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Revival of an MSME by existing management under IBC: Effects on asset classification

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Background

Section 29A of the Insolvency and Bankruptcy Code prohibits existing management from participating in the resolution plan of the corporate debtor. However, Section 240A of the Code exempts micro, small and medium enterprises (MSMEs) from the application of Section 29A. In view of this, the existing management of an MSME could participate in the resolution plan.

RBI’s Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated October 01, 2021 provides that the financial entities can upgrade the credit facilities as ‘standard’ after change in ownership is implemented, either under Insolvency and Bankruptcy Code or under RBI’s Framework.

A bare reading of both the provisions would imply that in case of resolution of MSMEs where the exisiting promoter/management is the successful resolution applicant, the banks could not upgrade the classification of the debt as there is no change in ownership.

NCLT Mumbai Bench Order

The bench noted that in case of an MSME enterprise, the existing management is allowed to revive the Company by giving a Resolution Plan so as to provide a clean start to the unit/Corporate Debtor and therefore, once the resolution plan is approved by the Adjudicating Authority, the management/ownership of the Corporate Debtor shall be considered as fresh, even if the directors/promoters of the Corporate Debtor (MSME) remain the same. The bench, therefore, directed the bank to change the asset classification of the company’s account to standard.

Our Views

It completely depends on the terms of the resolution plan which has been approved by the Committee of Creditors and the Adjudicating Authority (NCLT). Ambiguity, as in the present case, could lead to litigation and should be better avoided. Moreover, the law is not well settled on this aspect.