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The Insolvency and Bankruptcy Code, 2016 is listed for passage in Rajya Sabha today.  Last week, Lok Sabha passed the Code with changes recommended by the Joint Parliamentary Committee that examined the Code.[1],[2]  We present answers to some of the frequently asked questions in relation to the Insolvency and Bankruptcy Code, 2016. Why do we need a new law?Time resolve insolvency1 As of 2015, insolvency resolution in India took 4.3 years on an average.  This is higher when compared to other countries such as United Kingdom (1 year) and United States of America (1.5 years).  Figure 1 provides a comparison of the time to resolve insolvency for various countries.  These delays are caused due to time taken to resolve cases in courts, and confusion due to a lack of clarity about the current bankruptcy framework. What does the current Code aim to do? The 2016 Code applies to companies and individuals.  It provides for a time-bound process to resolve insolvency.  When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency within a 180-day period.  To ensure an uninterrupted resolution process, the Code also provides immunity to debtors from resolution claims of creditors during this period. The Code also consolidates provisions of the current legislative framework to form a common forum for debtors and creditors of all classes to resolve insolvency. Who facilitates the insolvency resolution under the Code? The Code creates various institutions to facilitate resolution of insolvency.  These are as follows:

  • Insolvency Professionals: A specialised cadre of licensed professionals is proposed to be created. These professionals will administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.
  • Insolvency Professional Agencies: The insolvency professionals will be registered with insolvency professional agencies. The agencies conduct examinations to certify the insolvency professionals and enforce a code of conduct for their performance.
  • Information Utilities: Creditors will report financial information of the debt owed to them by the debtor. Such information will include records of debt, liabilities and defaults.
  • Adjudicating authorities: The proceedings of the resolution process will be adjudicated by the National Companies Law Tribunal (NCLT), for companies; and the Debt Recovery Tribunal (DRT), for individuals. The duties of the authorities will include approval to initiate the resolution process, appoint the insolvency professional, and approve the final decision of creditors.
  • Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.  The Board will consist of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.

What is the procedure to resolve insolvency in the Code? The Code proposes the following steps to resolve insolvency:

  • Initiation: When a default occurs, the resolution process may be initiated by the debtor or creditor. The insolvency professional administers the process.  The professional provides financial information of the debtor from the information utilities to the creditor and manage the debtor’s assets.  This process lasts for 180 days and any legal action against the debtor is prohibited during this period.
  • Decision to resolve insolvency: A committee consisting of the financial creditors who lent money to the debtor will be formed by the insolvency professional. The creditors committee will take a decision regarding the future of the outstanding debt owed to them.  They may choose to revive the debt owed to them by changing the repayment schedule, or sell (liquidate) the assets of the debtor to repay the debts owed to them.  If a decision is not taken in 180 days, the debtor’s assets go into liquidation.
  • Liquidation: If the debtor goes into liquidation, an insolvency professional administers the liquidation process. Proceeds from the sale of the debtor’s assets are distributed in the following order of precedence: i) insolvency resolution costs, including the remuneration to the insolvency professional, ii) secured creditors, whose loans are backed by collateral, dues to workers, other employees, iii) unsecured creditors, iv) dues to government, v) priority shareholders and vi) equity shareholders.

What are some issues in the Code that require consideration?

  • The Bankruptcy Board (regulator) will regulate insolvency professional agencies (IPAs), which will further regulate insolvency professionals (IPs).  The rationale behind multiple IPAs overseeing the functioning of their member IPs, instead of a single regulator is unclear. The presence of multiple IPAs  operating simultaneously could enable competition in the sector. However, this may also lead to a conflict of interest between the regulatory and competitive goals of the IPAs.  This structure of regulation varies from the current practice where the regulator directly regulates its registered professionals.  For example, the Institute of Chartered Accountants of India (which regulates chartered accountants) is directly responsible for regulating its registered members.
  • The Code provides an order of priority to distribute assets during liquidation. It is unclear why: (i) secured creditors will receive their entire outstanding amount, rather than up to their collateral value, (ii) unsecured creditors have priority over trade creditors, and (iii) government dues will be repaid after unsecured creditors.
  • The smooth functioning of the Code depends on the functioning of new entities such as insolvency professionals, insolvency professional agencies and information utilities.  These entities will have to evolve over time for the proper functioning of the system.  In addition, the NCLT, which will adjudicate corporate insolvency has not been constituted as yet, and the DRTs are overloaded with pending cases.

 


 

  1. The Insolvency and Bankruptcy Code, 2016, http://www.prsindia.org/administrator/uploads/media/Bankruptcy/Bankruptcy%20Code%20as%20passed%20by%20LS.pdf.
  2. Report of the Joint Committee on the Insolvency and Bankruptcy Code, 2015, April 28, 2016, http://164.100.47.134/lsscommittee/Joint%20Committee%20on%20Insolvency%20and%20Bankruptcy%20Code,%202015/16_Joint_Committee_o n_Insolvency_and_Bankruptcy_Code_2015_1.pdf

A version of this blog appeared in the Business Standard on May 7, 2016.

