The Micro, Small and Medium Enterprises (“MSMEs”) Sector plays an essential role in strengthening the Indian economy. In last five decades, MSMEs have contributed immensely in economic and social development of the country by generating employment opportunities, mobilization of resources and by industrializing the rural and backward areas. The equitable distribution of national income and wealth would be assured only when the small and medium enterprises are strengthened.
With the aim to develop the MSMEs, the Micro, Small and Medium Enterprises Development Act, 2006 (“MSMED Act“) was enacted by the legislature. The Act aims at facilitating the promotion and development of MSMEs as well seeks to enhance their competitiveness.
It is the first legislation which gave legislative recognition to the term “enterprise” in India. Section 7 of MSMED Act classifies ‘enterprises’ in two categories; the Manufacturing Enterprises and Service Enterprise, and further categories them in three categories; namely, Micro, Small and Medium Enterprises.
1. Manufacturing Enterprises
Section 7 of the MSMED Act provides that the manufacturing enterprises are those enterprises which are engaged in manufacturing or production of goods pertaining to any industry specified in the First Schedule of the Industries (Development and Regulation) Act, 1951. These enterprises are defined as per the terms of Investment in Plant & Machinery.
- A manufacturing enterprise is called “Micro Enterprise” when its investment in plant and machinery does not exceed Twenty-Five Lakh Rupees.
- A manufacturing enterprise is called “Small Enterprise” when its investment in plant and machinery is more than twenty-five lakh rupees but does not exceed Five Crore Rupees.
- A manufacturing enterprise Is called “Medium Enterprise” when its investment in plant and machinery is more than five crores but does not exceed Ten Crore Rupees.
2. Service Enterprises
Section 7 of the MSMED Act provides that service enterprises are those enterprises which are engaged in providing or rendering of services. These enterprises are defined as per the terms of investment in equipment.
- A service enterprise is called “Micro Enterprise” when its investment in equipment does not exceed Ten Lakh Rupees.
- A service enterprise is called “Small Enterprise” when its investment in equipment is more than Ten Lakh Rupees but does not exceed Two Crore Rupees.
- A service enterprise is called “Medium Enterprise” when its investment in equipment is more than Two Crore Rupees but does not exceed Five Crore Rupees.
The “financial liquidity” plays a vital role in the development, growth and sustenance of MSME Sector. However, one of the major challenges faced by the MSMEs is the recovery of payments.
PROVISION FOR RECOVERY OF PAYMENTS
MSMEs are considered as the backbone of Indian economy due to their immense contribution to the overall production and export of good or services, in domestic as well as global market. Nevertheless, MSME Sector has been facing the issue of delayed realisation of payments which led to liquidity and financial constraints in the growth of the enterprises. Due to financial hardships, the risk of them turning into non-performing assets only increases which hits the sustainability of the enterprises.
Considering the rising concerns over the liquidity issues of MSMEs, the Indian Legislature has introduced certain provisions in MSMED Act to mitigate the problem of delayed payments to the suppliers. MSMED Act provides a framework to resolve the issue of liquidity and delayed payment to the MSMEs.
Section 15 to 24 of the MSMED Act deal with the issue of delayed payments and provides a framework for the recovery of such payments.
Section 15 puts a liability on buyer and obligates him to make payment to the supplier when the goods are supplied, or services are rendered to him, on or before the date agreed by them. The Section reads as under:
“Where any supplier, supplies any goods or renders any services to any buyer, the buyer shall make payment therefor on or before the date agreed upon between him and the supplier in writing or, where there is no agreement in this behalf, before the appointed day”
The proviso to the Section provides that such payment must be made within the period of forty-five days from the day of acceptance or deemed acceptance.
Further, Section 16 provides that if the buyer fails to make the payment to the supplier, as provided under Section 15, he will be liable pay a compound interest on the principal amount at three times of the bank rate notified by the Reserve Bank of India on the monthly basis. The Section reads as under:
“Where any buyer fails to make payment of the amount to the supplier, as required under section 15, the buyer shall, notwithstanding anything contained in any agreement between the buyer and the supplier or in any law for the time being in force, be liable to pay compound interest with monthly rests to the supplier on that amount from the appointed day or, as the case may be, from the date immediately following the date agreed upon, at three times of the bank rate notified by the Reserve Bank.”
Moreover, Section 17 expressly provides that the supplier can recovery any amount due under Section 16 from the buyer for any goods supplied or services rendered. The Section reads as under:
“For any goods supplied or services rendered by the supplier, the buyer shall be liable to pay the amount with interest thereon as provided under section 16.”
