Applicability of Section 29A to Pre-Packaged Insolvency Resolution of MSMEs

[Tushar Kumar is an Associate at Ernst Young Global Delivery Services]

Section 29A of the Insolvency & Bankruptcy Code, 2016 (IBC) makes certain persons ineligible to buy the assets of the insolvent corporate debtor, owing to the fact that they are either undesirable or have, due to their misconduct in the past, contributed to the present insolvency of the corporate debtor. It is pertinent to analyse the relevance of section 29A in the recently promulgated Insolvency & Bankruptcy Code (Amendment) Ordinance, 2021 (the “Pre-Pack Ordinance”) which introduced pre-packaged insolvency resolution process only for corporate debtors, registered as micro, small & medium sized enterprises (MSMEs) under the Micro,Small and Medium Enterprises Development Act, 2006. The author believes that, due to a minor drafting error, the applicability of section 29A to the Pre-Pack Ordinance remains unclear, but can be conveniently rectified by changing the wording of the law.

Role of Section 29A in MSME Insolvency

Section 29A of the IBC is a widely worded section, which prescribes criteria for disqualifying certain persons (ranging from undischarged insolvents to willful defaulters to those prohibited by the Securities and Exchange Board of India (SEBI), and also concert parties or connected persons) from becoming an eligible resolution applicant in the corporate insolvency resolution process (CIRP). However, while considering the issue of MSME insolvency, it is worthwhile to examine the two most significant provisions of section 29A, i.e., clauses (c) and (h).

According to section 29A(c) of the IBC, if, at the time of submission of the resolution plan, a person (or concert party) has an account or an account of the corporate debtor under the control of such person or a promoter and such account has been classified as non-performing asset by the Reserve Bank of India (RBI) and at least one year has passed from the date of such classification until the commencement of CIRP, then such person would be ineligible to submit the resolution plan under IBC. Further, according to section 29A(h) of the IBC, if a person (or any concert party) has executed a guarantee against the debts of the corporate debtor, which has been invoked but the debt remains unpaid either fully or partially, then such person would be ineligible to submit the resolution plan. In essence, these two clauses of Section 29A disqualify the erstwhile promoters of the corporate debtor from reentering the fray and buying the assets in the CIRP.

However, in 2018, the report of the Insolvency Law Committee (in paragraph 27.4) stated that the insolvency resolution process of an MSME primarily attracts the interests of the erstwhile promoters and, therefore, their ineligibility to become a resolution applicant would severely jeopardize the insolvency resolution of MSME.Based on this recommendation and the fact that most of the loans taken by MSMEs are guaranteed by their entrepreneurs or promoters,the IBC was amended in 2018 to incorporate section 240A, which excluded the applicability of clauses (c) and (h) of Section 29A of the IBC to the insolvency resolution process of an MSME.

Interplay between Section 29A and the Pre-Pack Ordinance

Pre-packaged insolvency resolution essentially refers to an agreement between the corporate debtor, senior or secured creditors and the potential buyer for the sale and purchase of the assets of the corporate debtor, before the initiation of formal insolvency process. The Pre-Pack Ordinance, although named as such, introduces a hybrid model of insolvency resolution for MSMEs in India, as it is not just an informal restructuring mechanism but intensely involves the court and has various embedded safeguards which take away the flexibility of the process.

The Pre-Pack Ordinance incorporates section 54A into the IBC, which basically enlists the conditions for an MSME to be eligible for initiating the pre-pack process. It is interesting to note that, according to section 54A(1)(d) of the IBC, an MSME can initiate the process and submit the base resolution plan only if it is eligible to submit a resolution plan in terms of section 29A of the IBC. Prima facie, this would lead the stakeholders to believe that such an MSME, in order to be eligible for the process under the Pre-Pack Ordinance, has to stay clear of the wide disqualification criteria prescribed under section 29A of the IBC. However, the same is not true, as section 54A(1)(d) of the IBC must be read with Section 240A of the IBC, which is an overriding provision and has been amended by the Pre-Pack Ordinance to exclude the applicability of sections29A(c) and 29A(h) to the pre-packaged insolvency resolution process of MSMEs. Hence, except for sections 29A(c) and 29A(h), the MSME has to be compliant with the provisions of section 29A in order to be eligible for the pre-packaged insolvency resolution process.

Furthermore, it is significant to note that the promulgation of the Pre-Pack Ordinance comes in light of the report submitted by the Sub-Committee of the Insolvency Law Committee in October, 2020, which recommended a draft framework for incorporating pre-packs into the IBC.Even then, the Sub-Committee, while making pre-packs available for all the debtors including MSMEs, ignored the concerns of MSME sector and recommended the application of all the provisions of section 29A to the pre-packaged insolvency resolution process. Even though some members of the Sub-Committee advocated for diluting the provisions of section 29A(c) of the IBC, the  report states that the majority opinion was not to dilute any clause and to make all the clauses of section 29A applicable to the pre-packaged insolvency resolution of corporate debtors, including MSMEs.

Conclusion

The author firmly believes that section 54A(1)(d) of the IBC must be read together with the overriding provision of section 240A of the IBC, thereby leading to the view that MSMEs have to be compliant with all clauses of section 29A, except for sections29A(c) and 29A(h), in order to access the pre-pack regime. In a bid to avoid any further litigation on the issue, it is imperative that the Ministry of Corporate Affairs takes cognizance of the issue, and accordingly amends section 54A(1)(d) to read: “It is eligible to submit a resolution plan under Section 29A read with Section 240A” or “It is eligible to submit a resolution plan under Section 29A, except for clauses (c) and (h).” This would also require subsequent amendments to the instructions provided under the Insolvency and Bankruptcy (Pre-packaged Insolvency Resolution Process) Rules, 2021 and the respective forms provided under the Insolvency and Bankruptcy Board of India (Pre-packaged Insolvency Resolution Process) Regulations, 2021. The aforementioned amendments will eradicate any element of confusion pertaining to the applicability of section 29A of the IBC to the pre-packaged insolvency resolution process of MSME.

Tushar Kumar

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