MSMEs and Insolvency: A Special Treatment under the Insolvency and Bankruptcy Code

Introduction

Micro, Small and Medium Enterprises represent the backbone of India’s economic structure, serving as crucial drivers of employment, manufacturing output, and entrepreneurial innovation. These enterprises contribute significantly to the nation’s gross domestic product while providing livelihood opportunities to millions across the country. Despite their substantial economic contribution, MSMEs face numerous operational challenges including limited access to formal credit channels, technological constraints, inadequate infrastructure, and difficulties in accessing competitive markets. These vulnerabilities become particularly acute during periods of economic distress, potentially threatening their long-term viability and sustainability.

The Insolvency and Bankruptcy Code enacted in 2016 represents a watershed moment in Indian corporate law, establishing a unified framework for addressing insolvency and bankruptcy proceedings across corporate entities, partnership firms, and individual debtors [1]. The legislation aims to maximize asset value during insolvency proceedings, promote entrepreneurial culture, balance stakeholder interests, and establish the Insolvency and Bankruptcy Board of India as the regulatory authority overseeing these processes. Recognizing the distinctive position and requirements of MSMEs within India’s economic landscape, the Code incorporates specific provisions that extend preferential treatment to these enterprises during insolvency resolution proceedings.

Understanding MSME Classification and Registration Framework

Legislative Framework and Definition

The Micro, Small and Medium Enterprises Development Act of 2006 establishes the foundational legal framework for defining, classifying, and promoting MSMEs throughout India [2]. This legislation mandates provisions for registration, promotional measures, developmental initiatives, and facilitation mechanisms specifically designed for MSME advancement. The classification criteria underwent significant revision through a notification issued by the Ministry of Micro, Small and Medium Enterprises on June 1, 2020, which fundamentally altered how enterprises qualify under different MSME categories. The revised framework introduced composite criteria based on both investment in plant, machinery, or equipment and annual turnover, eliminating the previous distinction between manufacturing and service sector enterprises [3].

Current Classification Criteria

Under the revised classification effective from July 1, 2020, micro enterprises are defined as those with investment not exceeding one crore rupees and annual turnover below five crore rupees. Small enterprises fall within the bracket of investment between one crore and ten crore rupees, with turnover ranging from five crore to fifty crore rupees. Medium enterprises represent the largest category, encompassing entities with investment between ten crore and fifty crore rupees, and annual turnover spanning from fifty crore to two hundred and fifty crore rupees. This expanded threshold represents a substantial upward revision from earlier limits, reflecting evolving market conditions and economic realities.

Registration Mechanism and Benefits

The government established the Udyam Registration Portal to facilitate streamlined online registration for MSMEs [3]. While registration remains voluntary rather than mandatory, it unlocks numerous benefits including collateral-free credit facilities, subsidies for patent registration, exemptions from overdraft interest rates, eligibility for industrial promotion subsidies, and crucially, protection mechanisms against delayed payment issues. The registration process requires enterprises to provide their Aadhaar number, Permanent Account Number, and Goods and Services Tax Identification Number, creating a comprehensive digital database of registered MSMEs across the country.

Special Provisions for MSMEs under the Insolvency and Bankruptcy Code

The Genesis of Section 240A

The Insolvency and Bankruptcy Code introduced special dispensations for MSMEs through the incorporation of Section 240A via the Insolvency and Bankruptcy Code (Second Amendment) Ordinance, 2018, which became effective from June 6, 2018 [4]. This provision emerged from recommendations made by the Insolvency Law Committee constituted under the chairmanship of Shri Injeti Srinivas, which examined implementation challenges arising from the Code’s operation. The Committee’s comprehensive report acknowledged that MSMEs constitute the foundation of India’s economy, serving as primary drivers of employment, production, economic growth, entrepreneurship, and financial inclusion. The legislative intent behind Section 240A reflects a pragmatic recognition that pushing MSMEs into liquidation would adversely affect employee livelihoods and workers dependent on these enterprises.

Exemptions from Section 29A Disqualifications

Section 29A of the Insolvency and Bankruptcy Code, inserted through amendments effective from November 23, 2017, establishes comprehensive disqualification criteria preventing certain categories of persons from submitting resolution plans [5]. The provision aims to prevent individuals responsible for a company’s financial distress from regaining control through the insolvency resolution process at discounted valuations. However, Section 240A carves out specific exemptions for MSMEs by providing that provisions of clauses (c) and (h) of Section 29A shall not apply to resolution applicants in respect of corporate insolvency resolution processes or pre-packaged insolvency resolution processes involving MSME corporate debtors.