Even then, if any dispute arises, the concerned party can make a reference to the Micro and Small Enterprises Facilitation Council for resolution of their dispute and recovery of dues thereof.
MICRO AND SMALL ENTERPRISES FACILITATION COUNCIL
Section 20 of MSMED Act mandates the State Governments to establish one or more Micro and Small Enterprises Councils (“MSEFCs”) for the settlement of disputes pertaining to delayed payments. The State Governments shall also notify the place where such Councils shall be established by notification. Section 21 of MSMED Act provides that MSEFCs shall consist of not less than three but not more than five members. The members of MSEFCs must include:
- Director of Industries of the State Government having administrative control of the small scale industries;
- One or more representatives of associations of micro or small industry or enterprise;
- One or more representatives of banks and financial institutions which provides the loans to micro or small enterprises;
- One or more persons having special knowledge in the field of industry, finance, law, trade or commerce.
Further, the Director of Industries appointed under this Section shall be known as the Chairperson of the Micro and Small Enterprises Facilitation Council.
Thus, MSEFCs are authorised by the State Governments to resolves the disputes with regard to realisation of principal and interest. Under Section 30, the State Government are empowered to make rules to carry out the provisions of the MSMED Act.
PROCEDURE TO FILE A COMPLAINT BEFORE MSEFC
A complaint may be filed or reference of a dispute may be made to the MSEFCs by any party to dispute under Section 18 of MSMED Act. Section 18 lists the steps to be taken to refer a matter before MSEFCs and provides as under:
- Reference to the Council
Firstly, a reference of dispute with regard to an amount due under Section 17 should be made to the Micro and Small Enterprises Facilitation Council by the disputing party.
- Initiation of Conciliation Proceeding
On the receipt of a reference, the MSEFC must conduct a proceeding to resolve the dispute in two ways; either by conducting a conciliation proceeding on its own or by seeking the assistance from any institution or centre providing alternative dispute resolution services by making a reference to such institution or centre, for conducting conciliation. The provisions of Sections 65 to 81 of the Arbitration and Conciliation Act, 1996 shall be applied for resolving the dispute as if the conciliation was initiated under Part III of the Act.
- Reference of Matter to Arbitration on non-settlement
Section 18 provides that if dispute is not settled between the parties by conciliation and conciliation proceeding stands terminated without reaching any settlement, the matter shall be taken up for the arbitration proceeding; either by the MSEFC itself or MSEFC may refer it to any institution providing alternative dispute resolution services for conduction of such arbitration. Section 18, further, mandates that the provisions of the Arbitration and Conciliation Act, 1996 shall apply to resolve the dispute by arbitration as if the arbitration was in pursuance of an arbitration agreement as provided under Section 7 of Arbitration and Conciliation Act.
- Jurisdiction of the MSEFC
Under Section 18, the Micro and Small Enterprises Facilitation Council or Centre providing alternative dispute resolution services shall have jurisdiction to act as an Arbitrator or Conciliator to resolve a dispute between the supplier and the buyer, where the supplier must be located within MSEFC’s jurisdiction and buyer may be located anywhere in India.
- Time frame for resolving a dispute
Clause 5 of Section 18 expressly provides that every reference under Section 18 must be decided within a period of ninety days from the date of making such reference.
- Application before the Court to set aside the decree, award or order
Section 19 of the MSMED Act provides that an application for setting aside any decree, award or order made, either by the Council itself or by the Institution or Centre to which matter was referred under Section 18 to provide alternative dispute resolution services, shall be entertained by any Court unless the appellant, not being the supplier, deposits to the Court seventy-five percent of the amount in terms of the decree, award or, any other order made by the Court thereunder.
Further, proviso to Section 19 empowers the Court to order, during the pendency of disposal of the application filed under Section 19, to make the payment to the supplier of the amount deposited in such percentage as it considers reasonable under the circumstances of the case subject to such conditions as it deems fit.
Thus, the above procedure must be followed for resolving any dispute pertaining to recovery of dues.
The aforesaid procedure was introduced to deter the buyers who fail to make the payments on time and to mitigate the cases of delayed payment. In order to strengthen the prevalent mechanism for recovery of payment, the Ministry of MSME launched an online portal, namely, “Samadhan Portal”. This Portal was launched to enable the suppliers to file an online application against the buyers for the recovery of their dues. The said application will be reviewed by the MSEFCs, and would also be viewed by the Central Ministries, State Governments and Central Public Sector Enterprises (“CPSEs”) for pro-active actions.
