Summary: The Micro, Small and Medium Enterprises Development (MSMED) Act, 2006, aimed to promote and develop MSMEs and address delayed payments, though its practical effectiveness has been limited due to enforceability issues. The Insolvency and Bankruptcy Code (IBC) offers a comprehensive framework for insolvency resolution but primarily benefits corporate entities. While the Pre-packaged Insolvency Resolution Process (PPIRP), a hybrid model with informal pre-initiation and formal post-initiation phases, is currently available only to corporate MSMEs, most MSMEs in India are unincorporated (proprietorships or partnerships) and thus fall outside its purview. This significant disparity means a vast number of MSMEs, which form the backbone of the Indian economy, cannot leverage the PPIRP for their turnaround. To address some of the challenges, the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, introduced Section 240A, which relaxes the strict eligibility criteria of Section 29A for corporate MSMEs. This allows promoters, unless they are willful defaulters or fall under specific disqualifications, to bid for the resolution plan of their own MSME, preventing forced liquidation due to a lack of other bidders. This amendment reflects the understanding that for MSMEs, promoters are often the most likely interested parties for a resolution. However, the absence of a similar comprehensive and formalized pre-pack resolution process for unincorporated MSMEs under Part III of the Code remains a notable gap. International practices, such as the Company Voluntary Arrangement (CVA) and Individual Voluntary Arrangement (IVA) in the UK, Chapter 11 and Chapter 13 bankruptcies in the US, and streamlined consumer proposals in Canada and debt agreements in Australia, offer various mechanisms for both corporate and non-corporate entities to restructure debt and avoid liquidation, providing valuable insights for potential reforms in India.
The MSMED Act, 2006, this law has measures for the promotion, development, and enhancement of competitiveness of MSMEs. The Act also specifies how payment delays and related disputes are to be settled. In case of a default, the MSME could approach the Facilitation Council which can help with payment or impose a penalty or pass a decree. But in practice, this mechanism has met with limited success.
Although the Act addresses the issue of delayed payment, the said process has been highly questionable owing to the enforceability of the awards passed by the council.
Resolution under IBC: The IBC becomes relevant to MSMEs mostly when they are operational creditors to large debtors. There are cases where MSME can also be a financial creditor. The IBC provides a comprehensive framework for the resolution of insolvency and bankruptcy of corporate persons, LLP, individuals, partnership firms, and sole proprietorship firms in a time-bound manner for maximisation of value of assets.
The pre-packaged insolvency resolution process (PPIRP/Pre-Pack) at present applies only to corporate MSMEs. Most MSMEs by virtue of being a partnership or proprietorship firms have to resort to the standard corporate insolvency resolution process (CIRP).
The Insolvency and Bankruptcy Code (Second Amendment) Act, 2018 (Second Amendment) has brought relief to the MSME by relaxing the applicability of the provisions of section 29A of the Code.
SECTION 29A OF IBC: Section 29A of the Code provides for the persons ineligibility to be a resolution applicant(s) and thus, forms an important criterion of eligibility to submit a resolution plan.
THE SECOND AMENDMENT INTRODUCED SECTION 240A, which provides certain relaxations to MSMEs with respect to the applicability of restrictive provision of section 29A. The intention behind the enactment of this provision was to grant exemptions to corporate debtors (CDs) which are MSME(s), by permitting a promoter who is not a wilful defaulter or covered under any other specific disqualification as provided under section 29A, to bid for the resolution plan of an MSME.
The second amendment also empowers the Central Government to allow further exemptions or modifications with respect to the MSME sector, if required, in the public interest. With the introduction of these mindful exemptions, it is expected that the MSMEs may find bidders, and may not have to undergo liquidation.
In recognition of the importance of MSMEs to the Indian economy and the unique challenges faced by them, the Insolvency Law Committee (ILC) recommended the exemption of the application of certain provisions of the Code on MSMEs.
Illustratively, since usually only promoters of an MSME are likely to be interested in acquiring it, the applicability of section 29A has been restricted only to disqualify wilful defaulters from bidding for MSMEs.
