Introduction
The Covid-19 pandemic has crippled commercial activities and has aggravated the financial woes of business entities. Liquidity crunch coupled with supply chain disruptions and halted business activities is likely to induce increased insolvency on the horizon.
This article analyses the ensuing implications of increasing the minimum threshold to initiate insolvency resolution under Insolvency and Bankruptcy Code, 2016 (IBC) and the promulgation of the Insolvency and Bankruptcy (Ordinance), 2020 (‘Ordinance’). Additionally, this article also examines various lacunae in the changes introduced.
Changes Introduced
The central government, exercising its powers under Section 4 of IBC, vide notification dated 24 March, 2020 raised the minimum threshold for initiation of corporate insolvency resolution process (‘CIRP’) from Rs.1 lakh to Rs.1 crore. Orders of the NCLT benches of Kolkata and Chennai in Foseco India Limited v. Om Boseco Rail Products Limited and Arrowline Organic Products (P) Ltd v. Rockwell Industries Limited respectively clarify that the notification is prospective in nature. Therefore, the increased threshold will apply only to applications filed after the date of the notification.
Further, the Ordinance inserts Section 10A to the Code which imposes a blanket ban on filing applications under Sections 7, 9 and 10 of IBC for defaults arising from 25 March 2020 for a period of 6 months which may be extended to a maximum period of one year. The proviso to Section 10A stipulates that no application can ‘ever’ be filed for such defaults and gives total immunity to defaults occurring in the said period. The proviso is counter-intuitive and requires clarity.
The Ordinance also inserts Section 66(3) which restricts a resolution professional from filing an application against directors of a corporate debtor for wrongful trading in respect of defaults suspended under Section 10A.
Ensuing Implications
Even though the Ordinance aims to provide relief to the distressed debtors but it does not envisage the following repercussions:
- Availability of Alternative Remedies
The objective of the Ordinance is to provide succour to businesses that are already reeling under the financial distress induced by Covid-19 and save them from insolvency proceedings. However, the availability of alternative remedies for debt restructuring and debt enforcement like Section 230 of Companies Act, RBI Prudential Framework, SARFESI Act, RDBFI Act, etc. renders this objective redundant. Section 10A tries to protect businesses from debt enforcement under IBC.However, it fails to contemplate the debt restructuring mechanism envisaged under IBC and the statutory moratorium period granted under Section 14, which gives a breathing period against debt enforcement. During the period of suspension of IBC, creditors can opt for piecemeal debt enforcement which will lead to loss in value of assets of the debtor and this will not be in the collective interest of all the creditors once the suspension period ends.
- Blanket Ban
As of March 2020, 49.21% of the CIRPs were triggered by operational creditors. Increase in the threshold amount is likely to affect mostly operational creditors as financial creditors can meet the threshold either individually or along with aggregated default amount of other financial creditors as per section 7(1) of the Code. The increased threshold coupled with the Ordinance will ultimately affect the operational creditors, especially the workmen and the employees. The changes introduced create a paradoxical situation for MSMEs. These changes, instead of providing relief to MSMEs, inflict a double whammy on them by srecognising their plight as ‘corporate debtor’ but ignoring their interests as ‘operational creditors’. Suspending Section 10 of IBC is unreasonable as it will force the distressed companies to incur increasing debt when relief can be sought through CIRP and can trap already struggling companies in spiralling debt. Moreover, the Ordinance does not suspend initiation of CIRP against personal guarantors under Section 94 and 95 of IBC. Therefore, a spike in the number of insolvency applications against personal guarantors to corporate debtors under IBC can be apprehended.
- COVID-Related Debt
Since the suspension period prescribed by the Ordinance assumes that any default during such period will be caused due to Covid-19, it fails to contemplate defaults which might have occurred due to the worldwide pandemic before 25 March 2020. For example, defaults in the import and export sector. Non-linkage of defaults to Covid-19 may also excuse defaults by debtors in sectors least hit by the pandemic like the drugs and pharmaceuticals sector and the telecom sector.
