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  • Masad Khan

MSME Exemption under IBC: Closing the Loophole

[Masad is a student at NALSAR University of Law.]


Section 29A of the Insolvency and Bankruptcy Code 2016 (Code) bars certain persons from submitting the resolution plan(s) under Section 30 of the Code. Such persons include an undischarged insolvent and surety, a person who has been disqualified under the Companies Act 2013 to act as a director, and erstwhile promoters or management of the company, among others. Section 240A of the Code provides an exemption to the resolution applicants from Sections 29A(c) and 29A(h) when the corporate debtor is a micro, small and medium enterprise (MSME). In other words, erstwhile promoters of the company or an undischarged surety can submit a resolution plan as a resolution applicant when the corporate debtor is an MSME. Lately, a controversy has erupted as to when the ineligibility under Section 29A(c) arises. The cutoff date for the ineligibility holds importance to claim the exemption under Section 240A of the Code.


The article commences with explaining the rationale behind the insertion of Sections 29A and 240A into the Code. Then, it engages with the interpretation of Hon’ble Supreme Court of India (SC) with respect to the cutoff date under Section 29A(c) of the Code. Also, it discusses several scenarios in relation to Sections 29A and 240A of the Code to better understand their interplay. It concludes by arguing that the date of commencement of the corporate insolvency resolution process (CIRP) must be considered as a cutoff date from when the ineligibility under Section 29A(c) arises.

 

Rationale Behind Sections 29A and 240A


After the enactment of the Code in 2016, the legislature recognised the legitimate concerns that, in the absence of a statutory bar, the persons or management responsible for the insolvency of the corporate debtor with their misconduct may participate in the resolution process and regain its control. This undermines the purpose of the Code as unscrupulous persons would be rewarded at the expense of the creditors. Therefore, Section 29A ensures that persons responsible for insolvency of the corporate debtor do not participate in the resolution process. The SC observed that through this amendment Parliament rectified a loophole in the Code which allowed a backdoor entry to the erstwhile management in the CIRP of the corporate debtor.


The rationale for inserting Section 240A in the Code has been provided in the Insolvency Law Committee Report 2018 (Report). The Report explains that the MSMEs are the bedrock of the Indian economy, and the intent is to resolve their insolvency rather than push them into liquidation and affect the livelihood of its employees and workers. An MSME's business may not be of interest to others, and its promoters are the ones who are most interested in it. The resolution applicants other than the promoters may not be willing to submit the resolution plan which in turn will lead to liquidation of the MSME. To avoid such a possibility, an exemption under Section 240A has been provided for MSMEs.

 

Textual Interpretation by the SC


In the case of Hari Babu Thotathe SC was requested to render its opinion on when the ineligibility under Section 29A arises in the context of Section 240A. In other words, the SC had to determine the cutoff date from when the provisions of Section 29A(c) would be applicable. It held that the cutoff date for the application of Section 29A(c) would be the date of submission of the resolution plan. It rested its findings primarily on two premises. First, it laid emphasis on the text of the provision which says “at the time of submission of the resolution plan”. It observed that this phrase encompasses the intent of the legislature that the ineligibility would arise from the date of submission of the resolution plan. Second, it placed reliance on the statements of the then Finance Minister while introducing the 2017 amendment, which inserted Section 29A in the Code, in Parliament. With respect to Section 29A(c), he said that disqualification in clause (c) is regarding corporate debtors and persons who do not operationalize the account by paying the interest itself “on the date of the application making a bid”. Besides these two premises, the SC also observed that the first proviso to Section 29A(c) provides that the defect can be cured before submission of the plan which makes it the crucial date. It is argued that indeed the date of submission of the resolution plan is a crucial date; however, it cannot be regarded as a cutoff date because of its adverse practical implications.