The Supreme Court in Swiss Ribbon’s case reiterated that the rationale for excluding such industries from the eligibility criteria laid down in section 29A (c) and (h) is because qua such industries, other resolution applicants may not be forthcoming, which then will inevitably not lead to resolution, but liquidation.
THE PPIRP (PRE -PACKAGED INSOLVENCY RESOLUTION PROCESS) APPLIES ONLY TO CORPORATE MSMES.
| GOVERNING FRAMEWORK
The provisions governing PPIRP are available in: (i) the Insolvency and Bankruptcy Code, 2016, as amended by the Insolvency and Bankruptcy (Amendment) Ordinance, 2021; (ii) the Insolvency and Bankruptcy (Pre-packaged Insolvency Resolution Process) Rules, 2021; and (iii) the Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Regulations, 2021. ELIGIBILITY FOR PPIRP A Corporate Debtor, which is an MSME under sub-section (1) of the section 7 of the Micro, Small and Medium Enterprises Development Act, 2006, is eligible to apply for initiation of PPIRP, if it- (i) has committed a default of at least ₹10 lakh; (ii) is eligible to submit a resolution plan under section 29A of the Code; (iii) has not undergone a PPIRP during the three years preceding the initiation date; (iv) has not completed a CIRP during the three years preceding the initiation date; (v) is not undergoing a CIRP; and (vi) is not required to be liquidated by an order under section 33 of the Code. To evidence that the CD is an MSME, the application shall attach either a copy of the latest and updated Udyam Registration Certificate or proof of investment in plant and machinery or equipment and turnover as per Notification No. 2119(E) dated 26th June, 2020 of the Ministry of MSMEs. PRE-INITIATION PHASE PPIRP envisages a hybrid process, where pre-initiation phase is largely informal and post-initiation stage is formal. The informality at pre-initiation stage offers flexibility for the CD and its creditors to swiftly explore and negotiate the best way to resolve stress in the business, while the post-initiation stage drives value maximisation and bestows the resolution plan with the statutory protection. The following activities need to be undertaken in pre-initiation stage: (i) For seeking approval of creditors under section 54A(2)(e) and (3), the applicant (corporate applicant filing an application for initiation of PPIRP) shall convene meetings of the unrelated financial creditors (UFCs), that is, financial creditors who are not related parties of the CD. Where the CD has no financial debt or where all financial creditors are related parties, the applicant shall convene meetings of unrelated operational creditors (UOCs) and the UOCs shall perform the same duties and functions as the UFCs. (ii) For convening a meeting of UFCs, the applicant shall serve the notice of the meeting to UFCs at least five days before the date of the meeting (s) unless a shorter time is agreed to by all of them. The notice of the meeting shall indicate the date, time, and venue of the meeting and specific agenda items for discussion. (iii) The applicant shall enclose a list of creditors and the amount due to each of them in Form P2, along with the notice convening the meeting seeking approval for appointment of an IP as RP. (iv) In the meeting of UFCs, creditors having at least 10% of the value of debt shall propose the name of an IP eligible under the Regulations, for appointment as RP. An IP is eligible to be appointed as RP if he, and all partners and directors of the insolvency professional entity of which he is a partner or director, are independent of the corporate debtor. A person is considered independent if he meets the requirements specified under regulation 7. (v) The UFCs representing not less than 66% in value of debt due to such creditors shall approve the appointment as RP and the terms of appointment in Form P3. The terms of appointment shall include of Resolution Professional: (a) fee payable to him for performing duties in relation to pre-initiation phase. under section 54B, (b) fee payable to him and expenses to be incurred by him for conducting the PPIRP, and (c) fee payable to him and expenses to be incurred by him in case management of the CD is vested with him under section 54J. (vi) he majority of director/partners of the CD shall make a declaration in Form P6 stating; (a) that the CD shall file an application for initiation within a definite time not exceeding 90 days, (b) that the PPIRP is not being initiated to defraud any person, and (c) the name of the IP approved by creditors to be appointed as the RP. (vii) The members of the CD shall pass a special resolution, or at least three-fourth of the total number of partners of the CD shall pass a resolution, approving the filing of an application for initiating PPIRP as required in section 54A(2)(g). (viii) The CD shall prepare a BRP in conformity with the requirements under section 54K. (ix) Along