- Depreciation in Value
Disrupted business activity, the introduction of Section 10A and the consequent non-resolution of troubled firms can trap the businesses into spiralling debt which will affect their operationality. Even when the suspension is lifted, the potential resolution applicants may adopt a wait and watch approach as the economic downturn calls into question the viability of debt-ridden and insolvent firms. Delay in implementation of resolution plans coupled with less demand and oversupply of assets of insolvent firms will lead to fire sale of such assets.
- Exemption to Wrongful Trading
The rationale behind inserting Section 66(3) was to help the directors of companies to continue their business despite being uncertain of their solvency in the future due to the pandemic. Again a blanket ban on the initiation of proceedings against directors for wrongful trading coupled with Section 10A can easily be utilised to recoup the very “defaulter’s paradise” that the Code sought to abolish. Further, the debtor can siphon off or dissipate the company assets to the prejudice of the creditors and still be protected under the garb of the Ordinance.
Therefore, the Ordinance marks the transition of the insolvency regime from ‘creditor-in-control’ to ‘debtor-in-possession’ and enables piling-up of insolvency cases without resolution. The Ordinance will delay the initiation of CIRP and time-bound resolution of distressed firms which will lead to depreciation in the liquidation value of the firms. In the absence of an effective mechanism, once the period of suspension ends, it will result in a surge in NPAs for lending institutions which were already dealing with bad debt prior to the pandemic and will also cause excessive insolvencies which will result in premature liquidations, increased retrenchment and a sharp deterioration in the quality of assets and fire sales.
International Experience and Way Forward
Primarily, the government should have concerned itself with flattening the curve of insolvencies and preventing systemic liquidations and should have enacted an effective debt restructuring framework to ensure the long term operationality of companies. However, the measures adopted by the government are likely to give rise to a number of insolvent firms in the near future.
Section 10 of IBC should not have been suspended because the primary objective of the Code is to rescue the life of the troubled corporate debtor and as of 31 March, 2020, 254 CIRPs were triggered by corporate debtors themselves. Suspending Section 10 denies the debtor an efficient resolution mechanism which prioritises maximisation of the value of stressed assets instead of debt enforcement. Pertinently, France has permitted companies to voluntarily avail bankruptcy protection and undergo court-supervised debt restructuring or liquidation proceedings. Additionally, prescription of different thresholds for financial and operational creditors, which was also recommended by the Insolvency Law Committee Report, would have been conducive to the interests of both the creditors.
Also, the Indian government should have considered adopting some of the provisions of the UK’s Corporate and Insolvency Act, 2020, which suspends filing statutory demands and winding-up petitions for COVID-related debt retrospectively. It enables the companies to obtain a moratorium for a period of 20 business days which can be extended by another 20 days without the creditors’ consent and by a period of one year with the creditors’ consent. The Act introduces a new restructuring scheme which incorporates the cross-class cram down provision that enables the companies to bind the creditors even if they vote against a resolution plan. It also prevents suppliers from terminating their contracts with the debtor during the moratorium period which can endanger the rescue of the company. Since value improves when the business is continued, the Indian government should consider allowing companies to avail statutory moratorium under IBC to seek protection from debt enforcement proceedings and to ensure the continuation of supply of essential goods or services to meet their basic operational needs. Further, COVID-related debt should have been excluded from the gamut of default under Section 5(6) of IBC for initiation of CIRP to balance the interests of the genuinely affected debtors and lenders.
Conclusion
The measures adopted by the government in relation to insolvency laws in response to the pandemic are myopic and do not take into consideration a number of factors. They are incongruous to the sustenance of businesses and revival of the economy in the long run and are likely to cause excessive insolvencies. The measures only put a cap on the existing problems for a short period of time without addressing long-term concerns. In light of the above, the government needs to come up with a robust framework to deal with the tsunami of insolvencies once the Ordinance ceases to have effect.
[Sambhawi Sanghmitra is a Third-Year student at Chanakya National Law University, Patna and Vijay Rohan Krishna is a Fifth-year student at National University of Study and Research in Law, Ranchi. They can be reached at sambhawisanghmitra1@gmail.com & rohanvijay986@gmail.com.]
NUALS Restructuring and Insolvency Law Journal 