025.
“There’s not enough left on the table for the parties below financial creditors. In many cases, even the dues of financial creditors remain unpaid after the liquidation,” said Prateek Kumar, partner at Khaitan & Co.
Devendra Mehta, partner, PwC said that the proposal to enhance recoveries for MSMEs at the expense of secured creditors may not be a sound development for the IBC. “However, if political-economy considerations necessitate such a change, it should apply only to prospective insolvency admission applications, ensuring that the ecosystem is aware of the consequences before initiating a case,” he said.