with the notice for convening the meeting(s) seeking approval for filing of an application for initiating PPIRP, the applicant shall enclose; (a) a list of creditors and the amount due to each of them in Form P2, (b) declaration in Form 6, (c) the resolution of members or partners referred to in section 54A(2)(g), and (d) the BRP. (x) In the meeting of UFCs, creditors representing not less than 66% in value of debt due to such creditors shall approve filing of application for initiation of PPIRP of the CD under section 54A (3), in Form P4. (xi) The IP (proposed to be appointed as the RP) shall ascertain creditors in class(es), if any, from the list of creditors in Form P2, identify three IPs to act as authorised representative (AR) and obtain their consent in Form P5, seek choice of creditors in the class, select the IP, who is the choice of the highest number of creditors in the class to act as the AR, and inform the name of the IP, along with his consent in Form P5, to the applicant, in accordance with regulation 15. (xii) The IP (proposed to be appointed as the RP) shall prepare report in Form P8 confirming if the CD is eligible for PPIRP and the BRP confirms the requirements. APPLICATION FOR INITIATION (i) Only a corporate applicant can file an application for initiation of PPIRP. (ii) The applicant shall file the application in Form 1, in electronic form, before the AA for initiating PPIRP. (iii) The application shall be accompanied by the following documents: (a) Record of default; (b) Consent of the IP proposed to be appointed as RP, in Form P1; (c) Approval of UFCs for initiation, in Form P4; (d) Consent of the IP proposed to act as AR, if any, in Form P5; (e) Declaration by Directors/Partners, in Form P6; (f) Members’ Resolution or Partners’ Resolution; (g) Declaration by CD regarding avoidance transaction(s), in Form P7; (h) Report of the RP, in Form P8; (i) Audited financial statements of the last two financial years; (j) Provisional financial statements for current financial year made up to the date of declaration under section 54A(2)(f); (k) Latest and updated Udyam Registration Certificate, or proof that the CD is an MSME; (l) Affidavit stating that the CD is eligible under section 29A of the Code to submit resolution plan in the PPIRP of the CD; (m) A statement of affairs made up to a date not earlier than 14 days from the date of application; (n) A statement giving the names and addresses of the members or partners of the CD, with details of their respective shareholdings; (o) Proof that the application fee of ₹15,000 has been paid; (p) Proof that a copy of the application has been served to the IBBI; and (q) Document that records the authority of the applicant to make the application, where the applicant is a member or partner of the CD. (iv) The applicant shall serve a copy of the application (for initiating PPIRP) to the IBBI before filing it with the AA. (v) Within 14 days of the receipt of the application, the AA shall admit the application, if the application is complete or reject the same, if incomplete. However, before rejecting the application, the AA shall provide a period of seven days to the applicant for rectifying the defects, if any, in the application. The AA shall also deal with any application for initiation of CIRP pending for admission in accordance with the Code while deciding on the application. (vi) The PPIRP shall commence on the date of admission of the application. (vii) The AA shall, on the PPIRP commencement date along with the order of admission, declare a moratorium of the purposes of sub-sections (1) and (3) of section 14 of the Code, appoint the IP named in the application as the RP, and cause a public announcement to be made by the RP. (viii) The duties of the IP shall cease if the application is either not filed within the time specified in declaration in Form 6 or is not admitted by the AA. POST-INITIATION PHASE (i) The process is required to be completed within a time frame of 120 days from the PPIRP commencement date. A model timeline along-with details of the activities to be undertaken during the process is presented in Annexure C. (ii) During the PPIRP, (a) the management of the affairs of the CD shall continue to vest in the Board of Directors / the partners of the CD; (b) the Board of Directors / the partners of the CD shall make every endeavour to protect and preserve the value of the property of the CD, and manage its operations as a going concern; and (c) the promoters, members, personnel and partners of the CD shall exercise and discharge their contractual or statutory rights and obligations in relation to the CD. (iii) The CD shall, within two days of the PPIRP commencement date, submit to the RP, updated as on that date, (a) a list of claims, along with details of the respective creditors, their security interests and guarantees, in Form P10, and (b) a preliminary