The startup ecosystem and Micro, Small, and Medium Enterprises (MSMEs) form the backbone of India’s economic growth. The legal framework governing their insolvency resolution, primarily through the Insolvency and Bankruptcy Code, 2016 (IBC), provides structured mechanisms for addressing financial distress. This article explores the comprehensive legal framework available to startups and MSMEs in India, with particular emphasis on statutory provisions and recent legal developments.
Legal Framework Overview
It gets constitutional validity from the Entry 9 of List III (Concurrent List) to the Seventh Schedule of the Constitution of India, in relation to “Bankruptcy and Insolvency”. This constitutional power enables both the Centre and the States to pass legislation on matters of bankruptcy and insolvency in which IBC remains the central enactment of federal law.
Primary Legislation
The core legislation is the Insolvency and Bankruptcy Code, 2016. This code is supported by:
- The Micro, Small and Medium Enterprises Development Act, 2006
- The Companies Act, 2013 especially the provisions under sections 253 to 269 which deals with compromise and arrangements
- The Limited Liability Partnership Act, 2008
- The Partnership Act, 1932
Important Legal Provisions Under IBC
Threshold of Default for Invoking the Code
Section 4 of the IBC, as amended in 2020, has set the minimum default threshold of ₹1 crore for initiating CIRP. However, specifically for the MSMEs, Section 4(2) of the same amendment, by 2021, allows the Central Government to notify a different threshold and the same has been notified at ₹10 lakhs.
How to file
The legal process to initiate the insolvency resolution process is governed by:
Section 7: Financial creditors can file an application for the initiation of CIRP before NCLT.
Section 8 and 9: Operational creditors have to issue a demand notice and can file an application within 10 days if the same is not paid.
Section 10: Even the corporate debtor can file an application for voluntary insolvency process.
Pre-Packaged Insolvency Resolution Process (PIRP)
Chapter III-A of the IBC, under amendments made in 2021, provides a separate PIRP framework for MSMEs. The critical provisions are as follows:
Section 54A: Eligibility criteria for the invocation of PIRP, inter alia, is as follows:
- Considered to be an MSME under Section 7(1) of the MSME Development Act, 2006
- Has defaulted with an amount of at least ₹10 lakhs
- No ongoing CIRP or liquidation proceedings
- No PIRP in preceding three years
Section 54C: Requires approval from 66% of unrelated financial creditors for PIRP initiation.
Section 54D: Mandates submission of base resolution plan at the time of PIRP application.
Section 54E: Establishes a 120-day timeline for PIRP completion from the pre-packaged insolvency commencement date.
Moratorium Provisions
Section 14 of the IBC provides for a moratorium period during which:
- No legal proceedings can be initiated or continued against the corporate debtor
- The corporate debtor’s assets cannot be transferred or encumbered
- No enforcement action can be taken under SARFAESI Act, 2002
- Essential goods and services cannot be terminated or suspended
Resolution Professional Appointment
Section 22 governs the appointment of Resolution Professionals (RP), with specific provisions for MSMEs under Section 54B for PIRP. The RP must be proposed by the MSME and approved by unrelated financial creditors.
Recent Legal Amendments and Notifications
MSME Definition Changes
The Ministry of MSME’s notification dated June 1, 2020, revised the MSME classification criteria:
– Micro enterprises: Investment up to ₹1 crore and turnover up to ₹5 crore
– Small enterprises: Investment up to ₹10 crore and turnover up to ₹50 crore
– Medium enterprises: Investment up to ₹50 crore and turnover up to ₹250 crore
Special Framework for MSMEs
The Insolvency and Bankruptcy Board of India (IBBI) has issued several regulations specifically for MSMEs:
IBBI (Pre-packaged Insolvency Resolution Process) Regulations, 2021:
– Regulation 14: Details the information memorandum requirements
– Regulation 42: Establishes evaluation criteria for resolution plans
– Regulation 43: Sets out the process for approval of resolution plans
Judicial Precedents
The Supreme Court upheld the constitutional validity of the IBC and emphasized its role in promoting entrepreneurship and credit availability.
The case M/S Innoventive Industries Ltd. v. ICICI Bank & Anr. ([2017] 8 S.C.R. 33)
Established the primacy of the IBC over other laws and clarified the scope of judicial intervention in the admission of insolvency applications. Committee of Creditors of Essar Steel India Limited v. Satish Kumar Gupta (2019)Clarified the role and powers of the Committee of Creditors in the resolution process, particularly relevant for MSME cases.
Regulatory Compliance Requirements
Filing Requirements
MSMEs must maintain compliance with various statutory filings under:
- Form MSME-1 for Udyam Registration
- Form 6 for PIRP initiation under IBC
- Form 2 for public announcement under PIRP
Documentation Requirements
The law mandates specific documentation for PIRP:
- Declaration regarding eligibility under Section 54A
- Base resolution plan
- List of claims by creditors
- Approval from financial creditors
- Preliminary information memorandum
Conclusion
The legal framework for insolvency resolution of startups and MSMEs in India represents a balanced approach between creditor rights and business revival. The introduction of PIRP through Chapter III-A of the IBC marks a significant evolution in addressing the unique needs of MSMEs. As this framework continues to evolve through legislative amendments and judicial interpretations, it remains crucial for stakeholders to stay informed about their rights, obligations, and available remedies under the law.
Understanding these legal provisions is essential for effective utilization of the insolvency resolution framework, whether for business revival or orderly market exit. The success of this framework will depend on continued legislative refinement and practical implementation aligned with the unique challenges faced by startups and MSMEs in India.
For startups and MSMEs (Micro, Small, and Medium Enterprises), the insolvency resolution procedure is essential to maintaining viable companies in financial difficulties. With the introduction of time-bound procedures that have increased efficiency and transparency, India’s Insolvency and Bankruptcy Code (IBC) has offered a systematic framework for handling insolvency. But within this framework, particular considerations are needed for the particular difficulties that startups and MSMEs encounter.
Startups frequently encounter challenges such restricted financial availability, elevated operational risks, and the requirement to safeguard human resources and intellectual property. The insolvency procedure for startups should be more adaptable in order to handle these issues. Preventing the premature liquidation of creative enterprises can be achieved by including rules that permit the recognition of intangible assets such as intellectual property and future income potential. The startup’s viability might also be maintained by encouraging out-of-court settlements and including industry specialists in the resolution process to give customised solutions.
