Section 29A of the Insolvency and Bankruptcy Code, 2016: The Ambit Narrows

[Rudresh Mandal is a 4thyear student at NALSAR University of Law and Mallika Sen is a 3rdyear student at National Law School]

Section 29A of the Insolvency and Bankruptcy Code, 2016, (‘IBC’) has been heavily criticised for casting a net exceedingly wide for preventing maximisation of pay-outs to creditors merely because the bidder is the promoter of the corporate debtor, or for ignoring the causes of business failure. It has been amended again by way of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 on June 6, 2018 (‘Amendment’), which is a welcome relief for promoters of micro, small and medium enterprises (‘MSMEs’), whose total value of non-performing assets (‘NPAs’) amounts to Rs 77,000 crore, and also for pure play financial entities. Rightfully referring to section 29A as a pandora’s box, an overview of the amendment has been discussed on this blog earlier here.

At the outset, we ought to understand the rationale behind the differential treatment of MSMEs within insolvency law. The World Bank Report on MSME Insolvency (which was duly noted by the Report of the Insolvency Law Committee responsible for conceptualising the Amendment) argues that while Governments globally encourage the growth of MSMEs, there is recognition of the fact that insolvency processes should treat them differently in times of financial distress. A number of reasons contribute to this understanding.

For instance, first,the corporate insolvency resolution process (‘CIRP’) is often expensive for MSMEs and does not provide them with adequate financial returns. Second, with regard to the financing of MSME proceedings, both at the inception of business stage and at business recovery stage, global experience shows that the MSME sector often suffers from a dearth of financing and consequently piece-meal liquidation and loss of jobs. In jurisdictions where the market has yet not matured, further hindered by social stigma, a lack of rescue culture and an effective enabling legal framework, it is imperative that MSME insolvency be treated differently. Third, specific to India, since the MSME sector is pivotal to the economy, being labour-intensive and the second largest employer after the agricultural sector, special provisions are required. Fourth, and more importantly for the purposes of the Amendment, these small businesses are often not of interest for people other than the erstwhile promoters. For instance, as of date, there has been minimal interest for MSME units at the National Company Law Tribunal. Resultantly, liquidation is the only way out for creditors, which yields insignificant amounts when compared to a rescue of a business, even by the erstwhile promoter.

The amendment to section 29A also exempts ‘pure play financial entities’ holding an NPA from the prohibition of the said provision. During corporate debt restructuring, upon defaults by the debtor, banks often convert loans into equity (up to 51%) of the debtor-company. In such a situation, these financial entities would be debarred from being a resolution applicant since it could be in ‘control’ or be classified as promoters of a corporate debtor classified as an NPA account [section 29A(c)]. It is imperative that the term ‘financial entity’ be defined under the IBC to ensure there is no ambiguity regarding the scope of this exemption. Additionally, these pure-play financial entities, asset reconstruction companies and so on, often acquire an NPA in the insolvency resolution process, and such entities should not be hit by the bar in section 29A(c) from bidding for other corporate debtors for a period of 3 years after approval of the prior resolution plan by the NCLT. Following the burgeoning problem of NPAs in the country, this move is indeed a much needed one.

Thus, the June Amendment to section 29A narrows the ambit of the said provision and enables promoters of MSMEs (whose turnover is below Rs 250 crore) to bid for the assets of the enterprise during resolution proceedings. This is however, subject to the question of whether the promoter is a wilful defaulter and whether the promoter attracts other disqualification provisions. As a positive step, the amendment is in tune with the broader objective of the IBC to promoter resolution rather than liquidation. Given the significant amount of persons employed by the MSME sector, liquidation would sharply affect India’s already grave employment crisis. The Government also plans on introducing a ‘debt threshold’ to ensure that MSMEs which possess high amounts of unpaid loans but a significantly low turnover cannot misuse the exception. The amendment is certainly a step in the right direction as far as MSME insolvency goes, for it not only recognises the differential treatment which should be meted out to MSMEs, but also protects public interest along with the objective of the IBC of maximising returns.

Rudresh Mandal & Mallika Sen

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