information memorandum (PIM) containing information relevant. for formulating a resolution plan. If any person sustains any loss or damage as a consequence of the omission of any material information or inclusion of any misleading information in the list of claims or the PIM, every person who (a) is a promoter or director or partner of the CD at the time of submission of the list of claims or the PIM, or (b) has authorised the submission of the list of claims or the PIM, shall be liable to pay compensation. (iv) The CD shall submit the BRP to the RP within two days of the PPIRP commencement. date. It may revise the BRP if permitted by the CoC. (v) The RP shall make a public announcement, in Form P9, within two days of the commencement of the process in the manner specified in regulation 19. (vi) The RP shall exercise powers and carry out duties as required under section 54F. APPROVAL OF RESOLUTION PLAN (i) If BRP does not impair claims owed to operational creditors (OCs), the CoC may approve it for submission to the AA. (ii) If the CoC does not approve the BRP or the BRP impairs the claims of OCs, the RP shall invite prospective resolution applicants to submit resolution plans to compete with the BRP. He shall publish brief particulars of the invitation for resolution plans in Form P11, not later than 21 days from the PPIRP commencement date, in accordance with regulation 43. (iii) The invitation for resolution plans shall detail each step in the process, and the manner and purposes of interaction between the RP and the resolution applicant, along with corresponding timelines. It shall include; (a) the basis for evaluation; (b) the basis for considering a resolution plan significantly better than another resolution plan; (c) the tick size; and (d) the manner of improving a resolution plan. It shall not require any non-refundable deposit for submission of or along with resolution plan. (iv) The resolution plans received in response to invitation and complying with the requirements of the Code and the Regulations shall be evaluated on the basis for evaluation. The resolution plan which gets the highest score shall be selected as best alternate plan (BAP) for competition with the BRP. (v) The CoC may consider BRP for approval if no resolution plan is received. (vi) The CoC may consider the BAP for approval if it is significantly better than the BRP. If it does not approve a significantly better BAP, the process terminates. (vii) If the BAP is not significantly better than the BRP, the RP shall disclose the scores of the BAP and BRP to submitters of these plans and invite them to improve their plans in accordance with regulation 48. (viii) The process of improvement shall continue till either of the submitters fails to use the option within the specified time. The resolution plan having higher score on completion of process of improvement shall be considered by the CoC for approval. If the CoC does not approve it, the process terminates. CLOSURE OF PPIRP The PPIRP closes in the following circumstances: (i) On approval of either the BRP or the BAP by the AA. (ii) On expiry of 90 days if no resolution plan is submitted to the AA for approval. (iii) On rejection of resolution plan by the AA. (iv) On approval by the AA of application filed by the RP for termination of PPIRP, where the CoC approves termination with 66% of voting share. (v) On conversion into CIRP based on an application filed by the RP, where the CoC approves so with 66% of voting share, and the CD is eligible for CIRP. The RP of the PPIRP is appointed as the IRP of the CIRP. (vi) On an order of termination in case either no resolution plan is approved by CoC, or the resolution plan approved by the CoC does not result in change in management, where the AA has vested the management of the CD with the RP under section 54J. |
RESOLUTION & BANKRUPTCY PROCESS FOR NON-CORPORATE MSMEs
Although Part III of the Code provides for a resolution and bankruptcy process to address the insolvency of proprietorships and partnership firms, its provisions are yet to be notified. It is found that a vast number of MSMEs in the country fall outside the purview of PPIRP for their turnaround under IBC as these are not registered companies.
As noted above, in 2015-16, there were 633.88 lakh unincorporated non-agriculture MSMEs in the country engaged in different economic activities. These far outnumber the MSMEs which are registered as companies around 780,000 or 60% of all active companies in the country which will benefit from the PPIRP.
These companies represent just above 1% of all the unincorporated MSMEs, implying that the informal sector businesses far outnumber the organised sector and will not be covered by the PPIRP. Extending an insolvency resolution scheme under IBC to unincorporated entities and proprietorships, however, is hugely challenging given the large number of such enterprises.
