BACKGROUND

Over the past few years, micro, small and medium enterprises (“MSMEs“) have contributed significantly towards the growth and development of the Indian economy. In addition to contributing towards the gross domestic product, MSMEs have also created numerous employment opportunities across the country.

However, the socio-economic growth and development fostered by MSMEs has been disrupted due to the COVID-19 pandemic. Consequently, Reserve Bank of India (“RBI“) and Government of India (“GOI“) did adopt various measures for revival of the Indian economy through this sector, in terms of both production and employment. Some of these measures included an enhanced stimulus package for MSMEs, relief in the asset classification norms and access to collateral free credit for financially distressed enterprises.

MICRO, SMALL AND MEDIUM ENTERPRISES – MEANING

The Ministry of Micro, Small and Medium Enterprises, GOI, vide notification dated June 26, 2020 (“Notification“) has set out a composite criteria of investment and turnover for classification of enterprises as MSMEs. As per the Notification, with effect from July 01, 2020, an enterprise shall be categorized as (i) a micro enterprise, if the investment in plant and machinery or equipment does not exceed INR 1,00,00,000/- (Indian Rupees One Crore Only) and turnover does not exceed INR 5,00,00,000/- (Indian Rupees Five Crores Only); (ii) a small enterprise, if the investment in plant and machinery or equipment does not exceed INR 10,00,00,000/- (Indian Rupees Ten Crores Only) and turnover does not exceed INR 50,00,00,000/- (Indian Rupees Fifty Crores Only); and (iii) a medium enterprise, if the investment in plant and machinery or equipment does not exceed INR 50,00,00,000/- (Indian Rupees Fifty Crores Only) and turnover does not exceed INR 250,00,00,000/- (Indian Rupees Two Hundred and Fifty Crores Only).

The calculation of an enterprise’s investment in plant and machinery/ equipment and turnover will be linked to the returns filed by such enterprise for the previous years under the Income Tax Act, 1961 and/ or Central Goods and Services Act, 2017. In case of a new enterprise, wherein no prior returns are available, the investment will be determined based on the self-declaration made by the promoters of such enterprise and such relaxation shall end after the March 31 of the financial year in which it files its first income tax return.

PRE-PACKAGED INSOLVENCY RESOLUTION PROCESS

The Ministry of Law and Justice, GOI, vide the Insolvency and Bankruptcy Code (Amendment) Ordinance dated April 04, 2021 (“Ordinance“) has introduced a pre-packaged insolvency resolution process (“PIRP“) for corporate debtors classified as MSMEs under the Micro, Small and Medium Enterprises Development Act, 2006[1]. Vide notifications dated April 09, 2021, the Ministry of Corporate Affairs, GOI has introduced the Insolvency and Bankruptcy (Pre-packaged Insolvency Resolution Process) Rules, 2021 and the Insolvency and Bankruptcy Board of India has introduced the Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Regulations, 2021, to provide further clarity with respect to the functioning of PIRP.

As per the Ordinance, PIRP may be initiated by an MSME for defaults of value up to INR 1,00,000/- (Indian Rupees One Lakh Only) or such higher amount as may be notified by GOI, which shall not be more than INR 1,00,00,000/- (Indian Rupees One Crore Only), subject to an approval received from the unrelated financial creditors of the MSME, representing not less than 66% (sixty six percent) in value of the total financial debt due and payable by the MSME to such creditors. It is pertinent to note that PIRP cannot run parallel to CIRP. Prior to commencement of PIRP under the Insolvency and Bankruptcy Code, 2016 (“Code”), it must be ensured that the MSME is not currently undergoing PIRP or has not undergone PIRP or CIRP in the immediately preceding 3 (three) years. Further, it must be ensured that no order for liquidating the MSME has been passed under the Code and that the MSME is eligible to submit a resolution plan under the Code.

In order to initiate PIRP, the corporate debtor (i.e. MSME) is required to file an application, along with a fee of INR 15,000/- (Indian Rupees Fifteen Thousand Only), with the National Company Law Tribunal (“NCLT“). Thereafter, NCLT may either admit or reject the application for initiation of PIRP within 14 (fourteen) days from the date of receipt of such application. PIRP shall be deemed to have commenced against the MSME from the date of admission of the application by NCLT (“Pre-Packaged Insolvency Commencement Date“).

