Saving MSMEs in the COVID Era: An analysis of IBC’s changing nature
Jul 8, 2021
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*Aaryan Agarwal
Abstract
The paper discusses the impact of covid on MSMEs. It illustrates the needs of businesses in the covid era. The paper distinguishes the needs of businesses in their operating cycles and those that arose in these unprecedented times. Further it analyses the response undertaken by the government. This encompasses the steps taken by the ministry of finance and corporate affairs as well as the Amendment Ordinance that was a step in the direction of the IBC adapting to covid requirements. Furthermore, the paper provides a critical analysis of the measures taken up by the government in light of the requirement of MSMEs.
Introduction
The Government of India celebrates Micro, Small and Medium Enterprises (“MSMEs”) as significant contributors to the “inclusive industrial development” of the country. The sector is estimated to involve 6.3 crore unincorporates MSMEs and employ a manpower of 11 crores.[i] However, the emergence of Covid-19 pandemic and the consequent lockdown had severe economic impacts on the sector. MSMEs in India had already suffered due to the suddenness of demonetisation and chaotic implementation of GST. The unprecedent changes induced by the pandemic brought severe economic distress to MSMEs. For the multitude of MSMEs in India, it has driven down sales and forced some businesses to close shop. The number of closed companies account for 36.07 per cent of the total 18, 94,146 companies that were registered under Registrar of Companies 2019.[ii] It became imperative for the Government of India to protect MSMEs with substantial legal and economic policies.
The Covid-19 lockdown triggered a range of problems for Indian MSMEs. In terms of trade, the largest affected sector was exports. Exports , especially from China, stopped.[iii] A plethora of factories and shops were shut down in during lockdown; production and sales slowed down considering a number of MSMEs do not have an online presence. The global pandemic affected businesses disproportionately as it pushed brick and mortar stores to profit and gave a boost to sales for numerous online ventures.[iv]
Further, the large-scale reverse migration of daily-wage labourers from centres of production back to their villages meant severe shortage of manpower. Many MSMEs plummeted to dangerous levels of indebtedness and many have thus turned insolvent. In such a dire scenario for India’s MSME sector, the government decided to extend economic relief.
On 5th May 2020, the Ministry of MSMEs published a document titled “Covid 19: Relief for MSME Sector” on its website [v], highlighting the steps taken by the central government to provide support to the sector. The Ministry vouched for facilitation of passes for functioning of units, ease of registrations and even facilitation of credit. It established a dedicated help desk for MSMEs, allowing for easy access of governmental support. National Small Industries Corporation (NSIC) the nodal office for Ministry of MSME, also executed a number of steps for the assistance of MSMEs. It allowed a 3-month moratorium to MSMEs availing Raw Material Assistance against Bank Guarantee for repayment of outstanding dues. It also decided to freeze those MSME accounts whose outstanding dues were going to touch 99.99% of the BG value. The Ministry of MSME also urged state governments to exempt or reimburse the electricity and other fixed charges of MSMEs during this period.
In quick succession to this document, Prime Minister Narendra Modi announced an economic relief package of Rs. 20 Lakh crores on 12th May, 2020, titled ‘Atmanirbhar Bharat Abhiyan’, the first tranche of the package focused largely on the MSME sector of India. It allocated Rs 3 lakh crores for an emergency credit line. The Centre offered collateral-free loans to MSMEs with a principal repayment moratorium for 12 months and capped interest rate, without a guarantee fee. MSMEs with a turnover less than or equal to Rs 100 crore and outstanding credit up to Rs. 25 crore could borrow up to 20% of their outstanding credit as on 29th February, 2020. These loans had a tenure of four years. The centre also decided to backstop banks up to Rs. 3 lakh crores to eliminate the risks for banks and the hesitation to lend money to businesses who had already pledged all their other assets. It also facilitated a provision of Rs. 20 thousand crores as subordinate debt 2 lakh MSMEs which fall under the category of stressed or non-performing assets. It also planned a Rs.50,000 crore equity infusion through an MSME fund of funds. The corpus for the same was Rs. 10,000 crores.