The portal facilitates the entrepreneurs or micro and small enterprises:
- To file an online application for delayed payments using the portal. For filing an application, the applicant is required to have Udyog Aadhaar Number which is validated with Aadhaar for filing the application.
- To check status of their application filed for recovery of delayed payments.
- By providing information regarding the pending payment of micro and small enterprises with CPSEs, or Central Ministries, or State Government etc.
Under the Insolvency and Bankruptcy Code, 2016 (“IBC”) an MSME can be considered as operational creditors, as well as corporate debtor depending upon the fact whether the MSME owed a debt to a creditor or a debt, was owed to the MSME. Accordingly, the IBC has different provisions and framework which deals with the operational creditor and the corporate debtor.
FOR OPERATIONAL CREDITOR
As per the scheme of the IBC, creditors are classified as operational creditor and financial creditor. This distinction is based on the nature of debt owed to them.
As far as MSMEs are concerned, they are categorised as Operational Creditor under Section 9. As per Section 5 (20) of the IBC an operational creditor means “a person to whom an operational debt is owned.” It follows that when an MSME has to make a recovery of debt, it will be treated as operational creditor under the IBC.
A comparison between financial creditor and operational creditor under the IBC suggests that the former is given priority over the latter in many provisions.
For instance, under Section 21 of the IBC, the operational creditors are not allowed to be a part of the committee of creditors and has no right to vote on the resolution.
Under Section 53 of the IBC, which deals with the waterfall mechanism, the operational creditors are given less priority.
Also, in case, where a debt is disputed by the Corporate Debtor before the filing of the application under Section 9 of the IBC, the same could be rejected by the Adjudicating Authority. However, the condition does not remain the same when an application is filed by the financial creditor.
Therefore, MSMEs being an operational creditor is at a disadvantageous position as compared to the financial creditor.
For MSMEs, there are other alternatives available for recovery of dues under the MSMED Act, 2006. As per Section 15 of the Act, 45 days’ time period is fixed for the recovery of dues by the supplier from the buyer and in cases where the buyer fails to make the amount to the supplier in 45 days, then he becomes liable to pay compound interest to the supplier at three times the bank rate notifies by RBI. The Act also gives an option to approach the MSME Facilitation Council. The Council on the application may himself conduct the conciliation process or may seek help from any other institution to conduct conciliation under Section
65 to 81 as per the Arbitration and Conciliations Act, 1996.
Therefore, the provisions of the MSMED act facilitates the recovery of dues more convenient and faster as compared to the provisions of IBC, 2016.
FOR CORPORATE DEBTOR
As per Section 2(8) of the IBC, “Corporate Debtor means a corporate person who owes a debt to any person.” Accordingly, in the case where dues are to be recovered from the MSME and an application can be moved under applicable provisions of IBC. MSMEs is considered as corporate debtor under IBC. Accordingly, Corporate Insolvency Resolution Process (“CIRP”) can be initiated against MSMEs under IBC just like against any other corporate debtor. This increases the chances of the MSME going into liquidation.
IBC (Second Amendment) Act, 2018
Therefore, assessing the condition an amendment was made wherein Section 240A was added in IBC. As a result of amendment, Clauses (c) and (h) of Section 29A became inapplicable to resolution applicant in respect of CIRP of any MSME. It is pertinent to note that Section 29A provides for the list of persons who are not eligible to submit a resolution plan. Accordingly, as per Clause (c) and (h) of Section 29(A) the promoters of entities having non-performing assets and guarantors were not allowed to submit a resolution plan.
Sub-Sections (1) and (2) of Section 240(A) of the IBC are as under:
“240A. (1) Notwithstanding anything to the contrary contained in this Code, the provisions of clauses (c) and (h) of Section 29A shall not apply to the resolution applicant in respect of corporate insolvency resolution process of any micro, small and medium enterprises.
(2) Subject to sub-Section (1), the Central Government may, in the public interest, by notification, direct that any of the provisions of this Code shall—
(a) not apply to micro, small and medium enterprises; or
(b) apply to micro, small and medium enterprises, with such modifications as may be
specified in the notification.”
