MSME Promoter Eligibility Under Insolvency Law: Resolution Plans and Regulatory Framework

 

Introduction

The intersection of insolvency resolution and entrepreneurial rehabilitation has always presented a delicate balance in commercial law. The question of whether promoters who led a company into financial distress should be permitted to reclaim their businesses through resolution plans has been particularly contentious. The Insolvency and Bankruptcy Code, 2016 initially adopted a strict approach through Section 29A, which disqualified certain categories of persons from submitting resolution plans. However, recognizing the unique position of Micro, Small and Medium Enterprises in India’s economic ecosystem, the legislature carved out specific exemptions through Section 240A, creating a framework that balances creditor protection with the imperative of business revival.

This framework underwent judicial scrutiny when questions arose about the timing of MSME registration and its impact on promoter eligibility. The Supreme Court’s intervention in this matter has clarified the law and provided much-needed certainty to stakeholders in the insolvency resolution process.

The Legislative Framework: Section 29A and the Ineligibility Regime

Section 29A of the Insolvency and Bankruptcy Code, 2016 was introduced through an amendment that became effective on November 23, 2017. This provision emerged as a response to what the legislature perceived as a significant loophole in the original Code whereby defaulting promoters could regain control of their companies through the Corporate Insolvency Resolution Process at discounted valuations, effectively rewarding financial mismanagement while leaving creditors with substantial losses.

The provision establishes multiple categories of ineligibility for resolution applicants. Under Section 29A(c), a person becomes ineligible if they have an account, or control a corporate debtor whose account has been classified as a non-performing asset in accordance with Reserve Bank of India guidelines, and at least one year has elapsed from such classification until the commencement of the corporate insolvency resolution process [1]. This temporal element is crucial as it distinguishes between companies that quickly entered insolvency proceedings versus those whose financial distress became prolonged.

The provision also disqualifies individuals under Section 29A(h) who have executed guarantees in favor of creditors for corporate debtors against whom insolvency proceedings have been admitted, where such guarantees remain unpaid in full or part. The rationale behind these disqualifications was articulated by the Supreme Court in ArcelorMittal India Private Limited v. Satish Kumar Gupta [2], where the Court observed that Section 29A prevents persons responsible for the financial situation of a company from attempting to submit a plan and take over the company.

The Supreme Court in ArcelorMittal further clarified that the stage at which ineligibility attaches is when the resolution plan is submitted by the resolution applicant. The Court held that the date of commencement of the Corporate Insolvency Resolution Process is only relevant for calculating the period of one year from the date of classification of an account as a non-performing asset.

Constitutional Validation and Policy Rationale

The constitutional validity of Section 29A was challenged and ultimately upheld by the Supreme Court in Swiss Ribbons Private Limited v. Union of India [3]. The petitioners had contended that Section 29A treats unequals as equals and that good erstwhile managers cannot be lumped together with bad erstwhile managers. They argued that keeping out competent former managers from the resolution process would be counterproductive.

The Supreme Court rejected these contentions and upheld Section 29A, emphasizing that the provision serves the legitimate purpose of preventing unscrupulous persons from taking advantage of their own defaults. The Court held that resolution applicants have no vested right to be considered in the resolution process and that the classification created by Section 29A serves a rational purpose related to the Code’s objectives.

The Swiss Ribbons judgment reinforced the principle that economic legislation deserves significant deference from courts. The Court noted that the Insolvency and Bankruptcy Code represents a paradigm shift in India’s approach to corporate distress, moving from a debtor-friendly regime to one that prioritizes creditor rights and time-bound resolution.

The MSME Exception: Section 240A

Recognizing that the strict disqualification regime under Section 29A could have unintended consequences for the MSME sector, the legislature introduced Section 240A through the Insolvency and Bankruptcy Code (Second Amendment) Act, 2018, which came into force on June 6, 2018. Section 240A provides: “Notwithstanding anything to the contrary contained in this Code, the provisions of clauses (c) and (h) of section 29A shall not apply to the resolution applicant in respect of corporate insolvency resolution process of any micro, small and medium enterprises.”

This exemption reflects a deliberate policy choice to treat MSMEs differently from larger corporate entities. The Insolvency Law Committee Report of 2018 provided the rationale for this distinction, noting that MSMEs are the bedrock of the Indian economy and that the intent is to resolve their insolvency rather than push them into liquidation, which would affect the livelihood of employees and workers. The Committee observed that MSME businesses attract interest primarily from their promoters and may not be of interest to other resolution applicants [4].

The legislative wisdom behind Section 240A recognizes several commercial realities. First, MSME businesses often involve specialized knowledge or niche markets where the promoter’s expertise is integral to the business’s viability. Second, external investors may lack interest in acquiring small enterprises with limited scalability. Third, forcing MSMEs into liquidation due to promoter ineligibility could result in significant value destruction and employment losses.