Finance Minister, Nirmala Sitharaman, said that the provisions of the first tranche of Atmanirbhar Bharat would pull around 45 lakh units out of a dire situation.[vi] After a period of zero cash flow for MSMEs, the policies were expected to provide initial seed money. It helped some MSMEs continue their business activity and protect jobs. Several financial activities like procurement of raw materials, payment of daily-wage workers and paying bills was made possible for MSMEs which couldn’t afford the same. The Government of India walked in the right direction with substantial actions to provide economic succour to a sector that contributes almost 29% of India’s GDP.
Understanding needs of creditors and businesses
The market has always been dominated by two major players, namely, creditors and businesses. It is in lieu of the pandemic that a number of businesses have downsized, many have shifted to more rent friendly locations and the worst affected have had to close down entirely. What businesses most require is to reduce their expenses so that they can meet with the low sales owing to multiple lockdowns. A large part of businesses also depend on the procurement of raw materials ,thus easy repayment terms from raw material vendors can ease off pressure on businesses.
In order to cope from the loss of the pandemic, creditors require some basic safeguards to recover their investments. First, they need to be given priority over other stakeholders of the company as to recover their investments promptly via easy mechanisms company mechanisms. Secondly, they need to be provided with viable alternative investment options like mutual funds, bonds and government securities. Thirdly, there should be a proper redressal mechanism in companies where in creditors can reclaim their investments upon shutting down of their businesses. It is through these measures can creditors can absorb the shocks of the pandemic.
In light of the rapid closing down of businesses across the country in the period spanning 2020 to 2021, the Insolvency and Bankruptcy Code, 2016 (“IBC”) has had to rapidly evolve to keep pace with the times. The main purpose of the IBC was the attainment of the twin objectives , i.e. speedy resolution and maximizing recovery for lenders. The IBC initiated a time bound process wherein 180 days are given to resolve insolvency and 270 days in case an extension is granted on certain special circumstance.[vii] This has created waves of change in the financial sector.
Business protection due to IBC
In a stressful time for businesses across industries where consumer demands witnesses a rapid decline, the IBC came to the aid of dwindling businesses.
The fundamental purpose behind the institution of the IBC was the streamlining of corporate resolution insolvency process (“CIRP”). A systematic and effective CIRP prevents value destruction in times of corporate distress. An example of this may be how a well-defined CIRP that is executed in time prevents the depreciation of assets. This enables companies to pay off creditors in an organised manner and allows the shareholders to reduce their losses.
Further, the IBC does not cater to specific creditors. The CIRP mentioned under the IBC is not for the financial recovery of a single creditor but rather caters to the benefit of the class of creditors. The backdrop of the global pandemic made this treatment relevant as discrimination of creditors in such challenging financial times would have caused losses to bona fide creditors that were discriminated in the CIRP.
India’s rank in the Ease of Doing Business Index plummeted from 130th in 2017 to 63rd in 2020.[viii] A statement issued by the International Bank for Reconstruction and Development(“World Bank”) stated that the in the past two years, the presence of the IBC has improved the rate of recovery of stressed assets to 48%. This is a steep increase from the prevailing rate of recovery before the institution of the IBC which was 26%.[ix]
It can be regarded that the enactment of the IBC has positively impacted the rights of the creditors by streamlining the CIRP. This has caused for several successful resolutions and liquidations. As a result, banks and financial institutes across the country have experienced a positive cashflow since the enactment of the IBC. However, it is crucial to note that the effects of Covid are completely unprecedented. The unexpected rise in the number of business closures has created a sudden pressure on financial institutions as a number of loans extended to such businesses are unlikely to yield stable interest rates.
Response by the Government machinery
Response by Finance Ministry
The first response of the Ministry of Finance to the accumulating debt of companies was its announcement of the key policy changes relating to the pandemic. The Finance Ministry (“the ministry”) announced that the Debt related to Covid-19 would be excluded from the category of default.[x] The ministry sought to exclude the debt that arose from the global pandemic from the definition of debt mentioned in the IBC. Further, the ministry said that the Initiation of insolvency proceedings will remain suspended up to one year depending on the pandemic situation. The relief period prior to this was six months.