Clauses (c) and (h) of Section 29(A) of the IBC are as under: –
“(c) has an account, or an account of a corporate debtor under the management or control of such person or of whom such person is a promoter, classified as non-performing asset in accordance with the guidelines of the Reserve Bank of India issued under the Banking Regulation Act, 1949 and at least a period of one year has lapsed from the date of such classification till the date of commencement of the corporate insolvency resolution process of the corporate debtor:
Provided that the person shall be eligible to submit a resolution plan if such person makes payment of all overdue amounts with interest thereon and charges relating to non-performing asset accounts before submission of resolution plan;”
“(h) has executed an enforceable guarantee in favor of a creditor in respect of a corporate debtor against which an application for insolvency resolution made by such creditor has been admitted under this Code;”
Accordingly, the promoters after the amendment became eligible to submit the resolution plan. As per the Insolvency Law Committee Report, 2018 the objective behind the insertion of Section 240A was that under the IBC, a default of above Rs. 1 lakh and above gives the right to creditors to initiate proceedings which can lead to liquidation as well. Further, the Committee highlighted the importance of the MSME and observed that liquidation of MSME can hit the economy very badly as these enterprises are a source of income and livelihood to many employees and workers. Therefore, allowing promoters to bid for them will help their revival because a person apart from promoter might not be interested in reviving it.
The relevant excerpt of the Committee Report is as under: –
“27.4 Regarding the first issue, the Code is clear that default of INR one lakh or above triggers the right of a financial creditor or an operational creditor to file for insolvency. Thus, the financial creditor or operational creditors of MSMEs may take it to insolvency under the Code. However, given that MSMEs are the bedrock of the Indian economy, and the intent is not to push them into liquidation and affect the livelihood of employees and workers of MSMEs, the Committee sought it fit to explicitly grant exemptions to corporate debtors which are MSMEs by permitting a promoter who is not a willful defaulter, to bid for the MSME in insolvency. The rationale for this relaxation is that a business of an MSME attracts interest primarily from a promoter of an MSME and may not be of interest to other resolution applicants.”
The reasoning given by the Committee behind the amendment was affirmed by a landmark Supreme Court judgement in Swiss Ribbons Pvt. Ltd. & Anr. Vs. Union of India, Writ Petition (Civil) No. 99 OF 2018, decided on 25 January, 2019.
The observation of the Court was that “the rationale for excluding such industries from the eligibility criteria laid down in Section 29A(c) and 29A(h) is because qua such industries, other resolution applicants may not be forthcoming, which then will inevitably lead not to resolution, but to liquidation.”
In another judgement of the Appellant Authority in Sarvana Holdings Pvt Ltd. V. Bafna Pharmaceutical Pvt. Ltd. it was held that that in cases where the corporate debtor is an MSME, the promoter is not required to compete with the other resolution applicant while regaining the control of the corporate debtor. The Adjudicating Authority can do away with the process give under the Section 12A of IBC, if the promoter offers a plan which is feasible enough to maximize the value of assets.
Due to COVID-19 outbreak, the Indian economy suddenly came to a halt. As a result of which business enterprises have to suffered losses amounting to crores. Assessing that defaults in such a scenario can be on the rise, the Ministry of Corporate Affairs (“MCA”) vide its notification dated 24th March 2020, changed the default limit under Section 4 of the IBC from Rs. 1 lakh to Rs.1 Crore. The main objective behind the change was to safeguard the small-scale industries from going into liquidation.
The Government keeping in mind the difficulties which the business enterprises faced due to lockdown restrictions and impact of the pandemic on the economy as a whole brought another amendment in the form of the IBC (Amendment) Ordinance, 2020 wherein Section 7,9 and 10 of the IBC were suspended. Further Section 10(A) was inserted which provided that no application for CIRP shall be filed after 25th March for a period of at least six months, which was further extended for three months on 25th September 2020.
Analyzing the effect of the amendments on the MSME Sector
Both the amendments brought by the Government was much required for the MSME sector. In absence of these amendments thousands of proceedings against the MSME would have initiated and that could have made the matter worse for the MSME.
On the one hand, the amendment was beneficial to the MSMEs who are corporate debtor as it provided them protection from the creditors. However, it was non-beneficial to the MSMEs who are operational creditor as firstly, the threshold limit for limit went up to Rs. 1 Crore and further the suspension of the relevant provisions of the IBC also made it impossible for them to recover the dues. Here, looking at the business structure of MSMEs where the continuous supply of money is essential for working operation, non-recovery of dues becomes a critical issue.
