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  • Kaustubh Kulkarni

Navigating MSME Insolvency: SC Ruling in Hari Babu Thota and Section 29A Implications

[Kaustubh is a student at National Law University Odisha.]

On 29 November 2023, a division bench of the Supreme Court of India (SC) in Hari Babu Thota (Hari Babu) adjudicated on the exception from Section 29-A provided under Section 240-A of the Insolvency and Bankruptcy Code 2016 (Code) of the Code for Micro Small and Medium Enterprises (MSME). The SC here dealt with certain pertinent questions viz. whether a corporate debtor (CD) who obtains an MSME certificate post the commencement of the corporate insolvency resolution process (CIRP) would be eligible for the same exemption, and whether all promoters are restricted from being resolution applicants under Section 29-A of the Code.


The present appeal arose from an order dated 2 June 2023 of the National Company Law Appellate Tribunal (NCLAT), Delhi, which dismissed the resolution plan filed by the resolution professional. The grounds for such dismissal was that the promoters are prohibited from presenting a plan under the bounds of law once CIRP commences. In reversing the same order, the author argues that SC has indeed reaffirmed the commercial viability of the Code and hence has reassured the creditors of the repayment of dues. Alongside, the SC has also interpreted the language of the Code to allow the resolution applicant (RA) to file the MSME certificate at the time of submission of the resolution plan, disagreeing with the NCLAT, New Delhi in Digambar Anandrao Pingle v. Shrikant Madanlal Zawar and Others (Digambar). Further, the author argues that in allowing a certain class of promoters to file the resolution plan, the judgment has allowed MSMEs to seek relief, but the same cannot be a final solution.


Section 29A and MSME Insolvency


Section 29A of the Code puts restrictions on who can be an RA. It restricts an ineligible person as defined under the provision, persons connected with an ineligible person, related parties and persons acting “jointly and in concert with” ineligible persons. Introduced initially as an ordinance, the Code was later amended in 2018 to incorporate Section 29A. The predominant objective of the provision was to curtail the promoters turning RAs under the assumption that promoters are substantially the reason for the financial affairs of the CD. Section 29A(c) explicitly deems that a person who has an account of the CD under the management or control of would render him ineligible to be an RA, while Section 29A(h) entails that a person who is deemed to be a guarantor for a CD shall be ineligible to be an RA. Section 240A carves an exception for MSMEs to these specific provisions of the Code, in essence allowing the promoters to enter the fray of CIRP to ensure speedy resolution which also ensures that the value of the assets which are recovered is on a higher side.


The reason for MSMEs to have this exception is that they are smaller businesses, at least in India 99.5% of MSMEs are classified as micro as per Section 7 of the MSME Act 2006, and no one particularly would be an RA who is substantially concerned about the MSME surviving. Ergo, a promoter should be allowed to be a RA as he has a better perspective as to why the entity has failed and would be able to materially resolve its financial problems. MSME as a sector is deemed to be one where there are significant business failures in the light that an MSME entity is facing the highest private market competition, hence the government has tried to bring measures which provide a cushion to the industry. This cushion is indispensable in the context of the MSME sector employing over 11 crore people, a failing business in this sector will have an impact on the last man who is dependent on these employees. MSMEs have continued to operate without registering themselves, thus dispensing with limited liability which accrues post registration. For example, A is an unregistered MSME, hence the owner of A would become personally liable for any debt which has to be repaid during the course of its resolution. However, Section 240A was enacted for the specific purpose of providing an opportunity for the MSMEs to resolve themselves by granting another opportunity to the promoter to register an unregistered enterprise post the initiation of CIRP.


Conflict 


However, there are a slew of judgements which rely on the premise that promoters should not be afforded a backdoor entry into the management of the MSME once it has been admitted into CIRP.  In Digambar, the NCLAT, New Delhi, relying on Arun Kumar Jagatramka v. Jindal Steel and Power Limited, concluded that promoters who were the "problems" in the previous regime should not make a backdoor entry through disingenuous stratagems.


Further, National Company Law Tribunal, New Delhi in High-Tech Resource Management Limited v. Overnite and in Express Limited Ranjit Das and Others v. MSX Mall Private Limited relied on the judgment of the NCLAT in Harkirat Singh Bedi v. Oriental Bank of Commerce which held that a promoter who has applied for the MSME certificate post the commencement of the CIRP was barred from doing so as under Section 29A of the Code. The ground for the same was that the promoter(s) / director(s) should not be allowed to continue to possess control of the CD once the insolvency process begins, and that the insolvency professional has to take over the management of CD. In the same vein, Sections 17(1)(a) and (b) of the Code dictate that once an interim resolution professional has been appointed, the management of the affairs of the CD shall rest with them, including all the powers of the board of directors.


The SC in this context interpreted the non-obstante clause in Section 240A in the background of the Insolvency Law Committee Report of March 2018. The report stresses the fact that MSMEs are the bedrock of the Indian economy and have to be given certain privileges to ensure that there is a semblance of stability in their insolvency and restructuring regime. The other crucial aspect the report stresses on and so does the judgment is the primary aim of the Code, which is to resolve the financial problems of the CD rather than to push them into liquidation.


Further, the report examines the need for an exemption under Section 240A; it explains that the rationale of the exemption was that the business of an MSME attracts interest primarily from its promoter and may not be of interest to other resolution applicants. Examining Swiss Ribbons Private Limited and Another v. Union of India and Others in this light, the bench held that if the promoter is not allowed to get a back–door entry into the MSME, it is a push towards liquidation of the same. The judgment in this context also interprets Section 29A(c) to read that it is till the time of submission of the resolution plan that the promoter will be permitted to submit an application for an MSME certificate. Reading the clause with the legislative intent, the cut-off date is the date on which the resolution plan is submitted and not the date on which the CIRP begins.


Conclusion and Way Forward


MSME insolvency resolution thus varies significantly in comparison to the CIRP of any other company. In this vein, the Central Government, inspired by the likes of United Nations Commission on the International Trade Law and the US laws on insolvency, amended the Code to usher pre-packaged insolvency resolution process (PPIRP) for MSMEs entailing an out of court agreement for resolution of the MSME. However, this is not applicable on unincorporated MSMEs, which are substantially more than incorporated MSMEs. The author is of the opinion that it is imperative in this backdrop that the government should make PPIRP applicable to non-corporate MSMEs, which in essence means that the MSMEs are given a chance to resolve their problems out of court when they initially approach the Adjudicating Authority and are not pushed towards liquidation.


Further, a great number of SC rulings has indicated the importance of the decision of the committee of creditors (CoC) and yet has ignored the commercial wisdom of the CoC many times giving adverse decisions. It is appreciated that the apex court has reaffirmed that there has to be a commercial aspect which has to be considered in cases like these, where the MSME sector has a unique commercial problem.


Aside from the concern for MSMEs which has been shown in Hari Babu, the ruling gives scope for abuse of Section 29A by allowing backdoor entry of promoters in the insolvency proceedings of CDs that are yet to be registered as MSMEs. Allowing the promoters a backdoor entry has multiple repercussions; primarily, it extends an opportunity to the promoter to acquire assets of the CD at a significantly lower cost and get rid of legal crosshairs of the CD. There have been arguments that a complete disqualification of promoters is undesirable on the ground that the IBC was enacted to resolve a company. However, the opportunity cost of the same is the twisted use of law, which intended to restrict the promoters as they were responsible for the current poor financials of the CD. This demands the tribunals to take a cautionary approach towards cases where a CD is retrospectively registered as an MSME.

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