Contributed by Armaan Rai

Typically, during the CIRP process, the resolution professional (RP) sends across an Expression of Interest (EoI) often containing minimum net worth and earnest money deposit (EMD) requirements for prospective resolution applicants (RAs) to fulfil prior to placing a resolution plan before the Committee of Creditors (CoC). The extent to which these requirements may be imposed on promoters of MSMEs has ignited considerable debate due to S.240A of the Insolvency and Bankruptcy Code 2016 (IBC), which is popularly known as the ‘MSME exemption.’

To understand the judicial confusion at play, we must first briefly examine the statutory position of the exemption under the Code and the differing judicial opinions as to the scope of the exemption under the scheme of the IBC.

The Legislative Intent Behind the MSME Exemption: A Perusal of S.29A and S.240A

S.29A of the IBC bars certain categories of persons from becoming a resolution applicant, including inter alia promoters and other key managerial persons of the company. However, pursuant to S.240A of the Code, the applicability of S.29A (c) and (h) is excluded for MSMEs. Effectively, this provision provides that the promoters of MSMEs are exempted from the bar under S.29A and are consequently allowed to file resolution plans before the CoC.

The rationale of such an exemption, as explained by the 2018 IBC Committee Report was that an MSME primarily attracts business interests from its promoters, which places them at the best position to be amenable to the business concerns of the MSME. Consequently, as explained by the Supreme Court in Swiss Ribbons, not allowing promoters to take part in the restructuring of MSMEs would essentially be similar to pushing the company into liquidation since outsiders wouldn’t be as interested in keeping the company as a going concern. As a result, S. 240A or the ‘MSME exemption’ was enacted so as to allow promoters of MSMEs to participate in the restructuring proceedings of MSMEs.

Saravana Global Holdings and C. Raja John: Opening the Floodgates?

As seen above, a bare perusal of S.240A leads to the simple conclusion that promoters are granted a limited exemption in terms of presenting a resolution plan before the CoC. However, two NCLAT decisions i.e., Sarvana Global Holdings v. Bafna Pharmaceuticals and C. Raja John v. R. Raghavendra basically found that the exemption under S.240A also provided for an exemption to MSME promoters against fulfilling the EMD and Net Worth requirements.

Sarvana Global Holdings, while not directly dealing with the exemption of EMD and Net Worth requirements, is crucial to understand the legal position. The case resolved around the approval of a resolution plan of a former promoter by the CoC, where the Resolution Professional had not invited other prospective resolution applicants pursuant to Article 25(2)(h). Here, the Tribunal observed that the purpose of the Code is to maximize value of assets to ensure that the entity is run effectively as a going concern. Consequently, the Tribunal held that if the CoC finds that a plan is feasible and viable and the company is an MSME, the mandatory CIRP procedures could be relaxed.

In fact, the Tribunal went as far as to hold that “in exceptional circumstances, it is not necessary for the Promoters to compete with other ‘Resolution Applicants’ to regain the control of the ‘Corporate Debtor’.”

In C. Raja John, the Tribunal found the exemption under S.240A to include an exemption of the Net Worth and EMD requirements as well. In this case, a resolution plan put forth by the promoter of the MSME corporate debtor was rejected by the RP for non-fulfilment of the Net Worth requirements under the EoI. The Tribunal, relying on Saravana Global Holdings affirmed that in order to regain control over the corporate debtor, in certain instances, it is not necessary for the promoter of an MSME to compete with other resolution applicants. Consequently, the RP’s view was overturned and it was held that since the promoters of MSMEs did not have to compete with other RAs, they didn’t have to fulfil the mandatory EoI requirements.