However, the exemption is not absolute. Section 240A only exempts promoters from the disqualifications under clauses (c) and (h) of Section 29A. Other disqualifications, such as those relating to willful defaulters under Section 29A(a), continue to apply to MSME promoters. This partial exemption maintains a balance between facilitating MSME revival and preventing abuse of the insolvency process.

The Timing Question: Hari Babu Thota and the Supreme Court’s Clarification

The critical question that emerged in practice was whether a corporate debtor needed to possess MSME status at the time of commencement of the Corporate Insolvency Resolution Process or whether obtaining such status during the proceedings would suffice for the promoter to claim the benefit of Section 240A. This question came before the Supreme Court in the case of Hari Babu Thota v. Pritha Srikumar Iyer [5].

In that case, Shree Aashraya Infra-Con Limited was admitted into Corporate Insolvency Resolution Process on April 6, 2021. Subsequently, the corporate debtor obtained its MSME Registration Certificate on July 15, 2021, after the commencement of insolvency proceedings but before the submission of the resolution plan. The resolution professional presented a plan submitted by the promoters and approved by 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 the initiation of proceedings, it should be ignored and the promoters were ineligible under Section 29A.

The National Company Law Appellate Tribunal affirmed this decision on June 2, 2023, relying on its earlier judgment in Digamber Anandrao Pingle. The appellate tribunal held that when the MSME certificate was obtained after commencement of proceedings, the promoter could not avail the benefit of Section 240A to submit a plan for the corporate debtor.

On appeal, the Supreme Court reversed these decisions in a judgment delivered on November 29, 2023. The Court held that even if MSME registration was obtained after commencement of the Corporate Insolvency Resolution Process, the promoter of such corporate debtor would be eligible to submit a resolution plan under Section 240A, provided the registration was obtained before submission of the resolution plan.

The Supreme Court’s reasoning emphasized several key points. First, the Court noted that Section 240A begins with a non-obstante clause (“Notwithstanding anything to the contrary contained in this Code”), which indicates the provision’s overriding nature. Second, the Court observed that the objective behind introducing Section 240A was to facilitate resolution rather than liquidation for MSMEs due to the nature of business carried out by such entities and their importance to the Indian economy.

Third, and most significantly, the Court clarified that consistent with its earlier holding in ArcelorMittal, the relevant date for determining eligibility under Section 29A is the date of submission of the resolution plan, not the commencement date of insolvency proceedings. By logical extension, the Court held that the relevant date for determining MSME status under Section 240A should also be the date of submission of the resolution plan.

The Court appointed an amicus curiae to assist in the matter given the absence of opposing parties. The amicus supported the resolution professional’s position, contending that if the MSME certificate is obtained prior to presentation of the resolution plan, the disqualification under Section 29A would not apply and the benefit of Section 240A would be available.

The Supreme Court’s judgment has significant practical implications. It permits corporate debtors to obtain MSME certification during the pendency of insolvency proceedings and still qualify their promoters for the Section 240A exemption. This interpretation aligns with the legislative intent of facilitating MSME resolution and prevents technical interpretations from defeating the substantive purpose of the provision.

Regulatory Framework for MSMEs

The definition of MSMEs for purposes of the Insolvency and Bankruptcy Code is derived from the Micro, Small and Medium Enterprises Development Act, 2006. Under this Act, enterprises are classified based on investment in plant and machinery or equipment. The notification issued by the Ministry of Micro, Small and Medium Enterprises on June 26, 2020 provides the current classification criteria.

For manufacturing enterprises, a micro enterprise is one where investment in plant and machinery or equipment does not exceed one crore rupees and turnover does not exceed five crore rupees. A small enterprise has investment not exceeding ten crore rupees and turnover not exceeding fifty crore rupees. A medium enterprise has investment not exceeding fifty crore rupees and turnover not exceeding two hundred and fifty crore rupees.

For service enterprises, the investment and turnover thresholds are identical to those for manufacturing enterprises. The classification depends on both investment and turnover criteria, with enterprises required to satisfy both thresholds to qualify for a particular category.

The registration process for MSMEs has been simplified through the Udyam Registration portal. Enterprises can self-register based on Aadhaar authentication, and the system automatically captures investment and turnover data from government databases including the Income Tax Department and the Goods and Services Tax Network.

Pre-Packaged Insolvency Resolution Process for MSMEs

In addition to the exemption under Section 240A for regular Corporate Insolvency Resolution Process, the legislature introduced a special framework for MSMEs through the Pre-Packaged Insolvency Resolution Process. This framework was introduced through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2021, which came into effect on April 4, 2021.