The United Nations Commission on International Trade Law (UNCITRAL) referred to pre-packs as ‘expedited reorganisation proceedings’. In attempting to understand the pre-pack and framing the provisions of pre-pack for the Indian scenario, the ILC, in its report has studied several global jurisdictions, including the United Kingdom (UK), the United States (US), in order to frame relevant law for our country. There is no doubt that the UK and US continue to be the lead flag bearers of prepack arrangements, but pre-packs for unincorporated MSMEs is yet to be formally brought under Part III of the Code.
Therefore, it is imperative to examine the treatment of non-corporate MSMEs under other jurisdictions so that the pre-pack resolution process for non-corporate MSMEs in India, can be brought into existence that will benefit the un-incorporated MSMEs in India.
INTERNATIONAL PRACTICES
United Kingdom The primary legislation governing insolvency is the Insolvency Act, 1986 which was modified by the Enterprises Act, 2002 and has made radical changes to corporate and personal insolvency.
The UK legislation does not specifically use the term MSME. However, a company voluntary arrangement (CVA) is a vehicle for SME to restructure, rather than to liquidate through bankruptcy. The UK law has made provisions for Individual and Partnership firms.
Individual Voluntary Arrangement (IVA) is a private negotiation between debtors and creditors wherein the debtors avoid the stigma of bankruptcy. While negotiations are outside of the court, they are supported by legal provisions embedded in the law.
If the debtors and creditors can come up with an agreement on the composition of debts, then the court only plays a role in sanctioning the agreement. There is no bankruptcy in the case of an IVA since a plan of repayment is agreed upon before a debtor can be called ‘bankrupt’.
An IVA is available to all individuals, sole traders or those in a business partnership who are experiencing financial difficulty.
TREATMENT OF MSME INSOLVENCY UNDER IBC
A PARTNERSHIP VOLUNTARY ARRANGEMENT (PVA) is a formal agreement between a partnership firm and its creditors to repay all or part of its debts over time. Much like the very similar Company Voluntary Arrangement (CVA), a PVA is a legally binding agreement to repay debts owing to creditors through monthly contributions over a typical period of between three and five years. Depending on the circumstances of the business and the amount it can afford to repay each month, this could mean that only a proportion of the total debt is paid. The PVA also provides the partnership with protection from creditor action. Once the PVA has been proposed, no creditor action can be taken. This extends for the length of the agreement if it is approved. That can make a PVA an especially useful restructuring tool.
Where an unincorporated/non-LLP partnership is insolvent and where a rescue of that partnership or business is possible, an administration may be appropriate. An Administrator is a licensed insolvency practitioner appointed by the partners of the business out of court, a floating charge holder (for example the holder of an agricultural charge) or by the court on application. An administration protects the partnership and its business from its creditors whilst proposals regarding its future are prepared. It does not protect the individual partners’ estates and other assets and the individual will need to deal with any residual claims of creditors following the administration.
The Administrators deal with all classes of the creditor. The procedure is similar to that of Company administrations.
United States In the US, businesses and individuals seeking relief under the US Bankruptcy Code are allowed to file a petition under the Bankruptcy Code Chapters 7, 9, 11, 12, 13, and 15. The US Bankruptcy Code specifies ‘small business debtors’, it does not refer to MSME or SME.
A Chapter 11 bankruptcy is a legal process that involves the reorganisation of a debtor’s debts and assets. It is available to individuals, sole proprietorships, partnerships, and corporations.
The main reason to file for Chapter 11 bankruptcy is to be able to prevent a business from permanently closing. Of course, the company needs to be in such a position that the restructuring of its debt makes financial sense.
Chapter 13 provides a reorganisation plan to individuals who do not want to go through a Chapter 7 bankruptcy. Individuals get an opportunity to reorganise their financial affairs while being under the protection of the Bankruptcy Court. Although an individual, who is operating a business as a sole proprietor or conducting a professional practice, can file a Chapter 13 petition as most Chapter 13 debtors are ‘consumer debtors’.
