IBC Ordinance: A Double-Edged Sword for MSMEs

BY JUBIN MALAWAT AND BHAVYA KALA, SECOND-YEAR STUDENTS AT RGNUL, PUNJAB

Introduction

CoVID-19 has created worst ever recessional conditions in the markets worldwide leaving everyone in distress. In light of the prevalent market conditions and the anticipated future contraction in the market, the government of India has introduced a few stabilizing and corrective measures keeping in mind the vulnerability of the Micro, Small and Medium Enterprises (‘MSMEs’) in these challenging times. One of the best examples of the measures adopted by the Union Government is the vision of making India self-reliant, ‘Atmanirbhar Bharat’. The government has also introduced a few changes in the Insolvency and Bankruptcy Code, 2016 (‘IBC’) with an intent to safeguard the MSME sector from the leash of CoVID-19 and improve the ease of doing business.

Although the intent of the government behind the promulgation of ordinance dated 5th June 2020 was to amend the IBC to provide some breathing space to the MSME sector, the measures have had some unintended effects on the sector. This piece analyses the impact of the recent ordinance to amend the IBC on the MSME sector and highlights the gaps which are to be bridged. Bridging of these gaps would not only make MSMEs sustainable in the times of economic downturn but also help India become ‘Atmanirbhar’

Highlights of the ordinance introducing sec. 10A to the IBC:

  1. Suspension of S. 7, 9 and 10 of the IBC for default arising on or after 25.03.2020 till 25.09.2020 and extendable up to 25.03.2021.
  2. No new application shall be allowed to initiate fresh CIRP from 25.03.2020 for a minimum period of 6 months extendable up to 12 months as and when notified.
  3. No application shall ever be filed for the initiation of CIRP of a corporate debtor concerning any default arising during disruption period starting from 25.03.2020.
  4. An application seeking initiation of fresh CIRP shall be allowed only if the following two conditions are fulfilled:
    • The default arose before 25.03.2020.
    • The said default amount is greater than Rs.1 Crore. 

Impact on MSME Sector

Micro, Small and Medium Enterprises, as defined in S. 7 of MSMED Act 2006, contribute significantly to the economy of the nation. It employs around 111 million people and accounts for approximately 48% and 28% of the nation’s export and GDP respectively. Hence, it is clear the MSME sector remains the backbone of the nation’s economy and deserves to be protected in these unprecedented times. The legislators with a similar intent promulgated an ordinance amending the IBC but the letter didn’t seem to match to the authority’s intent.

Recent changes in the IBC, including the rise in the default threshold under S. 4, suspension of S. 7, 9, and 10, and insertion of the proviso in S. 10A providing blanket protection to the debtors defaulting during the disruption period starting from 25th March have raised debates as to whether the ordinance helps MSMEs or harms them. Owing to the recent ordinances, MSMEs have been impacted in two ways, i.e. being a creditor and being a debtor.

MSMEs being the Operational Creditors

As per the study by the Brickwork Ratings, MSMEs have approximately Rs.303 lakh crore of their funds stuck with large corporates in the form of receivables. Hence, it can be asserted that MSMEs play a vital role in the economy being operational creditors to the large corporate houses. In the times of CoVID-19 when the whole economy is struggling to escape from the rippling effect over the economy, it becomes all the more important to ensure that the smaller firms contributing to the nation’s economy on such a large scale are duly paid back.

  • Suspension of S. 9 adding to the plight of MSMEs

The un-amended IBC framework facilitated negotiating leverage to the smaller firms against the mighty corporates as the MSMEs could enforce S. 9 of the IBC to recover their dues in a time-bound manner. But the recently introduced ordinance, although passed to provide breathing space to the distressed firms, has made the MSME firms helpless by disabling them to invoke insolvency proceedings for the recovery of their dues. In numerous cases, it has been that the corporate houses, fearing wide-ranging ramifications, settled their debts against the smaller firms after the application for insolvency proceeding was filled but before the same was taken up by the tribunals.

According to the data provided by the Insolvency and Bankruptcy Board of India, up to March 2020, 157 applications for corporate insolvency resolution process were withdrawn under S. 12A of the IBC, of which 64 cases involved amounts less than Rs.1 crore. The reasons for early withdrawal of cases were full settlement with the applicant and other settlement with creditors.

Now under the garb of amended IBC framework, the corporates who earlier feared harsh consequences of the insolvency proceedings would now fearlessly strong-arm the smaller firms by defaulting the repayment of their dues. Furthermore, the redressal forums other than NCLT fail to provide timely redressal adding to the plight of the creditors.

  • Proviso incentivizing corporate debtors to default

Apart from the above-stated problems, the proviso in the newly introduced S.10A has placed the MSMEs in a vulnerable position by allowing complete amnesty to the corporate debtors who default during the disruption period. The expression “no application shall ever be filed” has opened the flood gates of varied interpretation.

Recently, the Hon’ble National Company Law Tribunal, Chennai Bench in Siemens Gamesa Renewable Power Private Limited v. Ramesh Kymal interpreted the proviso to S. 10A and held that there shall be no insolvency proceedings ever against the defaults which arise after 25.03.2020. This interpretation allows an exemption to the defaulting debtors whether or not such default has arisen due to the economic downturn in the times of the pandemic.

If such an interpretation is taken up, it would incentivise the non-payment of dues by the corporates and would lead to the MSMEs turning up into non-performing assets. In these trying times when the economy is struggling to move out of the rippling effect, fall of MSME sector would adversely impact the nation’s economy. Among other things, a decline in MSME sector would cause a steep rise in the unemployment rate and set off India’s ambition of becoming self-reliant. 

MSMEs being the Corporate Debtors

Objectives of IBC include maximization of the value of assets, to promote entrepreneurship, availability of credit and balance the interests of the stakeholders. In consonance with the objectives, S.10 facilitates an exit route to a corporate debtor wherein the loss-making business is transferred to a prospective resolution applicant based on a resolution plan to revive the sick enterprise. The resolution plan is sanctioned by the adjudicating authority keeping in mind the interests of all the stakeholders.

Blanket suspension of S.10 defeats the core objective of the IBC to revive and not to liquidate the enterprise. Suspension of the section would lead to a slow death of the business enterprises which could be revived with a prospective plan. The ordinance would not only deprive the corporate debtor of rehabilitating the business but also force him to continue the distressed business. This would not only deplete the value of assets rather than maximizing them but also lead to the winding-up of a potentially viable business.

Conclusion

In the testing times of this pandemic, although the government has tried to modify the provisions of the IBC with a bonafide intention to provide safeguard to the MSMEs, it has ended up worsening the situation for them. The recent ordinance adding S. 10A in the IBC and the notification has created loopholes which would act against the interest of the MSMEs. These would make the smaller businesses vulnerable in the hands of larger corporates.

Furthermore, these additions and modifications to the IBC would act as a barrier for MSMEs to pull off under the government’s “Atmanirbhar Bharat” initiative. The liquidity crunch faced by the MSMEs owing to the suspension of S. 7 and 9 of IBC would compel the MSMEs to avoid further payments of their debtors and undergo unnecessary litigation which would certainly raise the burden of the MSMEs in the near future. Moreover, blanket suspension of S. 10 of IBC will destroy every hope of reforming viable MSMEs.

Keeping in mind the flickering market conditions and the upcoming competition in domestic as well as international market, more focused actions are called for on the part of the authorities. As pointed out by the Hon’ble Finance Minister in her press note, a special insolvency framework needs to be introduced under S. 240A of IBC accompanied with other focused initiatives. This would not only provide leverage to the MSMEs against the powerful corporates but also help India holdup its ambition of self-reliance.

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