Fallout from Saravana and C. Raja John: Wide Exemptions to the Promoters of MSMEs

In the matter of M/s. Blue Park Seafoods Pvt. Ltd., the Amravati Bench of the NCLT gave a broad pronouncement based on the dictum in Sarvana Global Holdings, holding that promoters of MSMEs are not only exempted from the bar under S.29A (c) and (h), but also other formalities under the Code, including EMD. Though the Court ultimately reaches the same conclusion as in C. Raja John, the Court’s explanation of the law raises red flags. Pertinently, the Court concluded that:
“Hence, not only the exemptions under Section 29 (c) & (h) but the MSMEs are also exempted from the other formalities like EMD, net worth certificate, etc., the underlying reason being to provide an opportunity for the promoters who are inclined to run the CD as a going concern.”
The implications of such a decision are grave and far-removed from the intended purpose of S.240A. Effectively, the NCLT found that the promoters of MSMEs are placed in such a unique position that they are exempt from a wide range of formalities encapsulated in the Code.
The result of such an irresponsible conclusion can be seen in the case of Small Industries Development Bank of India v. Viola Resorts Private Limited, where the Mumbai Bench of the NCLT, relying on the decision in M/s Blue Park Seafoods held similarly that the Applicant was entitled to an exemption from the EMD requirement. However, in this case, the Applicant had already requested the CoC for a waiver on the deposition of the EMD, which had been rejected by the CoC in their sixth meeting. Therefore, this case is peculiar, since the NCLT had gone beyond the commercial wisdom of the CoC and affirmed that promoters of MSMEs are placed in such a unique position that they are exempted from the requirements even against the decision of the CoC.

The Supreme Court decision in R. Raghavendra v. C. Raja John: Striking a Middle Ground

Following the abovementioned confusion arising out of Saravana Global Holdings and C. Raja John, the Supreme Court in R. Raghavendra v. C. Raja John, attempted to cull out a viable legal middle ground. The Court set aside para. 32 -34 of the NCLT decision in C. Raja John, which reads as follows:
“32) In any event, it is unequivocal that the Corporate Debtor is an MSME and as held by this Tribunal that it is not necessary for the Promoters to compete with other Resolution Applicants to regain the control of the Corporate Debtor.

34) Further, this Tribunal, keeping in view of the object of the Code that the Maximization of the Value of the Assets of Corporate Debtor is to be kept in mind in achieving its object. To give an opportunity to regain the control of the Corporate Debtor, the Management/Promoters/Erstwhile Directors of the Corporate Debtor being an MSME, not necessary to compete with other Resolution Applicants.”

Effectively, the Court held that a broad interpretation providing that promoters of MSMEs did not have to compete with other RAs to regain control of the CD is not feasible. Ultimately, the Court struck a middle ground and held that certain requirements may be relaxed, provided that the CoC finds that the plan is feasible and viable. Such an interpretation seemingly recognises the unique status of promoters of MSMEs while upholding the commercial wisdom of the CoC.

However, the Supreme Court, while restricting the potential ramifications of the earlier position, does not clarify what exactly are the criteria that may be relaxed. In the recent case of Mukesh Goel v. CA Santanu Brahma, the NCLT undertook a nuanced analysis of the issue. The Tribunal took a considered view of the importance of promoters for the business of MSMEs while being cognizant of the main aim of the process i.e., maximization of the value of the assets of the corporate debtor and the need to pay back the creditors. Consequently, it was held that since S.240A was aimed at allowing promoters of MSMEs to participate in the process, requirements like the Net Worth criteria could be relaxed. However, since the EMD requirement is essentially linked to the commercial viability of the plan, it could not be relaxed.
Current Position and The Way Ahead

Added by way of amendment in 2018, the exemption under S.240A was a beneficial legislation aimed at addressing the peculiar status of MSMEs during insolvency resolution proceedings. Though the provision itself facially only grants a limited exemption till the extent of the bar under S.29A, various Court decisions as well as the Committee’s preparatory work has shown us that the real intention was to allow promoters of MSMEs an avenue to participate in the CIRP process.

However, contrary to the finding in Saravan Global Holding and C. Raja John, it cannot be said that the intention of the legislature was to allow for such a wide exemption, holding that promoters of MSMEs did not have to compete with other applicants. Such an interpretation completely disregards the commercial wisdom of the CoC, and other key tenets of the IBC.

The correct and more sound position, as affirmed by the Supreme Court, is that in order to effectuate participation by promoters of MSMEs, certain exemptions should be granted subject to approval by the CoC. Though the exact nature of the restrictions which may be allowed is still not clear, the Mukesh Goel decision serves as a promising test, by balancing the intent behind the MSME exemption with the need for a commercially viable resolution plan.