The COVID-19 pandemic has made few changes in the bankruptcy laws of the US. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, made several changes to bankruptcy laws designed to make the process more available to businesses and individuals, economically disadvantaged by the pandemic.
Canada In Canada, Division II ‘consumer’ proposal is used as a highly streamlined mechanism for micro business which is provided under the Bankruptcy and Insolvency Act, 1985 (BIA).
These provisions are accessible to non-incorporated self-employed individuals and sole proprietors whose debts are less than 250,000 CAD, excluding a mortgage or hypothec on the individual’s principal residence.
The consumer proposal provisions of Division II of Part III of the BIA allow a much more streamlined summary process. The provisions were enacted as a mechanism to deal with smaller estates on a more cost-effective and expedited basis.
A Division II proposal must be made to creditors generally but is not binding on secured creditors that have not filed a proof of claim. Division II proposals were designed as consumer proposals; however, they are available to self-employed individuals and sole proprietors that fall within the criteria mentioned above. For individuals, bankruptcy offers an opportunity for a fresh start financially. Individuals, including business sole proprietors, who are first-time bankrupts have the option of automatic discharge after they make an assignment or are ordered into bankruptcy, which is either in nine months or 21 months, depending on whether the bankrupt has surplus income, unless it is opposed by a creditor, the trustee, or the Superintendent of Bankruptcy.
Australia Debt agreements were introduced as an alternative to bankruptcy. They were intended to provide debtors with a cost-effective means of making arrangements with their creditors while avoiding bankruptcy and some of its more serious consequences. Debt agreements are binding agreements made between debtors and their creditors in accordance with Part IX of the Bankruptcy Act, 1966. Under these agreements, insolvent debtors propose legally binding repayment arrangements to their creditors. If such a proposal is accepted by the creditors, the debtor is released from the debts owed to these creditors upon completion of the agreed payments.
Debt agreements are subject to the oversight of the Official Receiver, AFSA. Debtors proposing a debt agreement cannot have been bankrupt, nor have had a debt agreement or a Part X arrangement, within the preceding 10 years.
Republic of Korea the Debtor Rehabilitation and Bankruptcy Act (DRBA) consolidated the Corporate Reorganisation Act, 1962, the Composition Act, 1962 and the Bankruptcy Act, 1962 to make the procedure for bankruptcy and rehabilitation of insolvent companies more efficient and streamlined.
The Composition Act and the Bankruptcy Act apply to all types of legal entities including individuals, corporations, and unincorporated foundations or associations, etc.
The DRBA includes (i) a rehabilitation procedure for corporates and individuals; (ii) a streamlined summary rehabilitation procedure (SRP) for SMEs; (iii) a rehabilitation procedure for individuals 290 Treatment of MSME Insolvency under IBC with small debts; (iv) a liquidation procedure for individuals and corporates which includes a summary liquidation procedure for SMEs.
The process, timing, and product of the Korean Individual Rehabilitation Proceeding (IRP) is generally similar to the U.S. Chapter 13 process. Owners of unincorporated businesses are eligible to use the procedure for individual rehabilitation, provided they meet the debt thresholds for the procedure.
This simplified procedure enables individuals to restructure all debts (business and personal) in a single proceeding. The Summary Rehabilitation Proceedings (SRP) under the DRBA is a streamlined procedure that aims to reduce costs, increase efficiency, and boost the chances of successful plan adoption. SMEs with debts of no more than KRW 3 billion may access the process. The SRP modifies the corporate rehabilitation procedure described above by eliminating the need for a custodian and an inspector in most cases. An inspection commissioner, who is an accountant, or a court official may be appointed, with simplified duties under Supreme Court Regulations. In addition, a creditors’ council is not required in all cases and the voting thresholds for adoption of a plan are relaxed.
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DISCLAIMER: the article presented here is only for sharing information with readers. In case of necessity do consult with professionals for more clarity and understanding on subject matter.
SOURCES: https://www.ibbi.gov.in/uploads/whatsnew/a650764a464bc60fe330bce464d5607d.pdf
https://ibbi.gov.in/uploads/resources/b7dfd3332bc133fde5783cf70b9371a1.pdf
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