IBC Ordinance, 2020 and the MSME Sector in India: Analysing the Implications

[By Poorna Poovamma K.M. and Abhishek Wadhawan]

The authors are students at Gujarat National Law University, Gandhinagar

Introduction: A Conceptual Understanding

The President promulgated The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (“Ordinance”) on June 05, 2020. The Ordinance has suspended Sections 7, 9 and 10 of The Insolvency & Bankruptcy Code, 2016 ( “Code”) to prevent the corporate bodies facing financial distress from being dragged by the creditors to insolvency proceedings for not being able to meet their financial obligations due to the spread of the COVID-19.

In essence, the Ordinance has inserted Section 10A in the Code which provides for suspension of the Section 7, 9 and 10 of the Code for a period of six months (extendable by maximum one year). Further, no application for initiation of insolvency proceedings against any corporate persons for any default arising on or after March 25, 2020 shall be filed. The Ordinance has also inserted Section 66(3) to the Code that states that no application can be made to the Adjudicating Authority for directing the Director of the corporate debtor to contribute to the assets of the corporate debtor, if it comes under the ambit of Section 10A of the Ordinance.

The period from March 25, 2020 till the suspension of the Code is often referred to as the ‘Disruption Period’ as all business and economic activities are disrupted due to the pandemic. This Disruption Period has hit the Micro, Small and Medium Enterprises (“MSMEs”) the hardest. To protect the MSMEs in these trying times, the Ministry of Micro, Small and Medium Enterprises revised the definitions of MSME through the Gazette Notification dated June 01, 2020 in order to ensure that more enterprises fall within the ambit of the Micro, Small and Medium Enterprises Development Act, 2006 which provides various economic incentives to the MSMEs. Indeed, through the gamut of the Aatmanirbhar Bharat Package, the Government has introduced various incentives for MSMEs like approval of equity infusion of Rupees 50,000 crores from the Fund of Funds, Rupees three lakh crore of collateral free loans to the MSMEs for their operational needs among many others.

With the suspension of Section 7, 9 and 10 of the Code, initiating insolvency proceedings against any corporate debtor will not be possible and hence the cases of wilful defaults by the corporates might exponentially rise. These increased wilful defaults by the corporate debtors will have a negative impact on the MSMEs majorly as they may face a shortage of cash flow leading to operational difficulties, given the fact that MSME sector enterprises form a major part of the operational creditors.

Through this article, the author will try to analyse the potential impact of the Ordinance on the MSME sector of India.

The Ordinance and the MSME Sector

The promulgated Ordinance gives rise to a number of concerns for the MSME sector to ponder. A few concerns that arise are:

  • The micro and small industries which make up a large part of the MSME sector have recently been accorded new definitions according to which maximum investment in a micro enterprise is rupees one crore and that for a small enterprise is rupees ten crore. Additionally, the Central Government recently acted on the powers conferred on it by way of the proviso to Section 4 of the Code, 2016 and increased the minimum amount of default with relation to the insolvency and liquidation of corporate debtors from rupees 1 lakh to 1 crore. As a result of this, MSME creditors, in reality would not be empowered to file for defaults lower than 1 crore and, considering their altered definitions, it would be next to impossible for the micro enterprises, and highly unlikely for small enterprises to file a claim for default.

Issues in this regard that need clarification with respect to the blanket suspension of the Code are:

  1. Whether a MSME can file an insolvency petition against a corporate debtor for two separate claims that add up to a total of one crore, provided that the default occurred before the disruption period?
  2. Further, in case, a default is continuous in nature and the total value of default is more than rupees one crore, but the default for a part of this transaction occurs during the disruption period, can a creditor still initiate an insolvency proceeding for the default of the entire amount, or even a part thereof?

Only an affirmative response by the Adjudicating Authority to these questions can ensure financial stability of the MSMEs. The Adjudicating Authority will definitely be in a dilemma as on one hand it would have the corporate debtors to be saved from insolvency proceedings and on the other hand, the financial soundness of the MSMEs, the wheels of the Indian economy will be at stake.