The Pre-Packaged Insolvency Resolution Process represents a hybrid model that combines elements of formal insolvency proceedings with informal workout mechanisms. Unlike the regular Corporate Insolvency Resolution Process where control of the corporate debtor shifts to a resolution professional, the Pre-Packaged process allows the existing management to retain control while working on a resolution plan.

Under this framework, the corporate debtor initiates the process by filing an application with the National Company Law Tribunal. The application must be accompanied by a base resolution plan that has been approved by financial creditors representing at least sixty-six percent of the financial debt. The process is significantly shorter than regular insolvency proceedings, with a maximum duration of one hundred and twenty days from the date of admission.

The Pre-Packaged Insolvency Resolution Process is available only for MSMEs with a default of at least ten lakh rupees. However, it is not available for corporate debtors who have undergone the Pre-Packaged process or regular insolvency proceedings in the preceding three years. Additionally, persons ineligible under Section 29A cannot initiate the Pre-Packaged process.

The framework requires the corporate debtor to submit a detailed information memorandum along with the application, providing transparency to all stakeholders. The Committee of Creditors evaluates the base resolution plan and may approve it with modifications. If the Committee does not approve the base plan or if it impairs the claims of operational creditors, the resolution professional invites alternative resolution plans through a competitive process.

Judicial Interpretation and Emerging Issues

The application of Section 240A has generated considerable judicial discourse beyond the timing question addressed in Hari Babu Thota. Courts have grappled with several related issues that illuminate the boundaries of the MSME exemption.

One significant question concerns the role of the resolution professional in determining whether a corporate debtor qualifies as an MSME. In certain cases, resolution professionals have obtained MSME certification during the Corporate Insolvency Resolution Process without explicit authorization from the Committee of Creditors. The National Company Law Tribunal has held in some instances that such actions by the resolution professional, undertaken without Committee approval, are invalid and the MSME certificate should not be considered.

This raises important questions about the resolution professional’s powers and responsibilities. While the resolution professional manages the affairs of the corporate debtor during insolvency proceedings, significant decisions typically require Committee of Creditors approval. Whether obtaining MSME certification constitutes a ministerial act within the resolution professional’s authority or requires specific authorization remains an area requiring further clarification.

Another emerging issue concerns the interaction between Section 240A and the requirement for resolution plans to meet minimum thresholds such as net worth requirements or earnest money deposits. Some tribunals have held that exempting MSME promoters from Section 29A disqualifications does not automatically exempt them from competitive bidding requirements or financial qualification criteria imposed by the resolution professional.

The National Company Law Tribunal has observed in certain matters that while Section 240A permits MSME promoters to submit resolution plans despite disqualifications under clauses (c) and (h) of Section 29A, it does not grant them preferential treatment in the evaluation of their plans. The Committee of Creditors retains the commercial wisdom to evaluate all resolution plans, including those submitted by promoters, based on feasibility, viability, and the value offered to creditors.

However, other judicial pronouncements have suggested that the spirit of Section 240A requires facilitating promoter participation in the resolution process for MSMEs. Some tribunals have held that imposing prohibitively high net worth or earnest money requirements on MSME promoters would defeat the purpose of the exemption, as such requirements would effectively exclude promoters who may lack significant personal wealth but possess the expertise necessary to revive the business.

Comparative Analysis and Policy Considerations

The Indian approach to MSME insolvency resolution reflects a pragmatic balancing of competing policy objectives. On one hand, the strict eligibility criteria under Section 29A serve to maintain creditor confidence in the insolvency resolution process by preventing moral hazard and ensuring that defaulting promoters do not benefit from their own mismanagement. On the other hand, the exemption under Section 240A recognizes that MSMEs operate in a different economic context where rigid application of general rules could lead to suboptimal outcomes.

This calibrated approach finds some parallels in international insolvency regimes, although the specific mechanisms differ. The United Kingdom’s insolvency framework, for instance, permits pre-packaged administrations where existing management can retain control of a business through a pre-negotiated sale, subject to certain safeguards. The United States Bankruptcy Code provides for debtor-in-possession financing and reorganization plans under Chapter 11, which similarly recognize that existing management may be best positioned to rescue a distressed business.

However, these international frameworks do not make categorical distinctions based on enterprise size in the manner that Section 240A does. The Indian approach represents a distinctive policy choice to provide explicit statutory protection for a particular category of enterprises deemed critical to economic and employment objectives.

Critics of the Section 240A exemption argue that it creates moral hazard by reducing the consequences of financial mismanagement for MSME promoters. They contend that permitting defaulting promoters to submit resolution plans undermines the fundamental principle that insolvency law should penalize incompetent or dishonest management. There is concern that unscrupulous promoters might deliberately default and then use the Section 240A exemption to acquire their companies at reduced valuations.

