Lower the default threshold from Rs 1 crore for initiating action under IBC

October 26, 2020 6:00 AM

The threshold of Rs 1 crore is not only eroding borrowers’ fiscal discipline but also is effectively closing the option of approaching the NCLT for MSME operational creditors owed smaller amounts that are crucial for their survival

Thus, while financial creditors who maybe in a position to weather a failure to repay the debt will have the IBC option, the operational creditors like MSME who may not survive non-repayment can’t approach the NCLT.Thus, while financial creditors who maybe in a position to weather a failure to repay the debt will have the IBC option, the operational creditors like MSME who may not survive non-repayment can’t approach the NCLT.

By Vijay Kumar Gupta

In March 2020, the government raised the default threshold for invoking insolvency proceedings under the IBC to Rs 1 crore, from Rs 1 lakh, to prevent triggering of proceedings against MSMEs facing the Covid-19 heat.

The pandemic impact, apart from the fact that Rs 1 lakh was too low a threshold, did call for setting the threshold higher. However, such a high threshold undermines the unwritten objective of the IBC, i.e., encouraging financial discipline amongst the industry participants. Indeed, if the Corporate Insolvency Resolution Process (CIRP) is initiated against a corporate debtor, the board loses control. Hence, in many cases, the corporate debtor prefers to settle the outstanding amount. Thus, the higher threshold breaks financial discipline, as corporate debtors are wilfully stopping timely payments, which, in turn, is leading to a situation difficult to withstand to many lenders. In my opinion, the threshold should be revised to Rs 25 lakh, with clauses for special treatment to the MSME sector.

The definition of MSME has been changed to prod MSMEs to grow without losing the benefits associated with the MSME tag. A business entity is now classified as a micro-enterprise if its investment is up to Rs 1 crore and turnover is up to Rs 5 crore. The corresponding figures are Rs 10 crore and Rs 50 crore for classification as ‘small’ and Rs 50 crore and Rs 250 crore for classification as ‘medium’ enterprises. Earlier, the classification was only based on investment, with separate caps for the manufacturing and the service sectors.

Due to the raising of the threshold, MSMEs themselves are facing problems, with working capital blocked thanks to outstanding dues that are below the threshold. This is not only hampering the flow of money in the aggrieved firms, but also has caused the shutdown of several.

“As per the National Sample Survey (NSS) 73rd round, conducted by National Sample Survey Office, Ministry of Statistics & Programme Implementation during the period 2015-16, there were 633.88 lakh unincorporated non-agriculture MSMEs in the country engaged in different economic activities. Out of this the Micro Sector with 630.52 lakh estimated enterprises accounts for more than 99% of total estimated number of MSMEs.” (Source: FY2O Annual Report of the ministry of micro, small and medium enterprises)

If, of the total number of MSMEs, more than 99% are micro-entreprises—wherein investment in plant & machinery/ equipment doesn’t exceed Rs 25 lakh for enterprises in the manufacturing sector and Rs 10 lakh those in the service (investment not more than Rs 1 crore and annual turnover not more than Rs 5 crore w.e.f. July 1, 2020), then considering the size of the operations, it is highly likely that there are very few MSMEs that will have amounts higher than Rs 1 crore that are to be recovered from individual corporate debtors. Most, therefore, would benefit from a lower threshold in terms of recovery being aided by the IBC process.

With the threshold so high, it seems that the option of initiating insolvency proceedings under IBC will be available only to the financial creditors, since the claim of operational creditors is likely to be on the lower side, maybe even in just lakhs if the applicant is an MSME. Thus, while financial creditors who maybe in a position to weather a failure to repay the debt will have the IBC option, the operational creditors like MSME who may not survive non-repayment can’t approach the NCLT.

“Operational creditors have been in the forefront of availing this benefit under IBC having filed the maximum number of defaults with NCLT (of a total of 1858 resolution processes triggered as at the end of March 2019, operational creditors have caused 920 cases)”. (Source: Report of the Expert Committee on Micro, Small and Medium Enterprises, June 2019)

To nurture the MSME sector in India, the government must consider a reduction of the threshold of default for initiating insolvency proceedings by an MSME, from the present Rs 1 crore to Rs 5 lakh or such other amount that the it deems fit in the current circumstances and against the backdrop of other relevant data available with it regarding MSMEs.

This will help them stay afloat in the pandemic times, when business has been affected and recovery could be long and painful. As it is, the normal course of economic activity has been interrupted by the need for locking down and physical distancing.

The author is Managing director, KVG Insolvency Advisors Pvt. Ltd, & former central council member of ICAI
Views are personal

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