  • Another concern arising with respect to MSMEs is the suspension of Section 9 of the Code, which provides for the initiationbtw of Corporate Insolvency Resolution Process (“CIRP”) by an operational creditor. This concern is also fuelled by the fact that the Reserve Bank of India came out with a COVID-19 Regulatory Package whereby, a moratorium period of  6 months (till Aug. 31, 2020), for repayment of  loans provided by financial institutions has been provided to be availed by debtors in order to mitigate the disruption caused by the pandemic; operational creditors are not included in such capacity. It is to be noted that MSMEs have been considered to form a major part of operational creditors in the Indian economy. This, in all certainty, might lead to a high possibility of MSMEs not being able to invoke Section 9 of the Code even if the default reaches the minimum threshold of Rupees 1 crore that is prescribed, since Section 10A of the Ordinance has suspended initiation of CIRP during the disruption period.
  • Furthermore, Section 10A in the Ordinance provides that “no application for insolvency can be filed for any default arising on or after 25th March 2020 for a period of six months or further extendable till one year from such date”. A pertinent issue will be the interpretation of ‘from such date’ by the Adjudicating Authority. Further, the Ordinance is also silent on the aspect as to after the period of suspension is completed under this Ordinance, will the businesses be allowed to claim their dues, once the corporate debtors recover from the financial distress. In case, the Adjudicating Authority opines that the creditors cannot claim the dues that become payable during the Disruption Period even after the corporate debtors become financially sound, will have an unwelcoming impact on the MSMEs. Such an interpretation on permanently protecting the corporate debtors from paying their dues arising during the Disruption Period shall lead to an increase in wilful defaults by the corporate debtors which would again go unadjudicated due to insertion of the Section 66(3) to the Code. Thus, such an interpretation would only lead to an increase for the financial distress of the creditors and thus it becomes essential for the Adjudicating Authority to interpret the Ordinance in a manner that the operational creditors can initiate insolvency proceedings against the corporate debtor in case they fail to pay the dues even after they have financially recovered from the pandemic and the blanket suspension on the Code is removed.

In light of the recent events, the only protection available to MSMEs is that of Section 16 of the MSMED Act, 2006, which specifies the date from which interest is payable, has not been subjected to the Ordinance. This assures MSMEs that a debtor committing a default which occurred before the disruption period will in fact have to pay the specified interest regardless of the Ordinance passed. This would ensure that that those already owing repayment to MSMEs will not be able to draw excuses from the Ordinance. Even so, this cannot be considered as a benefit being conferred on the MSMEs by the Ordinance as it is just the maintenance of status quo.

Conclusion: The Final Remark

The Ordinance has certainly been passed with the intention of relieving corporate bodies in distress who are hard hit because of the pandemic. But, MSMEs will have to bear the cost of uplifting the defaulters. The concerns voiced above, namely- (i) the increase in the threshold amount of default under Section 4 of the Code, ambiguity as to how debts that are split into separate claims will be dealt with, (ii) MSMEs being majority of the operational creditors and unable to claim recourse under Section 9 of the Code during the disruption period and, (iii) the ambiguity in the interpretation of the term ‘from such date’ clearly highlight the disadvantage that MSMEs would be at. Despite the intention of the Ordinance in easing norms, it is clear that MSMEs certainly will not be the ones benefitting from it. It is important to note that the primary objective in increasing the default threshold was to protect stressed MSMEs from defaults that are likely to occur, but the Ordinance seems to suggest a different narrative altogether, quite contrary to what was intended.  It is also surprising to note that on one hand there are talks about distinctive insolvency regimes for MSMEs, while on the other hand they are barely considered in the promulgated Ordinance. Only time will tell if the Finance Minister’s intention in having a separate insolvency regime for MSMEs transpire into actions.

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