Clause (c) of Section 29A disqualifies persons having accounts classified as non-performing assets for one year or more from becoming resolution applicants [5]. This disqualification extends to accounts of corporate debtors under the management or control of such persons, or where such persons function as promoters. Clause (h) disqualifies persons who have executed enforceable guarantees favoring creditors of the corporate debtor, where such guarantees have been invoked and remain unpaid either fully or partially. By exempting MSMEs from these specific disqualifications, Section 240A enables MSME promoters who may have encountered financial difficulties or provided personal guarantees to participate in resolution proceedings for their own enterprises.

Rationale for Preferential Treatment

The exemptions under Section 240A reflect practical realities regarding MSME operations and resolution dynamics. MSME businesses typically depend heavily on their promoters for management expertise, technical knowledge, market relationships, and operational continuity. Finding suitable external resolution applicants for MSME entities often proves difficult given the specialized nature of their operations, limited scale, and niche market positioning. The Insolvency Law Committee Report of 2018 explicitly recognized that MSME businesses primarily attract interest from their own promoters, with external resolution applicants frequently showing limited enthusiasm for acquiring such enterprises [6]. Without the exemptions provided under Section 240A, many MSMEs would inevitably proceed to liquidation rather than successful resolution, resulting in job losses and value destruction.

Central Government’s Enabling Powers

Beyond the specific exemptions from Section 29A clauses, Section 240A also empowers the Central Government to issue notifications in public interest directing that provisions of the Insolvency and Bankruptcy Code shall either not apply to MSMEs or shall apply with specified modifications [4]. This grants the government substantial flexibility to extend additional relief or exemptions tailored to MSME requirements based on evolving circumstances and sectoral needs. Any such notifications must be tabled before both Houses of Parliament for a cumulative period of thirty days, ensuring legislative oversight over executive actions affecting MSME insolvency proceedings.

Judicial Interpretation: The Hari Babu Thota Landmark Judgment

Factual Background

The Supreme Court of India rendered a landmark judgment on November 29, 2023, in the matter of Hari Babu Thota versus Pritha Srikumar Iyer, addressing critical questions regarding the temporal application of Section 240A [7]. The corporate debtor, Shree Aashraya Infra-Con Limited, entered corporate insolvency resolution proceedings on April 6, 2021. Subsequently, the corporate debtor obtained registration as an MSME on July 15, 2021, after the commencement of insolvency proceedings but before submission of the resolution plan. The promoters of the corporate debtor submitted a resolution plan claiming benefits under Section 240A, which received approval from the Committee of Creditors. However, the National Company Law Tribunal dismissed the application on February 28, 2023, holding that since the MSME certificate was obtained after CIRP commencement, it could not confer eligibility benefits under Section 240A. The National Company Law Appellate Tribunal affirmed this decision, relying on its earlier judgment in Digamber Anand Rao Pingle.

Supreme Court’s Analysis and Ruling

The Supreme Court Division Bench comprising Justice Sanjay Kishan Kaul and Justice Sudhanshu Dhulia examined the interplay between Sections 29A and 240A comprehensively [7]. The Court noted that Section 29A was inserted to cure mischiefs of persons responsible for companies’ financial situations attempting to regain control through resolution plans. However, Section 240A begins with a non-obstante clause, specifically exempting MSMEs from clauses (c) and (h) of Section 29A due to the distinctive nature of MSME business operations. The Court emphasized that while Section 29A aims to prevent unscrupulous promoters from exploiting the insolvency framework, Section 240A recognizes that MSMEs require different treatment given their unique operational characteristics and limited attractiveness to external resolution applicants.

The Supreme Court held that the crucial date for determining eligibility under Section 240A is the date of resolution plan submission, not the date of CIRP commencement [7]. This interpretation flows from the statutory language of Section 29A(c) itself, which uses the expression “has an account” referring to the time of resolution plan submission rather than CIRP initiation. The Court referenced statements made by the Finance Minister while introducing the amendment bill, which emphasized that the date of making a bid should serve as the relevant cut-off date for determining eligibility. The judgment clarified that corporate debtors obtaining MSME status after CIRP commencement but before resolution plan submission remain eligible to claim Section 240A benefits, thereby enabling their promoters to participate in resolution proceedings despite disqualifications that might otherwise apply under Section 29A.

Impact and Implications

The Hari Babu Thota judgment established definitive jurisprudence on a contentious issue affecting numerous MSME insolvency cases nationwide [7]. By overruling the National Company Law Appellate Tribunal’s decision in Digamber Anand Rao Pingle, the Supreme Court provided clarity that tribunals had previously lacked when adjudicating similar matters. The judgment represents a significant victory for MSME promoters while maintaining the integrity of the insolvency framework. It acknowledges that MSMEs deserve special consideration without completely abandoning the accountability principles underlying Section 29A. The ruling enables MSME promoters to strategically obtain MSME certification during insolvency proceedings, provided they do so before submitting resolution plans, thereby preserving opportunities for promoter-led resolutions that might otherwise become impossible.