Opening the Loophole


With this flawed interpretation, the SC has again opened the loophole which was sealed by the legislature in 2017 and hitherto guarded by the company law tribunals. Consider a case wherein a corporate debtor becomes insolvent and CIRP is instituted against it. Consequently, the promoters or management of the company will be suspended from the board. During the CIRP, the affairs of the company would be managed by the resolution professional (RP). The RP invites the prospective resolution applicants to submit the resolution plan and take over the corporate debtor. In order to gain the control of the corporate debtor back, the erstwhile promoters or management of the company will submit the resolution plan to the RP and be involved in the resolution process. However, as discussed above, under Section 29A, they are barred from submitting a resolution plan as they are the ones who are responsible for the insolvency of the corporate debtor. Now, after the judgement of the SC, they will get MSME certification for the corporate debtor during the CIRP and, thereafter, submit the resolution plan and claim the exception under Section 240A of the Code. Thereby, they will be easily able to circumvent the rigours of Section 29A and exploit the loophole opened by the SC. Also, the promoters-turned-resolution applicant will take over the corporate debtor on a ‘clean slate’ which may lead to their unjust enrichment at the expense of the creditors.

 

Interplay of Sections 29A and 240A


A similar factual situation arose in the case of Digambar Anandrao Pingle v. Shrikant Madanlal Zawar before the National Company Law Appellate Tribunal (NCLAT). Therein, the application for MSME certification was made during the CIRP and the promoters claimed exemption under Section 240A. The NCLAT rejected their claim and held that they cannot be allowed backdoor entry into the resolution process of the corporate debtor. The NCLT in a case held that if such backdoor entries are allowed then the promoters would take over the corporate debtor in an indirect manner and it would amount to the abuse of the Code's procedure.


In several cases, the MSME certificate has been obtained for the corporate debtor during the CIRP. It has been obtained either by the promoter/erstwhile management of the corporate debtor or by the interim RP / RP themselves. In case the promoter / erstwhile management of the corporate debtor obtains the MSME certification during the CIRP, their actions are void in law as they do not have the authority because they are suspended from the board. In a case before the NCLAT, the promoters applied for MSME certification during the CIRP, and their actions were considered invalid. The NCLAT observed that the promoters lack the authority to do so and are ineligible to take advantage of Section 240A. However, it is unlikely that the promoters of the corporate debtor can secure the MSME certification for the corporate debtor during its CIRP without the knowledge of the interim RP / RP as they are at the helm of affairs of the corporate debtor. In case the interim RP / RP obtains or helps the promoters in obtaining the MSME certification, their actions would also be void in law. The SC has held that the interim RP / RP has to act in accordance with the law and cannot act according to the whims and fancies of the promoters. In a case before the NCLT, the MSME certificate for the corporate debtor was obtained by the RP during CIRP without the permission or approval of the committee of creditors (CoC). The National Company Law Tribunal held the actions of the RP invalid and neither considered the MSME certificate on record nor granted the exemption under Section 240A of the Code.


However, an interesting situation may arise when the management of the corporate debtor applied for the MSME certification before the insolvency of the corporate debtor, and the certificate is issued during the CIRP. It is difficult to ascertain whether the exemptions provided under Section 240A would be applicable or not. In such a scenario, the commercial wisdom of the CoC holds significant importance as it is the creditors' rights that are affected the most. Therefore, in case the CoC approves the resolution plan submitted by the promoters, it must be accepted by the adjudicating authority as well or vice versa.

 

Conclusion


In view of the foregoing discussion, it is concluded that the ineligibility under Section 29A(c) should arise at the time of initiation of CIRP of the corporate debtor, and not at the time of submission of the resolution plan. Otherwise, it gives opportunity to erstwhile promoters or management of the company to exploit the loophole and take advantage of their misconduct. It is also against the rationale of Section 29A and the broader spirit of the Code. The SC has merely provided a textual interpretation of the provisions in a case where it was required to interpret the provisions contextually. Therefore, it is important that the law laid down in the case of Hari Babu Thota be reviewed.

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