The corporate debtor (i.e. MSME) is required to submit a base resolution plan to the resolution professional (“RP“) within 2 (two) days from the Pre-Packaged Insolvency Commencement Date. The RP must subsequently present such resolution plan to the committee of creditors (“COC“). The COC may then approve the base resolution plan for submission to NCLT, if it does not impair any claims owed by the corporate debtor to its operational creditors. If the base resolution plan is not approved by the COC or does not provide for the full payment of the confirmed claims of the operational creditors, the RP may invite new resolution applicants to submit resolution plan(s) to compete with the base resolution plan. The resolution plan must be approved for submission to NCLT by a vote of the COC comprising not less than 66% (sixty six percent) of the voting shares. Thereafter, if NCLT is satisfied that the resolution plan approved by COC fulfils the requirements under the Code, it shall by an order, within 30 (thirty) days from the date of receipt of such plan, approve the resolution plan.

In the event no resolution plan is approved by the COC, the RP must file an application with NCLT for termination of PIRP.

PIRP is a cost-effective process that is modelled on the debtor-in-possession and control approach, which allows the management of the affairs of the corporate debtor to vest with the board of directors or partners of the corporate debtor. It is also a speedy resolution process as the entire process must be completed within a period of 120 (one hundred and twenty) days from the date of its commencement.

RESOLUTION FRAMEWORK 2.0 – RESOLUTION OF COVID-19 RELATED STRESS OF MSMEs

RBI, vide notification dated May 05, 2021[2], has proposed a new restructuring mechanism for MSMEs,  wherein the existing loans to MSMEs are permitted to be restructured without a downgrade in the asset classification, subject to fulfilment of inter-alia certain conditions, including (i) the aggregate exposure to the MSME being less than INR 25,00,00,000/- (Indian Rupees Twenty Five Crores Only) as on March 31, 2021; (ii) the MSME’s account being classified as ‘standard asset’ as on March 31, 2021; (iii) the restructuring of the MSME’s account being invoked by September 30, 2021; and (iv) the restructuring of the MSME’s account being implemented within 90 (ninety) days from the date of invocation.

LONG ROAD TO RECOVERY

Considering a potential rise in non-performing assets, and even more so due to lower returns on asset employment during the COVID-19 pandemic, PIRP and the other resolution mechanisms proposed by RBI and GOI are likely to support endeavors to revive the MSMEs and credit flow in the economy. These resolution mechanisms may prove beneficial for all MSMEs, especially the micro segment, which is the most rapidly growing segment for indebtedness, accounting for nearly 30% (thirty percent) of the outstanding MSME credit.[3]

However, it is pertinent to note that there are certain challenges in the PIRP mechanism. These include over-dependency on the existing management of MSMEs for successful completion of PIRP and requirement of NCLT approval despite obtaining the consent of 66% (sixty six percent) of the financial creditors. Moreover, the PIRP mechanism presupposes cooperation among different classes of creditors and debtors, which may be possible theoretically, but may pose difficulties during implementation. Essentially, if one has to apply this to a real estate developer company wherein the financial creditors include home buyer/ customer of such a company and a bank/ financial institution lender to such a company; their interest may not necessarily be aligned in a PIRP.

While there is no doubt that PIRP holds great potential for revival of financially distressed MSMEs, its viability can only be assessed upon completion of a significant number of processes under the proposed mechanism; and there may be some amendments down the road for its effective implementation.

Authors:

Hardeep Sachdeva, Senior Partner
Gautam Kumar Bhargava, Senior Associate
Anurag Singh, Associate

Footnotes:

[1] Section 7, Micro, Small and Medium Enterprises Development Act, 2006.
[2] Resolution Framework 2.0 – Resolution of Covid-19 Related Stress of Micro, Small and Medium Enterprises (MSMEs), Notification No. RBI/2021-22/32, May 05, 2021.
[3] Paragraph 7.2.3(i), Report of the Expert Committee on Micro, Small and Medium Enterprises, June 2019.