Amendments to IBC 2016- A comfort to SMEs under distress

Proposed amendments to allow the promoters to become part of the resolution of stressed business will support quick revival  MSMEs under the new law.

Recently Govt has formed a committee under Secretary of Corporate Affairs to review certain provisions of Insolvency and Bankruptcy code 2016. The review panel called for sweeping changes in the law aimed at easing insolvency rules for small enterprises and providing relief to home buyers by treating them as financial creditors while deeming the amount raised from them for real estate projects as financial debt.

The committee proposed that promoters of micro, small and medium enterprises (MSMEs) who are not wilful defaulters should be allowed to bid during the insolvency process.

Insolvency and Bankruptcy code- A tectonic shift in the resolution of stressed businesses:

Insolvency and Bankruptcy code has been making ripples in the Indian business environment which had been used to slow process of recovery of stressed loans by banks and extreme delay experienced in liquidation of bankrupt cases.

Suddenly there is a rush of proposals of the large value corporate borrowers under pressure from Govt to liquidate the stressed loans in the banks’ books to stimulate the economic revival.

Issues of importance to MSMEs in this proposed amendment to IBC 2016-Participation of Promoters in the resolution plan

Though the original law does not preclude existing promoters to participate in the resolution of stressed business under IBC-2016, In November last year, the government disallowed wilful defaulters and dubious promoters from submitting insolvency resolution plan. It also barred those whose accounts have been classified as non-performing assets for at least a year. The government also restricted the participation of those related to or connected to promoters in some way or the other in the resolution process.

The above law became a stumbling block for many MSES who are genuinely needed a  comprehensive resolution package for reviving the business as promoters are barred from participation and there is no ready market for small businesses to be brought over.

The suggestion from the committee to allow promoters to participate in the resolution is seen as positive for resolution of stressed MSMEs. The reasons are:

1 Promoters are the inseparable part of their business:

A basic feature of any MSME is its owner is an inseparable part of the business. Hence any attempt to shift the business to another person without the existing owner being part of it means there will be a risk for acquirer of loss of critical intellectual property and knowledge of organisation’s operating ecosystem. This will frustrate the process of resolution.

2. Difficult to ascribe the failure to entrepreneurs alone:

MSMEs by and large, are part of larger product ecosystem hosted by lager Original Equipment Manufacturer (OEMs). Hence the performance, as well as sustainability of the firm, hinges on the health of OEM. We have witnessed the failure of many MSMEs due to wrong strategic actions or outdated technology and manufacturing practices of many big entities including many public sector firms.  In such circumstances, blaming the entrepreneurs amounts to false implication for the reasons beyond their control.

3. MSMEs need breathing space to readjust to changing circumstances:

The prevalence of NPA cannot be attributed to any single factor. The lack of agility and absence of right advise at the right moment may hurt the business. Globalised operating environment and fast-changing technological elements are playing significantly on the MSMEs. They need to be given an opportunity to readjust to the changing realities. This will act as a risk management tool for SMEs as it creates headroom for readjustment of strategy.

4. The services sector is very delicate:

Services sector debt hang-over require very delicate handling for successful resolution. The promoters are significant and integral part of the business. Further lack of or minimal availability of physical tangibles in the business does not entice any new investors however cheaper the resolution package will be. Services sector mainly survives on intangible capabilities which the promoters hold forte. Further time factor plays an important role in seeing revival-earlier the resolution, better for the business. The amendment proposed will pave way for the revival of hope for many services sector stressed assets and leading to early resolution.

Is it enough?

The attempt by the govt. towards improving the resolution environment is a welcome step, But it needs to do more to make the facility available to all MSMEs who are bearing the brunt of disruptions like demonetisation, the introduction of GST in addition to other sector-specific and economic factors. Some of our  suggestions as below:

A) Presently there is confusion relating to exemptions from the IBC moratorium whether its scope may be restricted to the assets of the corporate debtor only. There is certain NCLT order allowing the exemptions to cover personal assets and guarantees. It seems the committee also suggesting an amendment that does not intend to bar actions against assets of guarantors to the debts of the corporate debtor. It could mean any personal guarantees furnished can be invoked during the moratorium period.

In case of MSMEs, it is highly desirable to give them a chance to revive without impacting their personal belongings. It is quite obvious to find MSMEs giving their personal asset as collateral security for loans to their businesses. If they have to lose their personal assets while their business undergoing resolution is too uncomfortable.

B) The new provision of participation in resolutions is available only if they are not declared as wilful defaulter. This declaration of willful defaulter by the banks is not considered sacrosanct and very objective. They may deprive many SMEs who otherwise can be nursed back, of a chance to revive. Hence more clear and objective assessment leading to declaring an entrepreneur as a wilful defaulter is needed.

C) Increase the access to Insolvency and Bankruptcy Code: Presently action under IBC-2016 can be initiated only for corporate entities and before National Company Law Tribunal (NCLTs). In order to make this law accessible to all, Govt should take steps to set up special courts in many parts of the country to deal with. This reach will make the access to law better and creates better and uniform business environment in the long run.

Conclusion:

The new amendment proposed will improve the opportunities for distress management for MSMEs. It would vastly improve the prospects of such companies being revived, thus saving jobs, instead of going into liquidation.