On June 1, 2020, the Cabinet Committee on Economic Affairs approved a revision in the definition of Micro, Small and Medium Enterprises (MSMEs).[1]  In this blog, we discuss the change in the definition as approved by the Cabinet, and examine some of the common criteria used for classification of MSMEs.

Currently, MSMEs are defined under the Micro, Small and Medium Enterprises Development Act, 2006.[2]  The Act classifies them as micro, small and medium enterprises based on: (i) investment in plant and machinery for enterprises engaged in manufacturing or production of goods, and (ii) investment in equipment for enterprises providing services.  As per the Cabinet approval, the investment limits will be revised upwards and annual turnover of the enterprise will be used as additional criteria for the classification of MSMEs (Table 1). 

Earlier attempts to amend the definition of MSMEs

The central government has sought to revise the definition of MSMEs in the Act on two earlier occasions.  The government introduced the MSME Development (Amendment) Bill, 2015 which proposed to increase the investment limits for manufacturing and services MSMEs.[3]  This Bill was withdrawn in July 2018 and another Bill was introduced.  The MSME Development (Amendment) Bill, 2018 proposed to: (i) use annual turnover as criteria instead of investment for classification of MSMEs, (ii) remove the distinction between manufacturing and services, and (iii) provide the central government with the power to revise the turnover limits, through a notification.[4]  The 2018 Bill lapsed with the dissolution of 16th Lok Sabha. 

Global trends in criteria for the classification of MSMEs

While India will now be using investment and annual turnover as the criteria to classify MSMEs, globally, the number of employees is the most widely used criteria for classifying MSMEs.  The Reserve Bank of India's Expert Committee on MSMEs (2019) cited a study by the International Finance Corporation in 2014 which analysed 267 definitions used by different institutions in 155 countries.[5],[6]  According to the study, countries used a combination of criteria to classify MSMEs.   92% of the definitions used the number of employees as one of the criteria.  Other frequently used criteria were: (i) turnover (49%), and (ii) value of assets (36%).  11% of the analysed definitions used alternative criteria such as: (i) loan size, (ii) years of experience, and (iii) initial investment. 

Evaluation of common criteria used to define MSMEs

Investment: The 2006 Act uses investment in plant, machinery, and equipment to classify MSMEs.  Some of the issues with the investment criteria include:

  • The investment criteria require physical verification and have associated cost overheads.[7]
  • The investment limits may need to be revised from time-to-time due to the impact of inflation.  The Standing Committee on Industry (2018) had observed that limits set under the Act in 2006 have become irrelevant due to the impact of inflation.7
  • Due to their informal and small scale of operations, firms often do not maintain proper books of accounts and hence find it difficult to get classified as MSMEs as per the current definition.5

  • The investment-based classification incentivises promoters to keep the investment size restricted to retain the benefits associated with the micro or small category.7

Turnover: The 2018 Bill sought to replace the investment criteria with annual turnover as the sole criteria for the classification of MSMEs.  The Standing Committee agreed with the proposal under the Bill to use annual turnover as the criteria instead of investment.7  It observed that this could overcome some of the shortcomings of classification based on investment.  While turnover based criteria will also require verification, the Committee noted that the GST Network (GSTN) data can act as a reliable source of information for this purpose.  However, it also observed that:7

  • With turnover as a criterion for classification, corporates may misuse the incentives meant for MSMEs.  For instance, there is a possibility that a multi-national company may produce a large quantity of products worth a high turnover and then market it through various subsidiaries registered as Micro or Small enterprise under GSTN. 

  • The turnover of some enterprises may fluctuate depending on their business, which may result in the change of classification of the enterprise during a year. 

  • The Committee noted that there is a wide gap in turnover limits.  For instance, an enterprise with a turnover of Rs 6 crore and an enterprise with a turnover of Rs 75 crore (as proposed in 2018 Bill) would both be classified as a small enterprise, which seems incongruous. 

The Expert Committee (RBI) also recommended using annual turnover as the criteria for classification instead of investment.5  It observed that turnover based definition would be transparent, progressive, and easier to implement through the GSTN.  It also recommended that the power to change the definition of MSMEs should be delegated to the executive as it will help in responding to changing economic scenarios.

Number of employees: The Standing Committee had highlighted that in a labour-intensive country like India, appropriate focus is required on employment generation and MSME sector is the most suitable platform for this.7  It had recommended that the central government should assess the number of persons employed in the MSME sector and also consider employment as a criterion while classifying MSMEs.  However, the Expert Committee (RBI) stated that while the employment-based definition is an additional feature preferred in some countries, the definition would pose challenges in implementation.5  According to the Ministry of MSME, employment as a criterion has problems due to: (i) factors such as seasonality and informal nature of engagement, (ii) similar to investment criteria, this would also require physical verification and has associated cost overheads.7  

Number of MSMEs

According to the National Sample Survey (2015-16), there were around 6.34 crore MSMEs in the country.  The micro sector with 6.3 crore enterprises accounted for more than 99% of the total estimated number of MSMEs.  The small and medium sectors accounted for only 0.52% and 0.01% of the estimated number of enterprises, respectively.  Another dataset to understand the distribution of MSMEs is Udyog Aadhaar, a unique identity provided by the Unique Identification Authority of India (UIDAI) to MSME enterprises.[8]  Udyog Aadhaar registration is based on self-declaration by enterprises.  Between September 2015 and June 2020, 98.6 lakh enterprises have registered with UIDAI.  According to this dataset, micro, small, and medium enterprises comprise 87.7%, 11.8% and 0.5% of the MSME sector respectively.