The Ministry promised to provide a covid related debt definition in the near future. The Secretary was to issue a notification with a date where debt incurred would be considered “Covid debt”.[xi]
2. Rapid evolution of IBC
The second wave of response came in the form of the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (“Ordinance”). A new Section 10A was instituted by the Ordinance. The primary purpose of the section was to create an enabling provision that may suspend the initiation of the company insolvency resolution process.[xii]
Through the ordinance , the government sought to suspended any new CIRP for defaults on payment that arose preceding or following 25th March 2020.
Analysing section 10A, it is noted that it applies to any default which is arising on or after 25 March 2020. In case of such a default, no such application for CIRP initiation could be filed under IBC Sections 7, 9 and 10. The stipulated period for the same was six months or any period further notified. This means that unless the additional 6 months are granted as an extension period. the suspended duration will operate from 25 March to 25 September 2020. Further, it is critical to note that the proviso to Section 10A specifies that no CIRP application can be for the defaults that happen during this period. This was a clear and pragmatic response of the government in light of the numerous loses faced by businesses in the covid era.
The Ordinance inserted Section 66(3) which offered legal protection to corporate debtor’s directors and partners who may in future undertake CIRP. The Ordinance placed an embargo on the resolution professional to file an application pursuant to Section 66(2), based on any defaults that took place in the period specified under Section 10A.
Critique of Government response
1. Suspension of Section 10 of the IBC
In the opinion of the author, the suspension must be understood in two groups. One consisting of section 7 and 9 of the IBC (“Group 1”) and the other consisting of Section 10 of the IBC (“Group 2”). Group 1 pertains to two classes of creditors, i.e. it caters to financial and operational creditors. The suspension of this group was justified as it was the need of the hour in the covid era. The suspension of Group 2 stands wholly unjustified as it pertains to corporate applicant. This provision caters to the heart of the IBC ,i.e. the fundamental purpose for which it was enacted. The suspension of Group 2 leads to the failure in providing a second chance of redemption. From a financial standpoint, firms were unable to initiate CIRP against themselves and were not able to free up the idle assets. This means that an optimum utilisation of debt was no longer possible by such firms pushing them into a debt cycle.
2. Absence of Alternate framework
In light of the global pandemic , a severe cash crunch was faced by firms across industries. This means that the need for finance was not just a growth need of businesses but a survival need without which they would have easily perished. In these difficult times, the government failed in its duty to provide a viable alternative to the cash crisis faced by businesses. None of the amended provisions to the IBC tackled the question on where businesses could procure funds on these difficult times. Businesses were left to their own demise as they struggled to cut costs in every avenue that existed. The lack of an alternative framework to procure credit was an adversity in these difficult times.
The grassroot impact of this was that creditors now pushed further to obtains the loans and advances they had lent out to businesses. Therefore, the situation for businesses became difficult as they were made to face the lack of availability of funds as well as the constant pressure of their creditors demanding back their loans.
Further, no legislative change in the definition on of ‘default’[xiii] under Section 3(12) of IBC came into being.
It was a failure in vision as many Corporate Debtors took advantage of IBC Suspension even when the defaults occurred before the IBC suspension period. The effect of this was on MSMEs. Several MSMEs, who were creditors, were unable to recover their debts. It is recommended by the author that the Ordinance should ideally have enabled an alternative framework that would address two aspects. First, the issue of the credit crunch, i.e. it would provide an alternative for businesses to provide funds. Second, the effective determination of the ‘default period’ to avoid any grey area with regard to the debt that arose in the default period.
3. Insertion of Proviso to Sec 10A
In analysing Section 10A, were the literal rule of interpretation to be followed by the courts, several issues would arise. First, due to the language used in the proviso, several ambiguities arise. It fails to answer when does the pandemic period end or prospectively end. It does not shed light on whether the debtor is in a position to repay his/her debts. This means that a higher propensity exists for the debtor to enjoy an unjust enrichment of the protection accorded by the IBC. This is a misuse of the purpose of the IBC and deviates from the legislative intent.
