Are MSMEs hampered by insolvency and Bankruptcy code?

Published: September 6, 2018 3:21 AM

There is a need for a reality check on the entire process.

msme, insolvency and bankruptsy codeOne of the issues that has not yet caught the attention of the government or the IBBI is the treatment of MSMEs under the resolution plan.

The Insolvency and Bankruptcy Code (IBC) is in its second year of operation; it has, at best, been a roller-coaster ride where the application of the said law has opened loads of issues that have been noted and acted upon by the Insolvency and Bankruptcy Board of India (IBBI) and/or the government.

One of the issues that has not yet caught the attention of the government or the IBBI is the treatment of MSMEs under the resolution plan. As the law currently stands, there is no difference that has been accorded to MSMEs and other operational creditors, and as such, these operational creditors are only guaranteed the liquidation value. In some resolution plans that have been approved by National Company Law Tribunals (NCLTs) across India, the liquidation value of the company is nil and, hence, nil amount is guaranteed to such operational creditors, including MSMEs.

It’s precarious situation for MSMEs for two vital reasons: (1) It is an important sector since it provides huge employment to the country at large and, one may argue, is the backbone of the economy; and (2) there is an effective legal regime that has been promulgated to consider the interest of MSMEs, i.e. the Micro, Small & Medium Enterprises Development (MSMED) Act, wherein MSMEs are guaranteed principal amount along with interest for delayed payment of more than 45 days from the delivery of goods or services, at three times bank rate (nearly 19%). It’s a guaranteed amount under the Act, which is totally abrogated by a resolution plan, wherein only liquidation value is guaranteed.

Now, let us step back and see why such a broad protection was given to MSMEs under the Act. The Supreme Court and various High Courts have noted that legislature wanted to accord special protection to MSMEs since there is a lack of working capital. Thus, a non obstante clause was incorporated in the MSMED Act to ensure that principal and interest are statutorily protected to MSMEs even if there is something inconsistent with other laws; this aspect has, time and again, been given the stamp of approval by constitutional courts. The problem now arises when an insolvency process is initiated against the buyer under the IBC, there is a moratorium that is imposed, and no actions can be instituted under the MSMED Act. Even the pending proceedings against the corporate debtor are stayed. Further, orders that may have been passed under the MSMED Act against the buyer (who is the corporate debtor) cannot be executed. Additionally, MSMEs have no role to play since they are not even on the committee of creditors, so there is complete opaqueness in the way their interests are taken care of, if at all.

During the insolvency process, MSMEs must file their claims with the interim resolution professional (IRP) or resolution professional (RP) and, thereafter, it is the sole prerogative of the IRP/RP to accept, reject or modify the liability. After the resolution process is over, these SMEs may have to take a massive haircut at the end, wherein they may not even receive the principal amount, leave alone the interest that is statutorily given under the MSMED Act. Due to their payments not coming on time, these SMEs have issues with respect to operations since they lack working capital. Further, due to lack of monies, they are unable to pay to their own suppliers from whom they had acquired goods, thus exposing them too declared insolvent.

The problem is severe and may be epidemic in times to come, unless steps are taken to stem the tide. One of the ways the author feels it can be done is: Section 30(2)(e) of the IBC provides that the resolution plan so adopted must be in conformity with the law for the time being in force. There was a discussion on this clause in a report by the Insolvency Law Committee, wherein it was noted the resolution plan must be in compliance with the Real Estate (Regulation and Development) Act, since it is a law for time being in force. The same logic would apply to the MSMED Act. Further, similar to RERA, the MSMED Act contains clause for delayed actions/payments. It is to be noted herein that the MSMED Act has a non obstante clause and, hence, a resolution plan cannot abrogate the rights that accrue to an MSME under the MSMED Act.

It is argued that even the IBC has a non obstante clause; that being said, the IBC only provides for a waterfall in case of liquidation wherein resolution plan is essentially a private document that must stand the scrutiny of law. It may be advisable to think that since the MSMED Act is a special statute, so if resolution plan does not provide for repayment of admitted debt of MSMEs in full, then such a plan is non est in law. This is one of the ways in which interest of MSMEs can be safeguarded from the law, which can be described as for the financial creditors, by the financial creditors and of the financial creditors.

By Abir Roy, Advocate, Seetharaman & Associates

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