Employment in the MSME sector

The MSME sector employed nearly 11.1 crore people in 2015-16.  The sector was the second largest employer after the agriculture sector.  The highest number of employed persons were engaged in trade activity (35%), followed by persons engaged in manufacturing (32%).

Implications of change in the definition of MSMEs

The change in the definition of MSMEs may result in many enterprises which are currently classified as Small enterprises be reclassified as Micro, and those classified as Medium enterprises be reclassified as Small.  Further, there may be many enterprises which are not currently classified as MSMEs, which may fall under the MSME classification as per the new definition.   Such enterprises will also now benefit from the schemes related to MSMEs.  The Ministry of MSME runs various schemes to provide for: (i) flow of credit to MSMEs, (ii) support for technology upgrade and modernisation, (iii) entrepreneurship and skill development, and (iv) cluster-wise measures to promote capacity-building and empowerment of MSME units.  For instance, under the Credit Guarantee Fund Scheme for Micro and Small Enterprises, a credit guarantee cover of up to 75% of the credit is provided to micro and small enterprises.[9]  Thus, the re-classification may require a significant increase in budgetary allocation for the MSME sector. 

Other announcements related to MSMEs in the aftermath of COVID-19 

MSME sector accounted for nearly 33.4% of the total manufacturing output in 2017-18.[10]  During the same year, its share in the country’s total exports was around 49%.  Between 2015 and 2017, the contribution of the sector in GDP has been around 30%.  Due to the national lockdown induced by COVID-19, businesses including MSMEs have been badly hit.  To provide immediate relief to the MSME sector, the government announced several measures in May 2020.[11]  These include: (i) collateral-free loans for MSMEs with up to Rs 25 crore outstanding and up to Rs 100 crore turnover, (ii) Rs 20,000 crore as subordinate debt for stressed MSMEs, and (iii) Rs 50,000 crore of capital infusion into MSMEs.  These measures have also been approved by the Union Cabinet.[12]    

For more details on the announcements made under the Aatma Nirbhar Bharat Abhiyan, see here

[1] “Cabinet approves Upward revision of MSME definition and modalities/ road map for implementing remaining two Packages for MSMEs (a)Rs 20000 crore package for Distressed MSMEs and (b) Rs 50,000 crore equity infusion through Fund of Funds”, Press Information Bureau, Cabinet Committee on Economic Affairs, June 1, 2020.

[2] The Micro, Small and Medium Enterprises Development Act, 2006, https://samadhaan.msme.gov.in/WriteReadData/DocumentFile/MSMED2006act.pdf.

[3] The Micro, Small and Medium Enterprises Development (Amendment) Bill, 2015, https://www.prsindia.org/sites/default/files/bill_files/MSME_bill%2C_2015_0.pdf.

[4] The Micro, Small and Medium Enterprises Development (Amendment) Bill, 2018, https://www.prsindia.org/sites/default/files/bill_files/The%20Micro%2C%20Small%20and%20Medium%20Enterprises%20Development%20%28Amendment%29%20Bill%2C%202018%20Bill%20Text.pdf.

[5] Report of the Expert Committee on Micro, Small and Medium Enterprises, The Reserve Bank of India, July 2019, https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/MSMES24062019465CF8CB30594AC29A7A010E8A2A034C.PDF.

[6] MSME Country Indicators 2014, International Finance Corporation, December 2014, https://www.smefinanceforum.org/sites/default/files/analysis%20note.pdf.

[7] 294th Report on Micro Small and Medium Enterprises Development (Amendment) Bill 2018, Standing Committee on Industry, Rajya Sabha, December 2018, https://rajyasabha.nic.in/rsnew/Committee_site/Committee_File/ReportFile/17/111/294_2019_3_15.pdf.

[8] Enterprises with Udyog Aadhaar Number, National Portal for Registration of Micro, Small & Medium Enterprises, Ministry of Micro, Small and Medium Enterprises, https://udyogaadhaar.gov.in/UA/Reports/StateBasedReport_R3.aspx.

[9] Credit Guarantee Fund Scheme for Micro and Small Enterprises, Ministry of Micro, Small and Medium Enterprises, http://www.dcmsme.gov.in/schemes/sccrguarn.htm.

[10] Annual Report 2018-19, Ministry of Micro, Small and Medium Enterprises, https://msme.gov.in/sites/default/files/Annualrprt.pdf.

[11] "Finance Minister announce measures for relief and credit support related to businesses, especially MSMEs to support Indian Economy’s fight against COVID-19", Press Information Bureau, Ministry of Finance, May 13, 2020.

[12] "Cabinet approves additional funding of up to Rupees three lakh crore through introduction of Emergency Credit Line Guarantee Scheme (ECLGS)", Press Information Bureau, Ministry of Finance, May 20, 2020.