4. Benefits given to financial creditors and not operational creditors
The Reserve Bank of India (“RBI”) has accorded a loan moratorium of six months.[xiv] This means that protection is accorded to Financial Creditors. Financial creditors mostly comprise of banks and Financial Institutions. However, operational Creditors such as MSMEs are at a clear disadvantage due to this Suspension as they are not accorded nay protection. IN the Covid era, MSMEs did not have financial resources to sustain operations and depriving them of this protection was unjust and discriminatory. Therefore, this is in violation of the Essar Steel Judgment. [xv] The judgment necessitates putting both the types of creditors in pari paso.
5. No special mechanisms prescribed for MSMEs
A criticism of the approach of the government could be formed on the lines of how no distinct regime was set up for MSMEs. MSMEs were in a dire need of funds in the period of 2019-2021 and when some of the MSMEs had to shut down operations, the mechanism available to them was not well suited to their needs.
Conclusion
The initial response of the Government in light of covid seemed promising when the concept of a covid debt was hinted at. However, when the government released their Ordinance , it failed to meet a multitude of needs that were very crucial to the covid era. This caused confusion and uncertainties for MSMEs across industries as they were forced to cut costs to survive. The government failed in its inherent duty of providing guidance in these perilous times as businesses not only shut down at a rapid rate but did so at the cost of monetary losses to their creditors.
*The author is a fourth-year student at National Law University Jodhpur. This blog was adjudged as the second best entry for the CIBS-IBBI Essay Writing Competition 2021.
Endnotes
[i] Ministry of Micro, Small and Medium Enterprises, 2021. Annual Report (2018-2019). [online] Available at: <https://msme.gov.in/sites/default/files/Annualrprt.pdf>.
[ii] Over 6.8 lakh Indian companies shut so far: Government, The Economic Times (2021), Available at <https://economictimes.indiatimes.com/news/economy/indicators/over-6-8-lakh-indian-companies-shut-so-far-government/articleshow/70026278.cms>.
[iii] Prashasti Awasthi , China retaliates to India by stopping Indian manufactured products at its ports , business line (2021), Available at <https://www.thehindubusinessline.com/economy/china-retaliates-to-india-by-stopping-indian-manufactured-products-at-its-ports/article31930852.ece>.
[iv] John Koetsier, COVID-19 Accelerated E-Commerce Growth ‘4 To 6 Years’ Forbes (2021), Available at
[v] Ministry of Micro, Small and Medium Enterprises, 2021. Covid 19: Relief for MSME Sector. [online] Available at: <https://msme.gov.in/sites/default/files/ActiononCOVID-19ReliefforMSMESector.pdf>.
[vi] Jebaraj, P., 2020. Coronavirus package | Nirmala Sitharaman announces major stimulus package for MSMEs. The Hindy, [online] Available at: <https://www.thehindu.com/business/Economy/coronavirus-package-nirmala-sitharaman-announces-major-stimulus-package-for-msmes/article31573533.ece>.
[vii] IBC 2016, §12.
[viii] Ease of doing business rankings, The World Bank, [online] Available at: <https://www.doingbusiness.org/en/rankings>.
[ix] Yogima Seth Sharma, India jumps to 63rd position in World Bank’s Ease of Doing Business 2020 report, The Economic Times, [online] Available at: <https://economictimes.indiatimes.com/news/economy/indicators/india-jumps-to-63rd-position-in-world-banks-doing-business-2020-report/articleshow/71731589.cms>.
[x] Nirmala Sitharaman Press Conference: Finance Minister Announces Fifth Tranche Of Economic Measures, BloombergQuint (2021), Available at:
[xi] Ibid.
[xii] Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, §10A.
[xiii] IBC 2016 ,§3 (12).
[xiv] RBI Notification, Reserve Bank of India, 2019, RBI / 2019-20/244 D.O.R No. B.P. BC 71/21.04.048/2019-20.
[xv] Update | Supreme Court’s decision in Jaypee matter clarifies various aspects under IBC, Trilegal.com (2021), Available at : <https://www.trilegal.com/index.php/publications/update/supreme-courts-decision-in-jaypee-matter-clarifies-various-aspects-under-ib >.
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