Since the default value has increased and the relevant portions have been suspended, some enterprises may deliberately stop the payment to the MSMEs and in that condition, they have no recourse available in the IBC till the time suspension continues. Therefore, this recourse of recovering dues under the IBC is not available for the time being it becomes important that MSMEs should opt for alternative methods like MSMED act, to recover their dues. As already discussed, the MSMED Act, at this juncture could prove to be of great relief to MSME for speedier recovery of their dues.
SPECIAL INSOLVENCY RESOLUTION FRAMEWORK
Recently IBBI Chief M. S. Sahoo announced that a Special Insolvency Resolution Process will be introduced under Section 240-A of the IBC especially for MSME’s.
In wake of the ongoing pandemic and stressed MSMEs, Government will soon notify a cheaper, faster and efficient Special Insolvency Resolution framework for MSME, which will allow MSME’s to get waiver from Insolvency resolution process up to one year. The special framework will speed up the process of cases under IBC by having provision for the pre-packed plan in which the company and creditor will agree upon a resolution plan well in advance.
Impact of the proposed framework
Shorter Time Frame
The proposed framework will reduce the mandatory time-frame for submitting a resolution plan for such businesses to just 90 days from the current 270 days for all companies, to cut delays along with cost-effective and easier procedures where the debtor continues to manage the business while negotiating with creditors. The promoters, who are not wilful defaulters, will also be allowed to bid for their stressed assets.
Further, the proposed framework has adopted a new definition of MSMEs which Include firms with an annual turnover of up to Rs 250 crore each or investments of up to Rs 50 crore. Further, it would provide a ‘debtor in possession’ model for MSMEs that would enable them to negotiate the resolution with creditors and incentivise them to continue running the business after insolvency resolution.
Waiver From Suspension of Proceeding
Insolvency proceedings are suspended against fresh defaults from 25 March 2020 after the induced lockdown. However, MSMEs will likely be allowed to approach the adjudicating authority even during this period to declare themselves as insolvent if they wish to pursue a resolution of their stressed assets. However, they can approach NCLT only when they take approval from their unrelated financial creditors accounting for at least 25% of the total outstanding financial claims.
However, creditor cannot drag MSMEs to the National Company Law Tribunal (“NCLT”) during this period of suspension because of the rise in threshold to Rupees 1 crore from just Rupees 1 lakh in order to insulate small businesses from being dragged to the NCLT.
The MSMEs are one of the strongest pillars of economic growth in India. The progress and development of MSMEs directly or indirectly plays a prominent role and immensely contributes in the development of the country. Considering this, the steps were taken by the Government to strengthen the legislative framework of regulation of MSME Sector.
As discussed, delay in payments is the major challenge faced by the enterprises. The MSMED Act was aimed at reducing the issues pertaining to liquidity and financial constraints by regulating the timely payments of dues to the supplier. The phrasing of Section 17 expressly provides for the “recovery of amount due” along with the payment of interest thereon.
The MSMED Act and its legal framework has come out as a big relief to the suppliers and enterprises. Further, in order to strengthen the sector and to fill the loopholes in the recovery proceedings before the MSEFCs, the Ministry of MSME introduced the online portal for efficient dispute resolution known as Samadhan Portal. The Portal is also another step to strengthen the MSMEs or we can say that to strengthen the backbone of Indian economy.
As far as the IBC remedy is concerned for the MSMEs, the analysis was divided into two parts. The first one from the perspective of the operational creditor and the second was from the perspective of the corporate debtor. Classification of MSMEs as an operational creditor does not provide them with many advantages for the speedy recovery of dues. Further, operational creditor is always given less priority as compared to the financial creditor under the IBC.
MSMEs has always been the guiding force for the growth process in the country considering the contribution to the GDP and employment generation and the same was highlighted behind the insertion of Section 240(A) in the IBC. However, relaxations only from clause (c) and (d) of Section 29(A) od IBC is not enough as limitations in the other clauses continues. The concrete policy is required to ensure that the revival of MSMEs takes place and the enterprise does not go into liquidation.
The faster resolution framework for MSME is aimed at complementing the Centre’s latest measures under the Atmanibhar Bharat Abhiyan Scheme in ensuring that MSMEs get adequate credit to resume operations.
This proposed Framework of Special Insolvency Resolution will be faster, cheaper and efficient, as it will cover those firms who has annual turnover of Rupees 250 Crore or investment cap of Rupees 50 Crore only. Further, it will allow MSME’s to approach NCLT to initiate Insolvency Proceeding even during the period, when NCLT has suspended other Companies from approaching NCLT due to adverse effect of Covid-19.