Regulatory Framework and Procedural Aspects

Information Memorandum Requirements

The Insolvency and Bankruptcy Board of India has progressively strengthened disclosure requirements relating to MSME status within insolvency proceedings. Regulation 36 of the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, mandates preparation of Information Memoranda by resolution professionals, providing comprehensive information about corporate debtors to prospective resolution applicants [8]. Recent amendments require explicit disclosure of corporate debtors’ MSME status within Information Memoranda, addressing instances where MSME classification was contested during resolution processes. This enhanced disclosure framework reduces uncertainty and potential delays arising from disputes over MSME classification.

Pre-Packaged Insolvency Resolution Process

The Insolvency and Bankruptcy Code introduced the Pre-Packaged Insolvency Resolution Process as a specialized mechanism exclusively available for MSMEs [4]. This streamlined process allows corporate debtors to negotiate resolution plans with creditors before formally initiating insolvency proceedings, reducing timelines and costs associated with traditional corporate insolvency resolution processes. The pre-packaged framework reflects legislative recognition that MSMEs require expedited resolution mechanisms tailored to their operational scale and resource constraints, enabling faster turnaround while preserving business continuity and employment.

Challenges and Considerations

While Section 240A provides crucial relief for MSMEs, implementation challenges persist. Determining whether enterprises genuinely qualify as MSMEs requires verification of investment and turnover criteria, which may be contested by creditors or resolution professionals. The timing of MSME registration becomes critical given the Supreme Court’s ruling that certification must precede resolution plan submission. Resolution professionals must conduct thorough due diligence to verify MSME status and ensure compliance with disclosure requirements. Additionally, concerns exist regarding potential misuse of Section 240A exemptions by promoters seeking to circumvent Section 29A disqualifications through strategic MSME registration during insolvency proceedings.

The broader policy question involves balancing MSME protection with creditor interests and insolvency framework integrity. While Section 240A aims to prevent unnecessary MSME liquidations, it simultaneously creates pathways for promoters with troubled financial histories to regain control of distressed enterprises. Courts and tribunals must carefully scrutinize each case to distinguish genuine MSME resolution scenarios from attempts to exploit exemptions. The regulatory framework continues evolving to address these challenges while preserving the fundamental objective of facilitating MSME revival rather than liquidation.

Conclusion

The Insolvency and Bankruptcy Code’s special treatment of MSMEs through Section 240A represents a nuanced legislative approach recognizing the distinctive position these enterprises occupy within India’s economic framework. By exempting MSMEs from specific Section 29A disqualifications while maintaining other eligibility criteria, the Code strikes a balance between facilitating resolution opportunities for MSME promoters and preserving insolvency process integrity. The Supreme Court’s landmark judgment in Hari Babu Thota has provided essential clarity regarding the temporal application of Section 240A, establishing that MSME certification obtained after CIRP commencement but before resolution plan submission confers eligibility benefits.

These provisions collectively acknowledge practical realities regarding MSME operations, including their heavy dependence on promoter expertise, limited attractiveness to external resolution applicants, and critical role in employment generation and economic growth. As India’s insolvency jurisprudence continues maturing, the framework governing MSME insolvency will require ongoing refinement to address implementation challenges while preserving the fundamental objective of maximizing MSME survival rates during financial distress. The success of Section 240A ultimately depends on balanced application by tribunals, effective oversight by resolution professionals, and responsible exercise of government powers to modify provisions based on evolving MSME sector needs.

References

1. Insolvency and Bankruptcy Code, 2016.
2. The Micro, Small and Medium Enterprises Development Act, 2006. Ministry of Micro, Small and Medium Enterprises, Government of India. 
3. Ministry of MSME. (2020). Notification on Revised MSME Classification. Press Information Bureau, Government of India. 
4. Section 240A, Insolvency and Bankruptcy Code, 2016. 
5. Section 29A, Insolvency and Bankruptcy Code, 2016. 
6. Insolvency Law Committee Report. (2018). Report of the Insolvency Law Committee. Ministry of Corporate Affairs, Government of India. 
7. Hari Babu Thota v. Pritha Srikumar Iyer, Civil Appeal No. 4422 of 2023, Supreme Court of India (2023). Available at: https://ibclaw.in/hari-babu-thota-supreme-court/
8. Insolvency and Bankruptcy Board of India. (2024). Discussion Paper on Disclosure of MSME Status in Information Memorandum. 

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Published and Authorized by Rutvik Desai