Proponents counter that the exemption is partial rather than absolute, as willful defaulters remain disqualified even for MSMEs. They emphasize that the Committee of Creditors retains full authority to accept or reject any resolution plan, including one submitted by a promoter, based on commercial wisdom. The exemption merely permits promoters to participate in the bidding process rather than guaranteeing them success.

The Supreme Court’s decision in Hari Babu Thota has been generally welcomed by MSME advocates as it provides clarity and prevents technical interpretations from defeating the legislative intent. However, concerns remain about potential abuse, particularly in situations where MSME certification is obtained during insolvency proceedings specifically to claim the Section 240A benefit.

Regulatory Oversight and Anti-Abuse Mechanisms

To address concerns about potential abuse of the Section 240A exemption, various safeguards exist within the regulatory framework. The Insolvency and Bankruptcy Board of India, as the regulatory authority overseeing insolvency professionals and processes, has issued regulations that govern the conduct of resolution professionals and the treatment of resolution plans.

The resolution professional bears responsibility for verifying the eligibility of resolution applicants and ensuring that information provided about MSME status is accurate. Professional misconduct by a resolution professional, including facilitating abuse of the MSME exemption, can result in disciplinary proceedings and sanctions by the Board.

The Committee of Creditors serves as a crucial check on potential abuse. Even if a promoter is eligible to submit a resolution plan under Section 240A, the Committee evaluates the plan based on its merits and the value it offers to creditors. The Committee can reject a promoter’s plan in favor of a better alternative or recommend liquidation if no satisfactory resolution plan emerges.

Additionally, the National Company Law Tribunal exercises judicial oversight over the entire process. The Tribunal must approve any resolution plan before it becomes binding, and in doing so, it verifies compliance with the Code’s requirements. The Tribunal can reject plans that violate legal requirements or appear to involve fraud or misrepresentation.

The appellate mechanism through the National Company Law Appellate Tribunal and ultimately the Supreme Court provides further safeguards. Aggrieved parties, including dissenting creditors or operational creditors whose interests may be affected, can challenge the approval of resolution plans that they believe involve improper application of Section 240A or other irregularities.

Conclusion

The framework governing MSME promoter eligibility to submit resolution plans under the Insolvency and Bankruptcy Code represents a nuanced approach to balancing multiple policy objectives. Section 29A establishes a general regime of strict eligibility criteria designed to prevent defaulting promoters from exploiting the insolvency process. Section 240A creates a targeted exemption for MSMEs, recognizing their unique economic significance and the limited interest that external investors may have in small enterprises.

The Supreme Court’s decision in Hari Babu Thota has clarified a critical aspect of this framework by holding that MSME status at the time of resolution plan submission, rather than at commencement of insolvency proceedings, is the relevant criterion. This interpretation aligns with the legislative intent of facilitating MSME resolution and prevents overly technical constructions from defeating the substantive purpose of the exemption.

As the insolvency resolution ecosystem matures, continued judicial interpretation and regulatory refinement will shape the practical application of these provisions. The balance between creditor protection and business revival, between preventing moral hazard and enabling entrepreneurial recovery, remains delicate and context-dependent. The MSME exemption under Section 240A exemplifies the challenges of crafting legal frameworks that are simultaneously principled in their approach to accountability and pragmatic in their recognition of economic realities. The coming years will reveal whether this framework successfully achieves its twin objectives of maximizing creditor recovery and preserving viable MSME businesses, or whether further refinements are necessary to address emerging challenges and prevent unintended consequences.

References

[1] Insolvency and Bankruptcy Code, 2016, https://ibclaw.in/section-29a-persons-not-eligible-to-be-resolution-applicant/ 

[2] ArcelorMittal India Private Limited v. Satish Kumar Gupta, (2019) 2 SCC 1, https://ibbi.gov.in/webadmin/pdf/whatsnew/2018/Oct/33945_2018_Judgement_04-Oct-2018_2018-10-04%2018:02:45.pdf 

[3] Swiss Ribbons Private Limited v. Union of India, (2019) 4 SCC 17, https://ibbi.gov.in/webadmin/pdf/order/2019/Jan/25th-Jan-2019-in-the-matter-of-Swiss-Ribbons-Pvt.-Ltd.-and-Anr-Writ-Petition-Civil-No.37-99-100-115-459-598-775-822-849-and-1221-2018-In-Special-Leave-Petition-Civil-No.28623-of-2018_2019-01-25-13-58.pdf 

[4] Insolvency Law Committee Report 2018, https://www.ibbi.gov.in/uploads/publication/e42fddce80e99d28b683a7e21c81110e.pdf 

[5] Hari Babu Thota v. Pritha Srikumar Iyer, Civil Appeal No. 4422 of 2023, https://www.latestlaws.com/latest-caselaw/2023/november/2023-latest-caselaw-919-sc