Empowering India's MSMEs: Tailored Insolvency Reforms For Sustainable Growth

Introduction 

 It is hardly an exaggeration to say that Micro, Small, and Medium Enterprises (MSMEs) form the backbone of the Indian economy. They contribute meaningfully to GDP, generate employment across regions, and sustain local supply chains in ways that larger corporations simply do not and cannot. However, the aspirations of MSMEs have not been catered to by the formal insolvency architecture in this country, particularly under the Insolvency and Bankruptcy Code, 2016 (‘IBC’). 

 The IBC is a landmark legislation but it was designed with a view to addressing/ resolving issues of insolvency for large corporate debtors, and it has been routinely observed that its efficacy has not been ideal whenever MSMEs are drawn into insolvency under IBC as the resolution proceedings are protracted, compliance costs overrun the actual money at stake which mostly leads to a high rate of liquidation of MSMEs. The underlying reasons are not difficult to identify as MSMEs largely being promoter backed entities, operate on thin capital reserves, their record keeping or books are usually informal and most specifically their assets are often specialized or location specific, which in turn affects their resale potential/ value. Thus, under the traditional Corporate Insolvency Resolution Process (‘CIRP’), the original promoters are kept out of the decision-making process even though they are the most required people who can engineer a turnaround. Further, since MSMEs are usually focused on a niche industry/ expertise, it attracts limited interest from external Resolution Applicants, which leads to CIRP often ending in liquidation instead of the intended resolution. It is important to note that the domino effect of these businesses closing results in losing jobs and eroding local economy. 

 The Foundational Reform under the IBC focused on MSMEs 

 It would not be out of place to mention that the policymakers have identified these issues as early as in 2018 which resulted in the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which introduced Section 240A, a special provision tailored to the circumstances of MSMEs within the IBC framework. The problem identified and sought to be addressed by Section 240A was the operation of Section 29A of the IBC (which disqualifies the erstwhile defaulting promoters not being able to file a Resolution Plan for resolving the insolvency, thereby, preventing irresponsible or unscrupulous managements from buying back their own distressed companies at a discount). The legislature observed that many MSMEs are closely held, family-run operations and most of the times their promoters are not corporate raiders or unscrupulous beneficiaries, but are businessmen facing a lean patch in business and usually these promoters are the only people with the requisite knowledge, relationships, and operational understanding which is needed to revive the business, and it was noted that barring them from the Resolution Process completely leads to the corporate death of the enterprise. 

 Section 240A provided a much-needed exemption thereby allowing promoters of MSMEs to now propose revival plans, provided they were not willful defaulters and were not involved in any fraudulent conduct. The Insolvency Law Committee’s 2018 report noted the rationale behind this reform as it noted that MSMEs are frequently viable only in the hands of their original promoters, and a rigid application of Section 29A would lead to unnecessary liquidations and a net destruction of economic value, and this reasoning has also been endorsed by the Hon’ble Supreme Court of India which affirmed that the letter of law under the IBC needed to accommodate the distinct realities of smaller enterprises rather than forcing the framework designed for a different class of debtors. 

 Pre-Packaged Insolvency Resolution Process (PIRP) 

 We have noted that the conceptual groundwork laid down by Section 240A and the slightly newer initiative of Pre-Packaged Insolvency Resolution Process (‘PIRP’), launched in 2021, which provides for a hybrid model for resolving insolvency, thereby marrying the flexibility of an informal out-of-court restructuring with the legal certainty and safeguards under the IBC.  

 This mechanism has been developed specifically keeping in mind the need for MSMEs, since by a statutory mandate, PIRP has been capped at 120 days, with a strict 90-day window for submitting a Resolution Plan which when compared to the 330-day ceiling under the traditional CIRP demonstrated the stark difference. We have already noted that a speedy resolution is the sine qua non for small businesses as every additional month or week of the enterprise reeling under insolvency erodes goodwill, customer relationships, and efficacious enterprise value.  

 More importantly, under CIRP, the existing management of the enterprise is displaced and a Resolution Professional steps in to assumes charge of running the business, however, under PIRP, the existing board of directors retain control of the business throughout the process, subject to only an oversight by the Resolution Professional. It is important to note that this continuity is not merely procedural, but it preserves operational knowledge, maintains stakeholder confidence, and avoids the disruption that inevitably accompanies a change of management at the moment when the business is reeling under financial distress. PIRP is also designed to be affordable and predictable as all the concomitant professional fees are pre-agreed and disclosed in advance, which ensures transparency and efficacious compliance costs, resolving a genuine concern for smaller enterprises which might otherwise consume the little value that the business retains. 

 The Hon’ble Supreme Court has also endorsed these reforms in multiple ways as the Hon’ble Supreme Court clarified that MSME status acquired before the submission of a resolution plan entitles the applicant to the benefits of Section 240A, even when the status was not in place at the time of initiation of CIRP. Such an interpretation ensures that promoters of MSMEs are not stuck due to procedural lapses and expands the benefit of the new exemption. 

On the regulatory side, Insolvency and Bankruptcy Board of India (‘IBBI’) has proposed amendments to the IBC regulations which require disclosure of a Corporate Debtor's status as a MSME during the CIRP. Presently, the Information Memorandum (‘IM’) prepared by the Resolution Professional does not mandate such a disclosure which has given rise to litigation by promoters and leads to inordinate delays. The proposed change by IBBI would require the IM to include details of the corporate debtor's MSME registration under the Micro, Small and Medium Enterprises Development Act, 2006 (‘MSMED Act’) and related notifications, which would settle classification issues early, and encourage greater participation from resolution applicants from those drawn to MSMEs on account of the regulatory and incentive advantages.  

 Conclusion 

 We do not in any way suggest that the work is finished as real challenges still persist. We note that the threshold default for PIRP eligibility remains a live question, and creditor behaviour where they hold-out giving consent complicates any effective resolution efforts. However, this does not take away the commendable exercise undertaken by the legislature and the regulators, as IBBI continues to innovate. E.g., Piloting digital asset-valuation tools and exploring simplified Insolvency Committees for Micro-enterprises, among other initiatives. 

 Collectively, India’s targeted insolvency reforms, anchored in Section 240A and an enabling mechanism through PIRP amongst other regulatory initiatives have genuinely transformed the insolvency landscape for MSMEs through lowering procedural barriers, preserving entrepreneurial involvement, and building a more supportive institutional ecosystem. We note that these reforms are more than rescue measures as they do more than protecting individual businesses but they reaffirm the IBC’s foundational ambition of preventing corporate death by ensuring resolution of insolvency.

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