The Author, Govind Hari Lath is a Final Year Law Student at the Faculty of Law, Delhi University.
Introduction:
The year 2020 is bringing new challenges and hardships, as people all over the globe are confronting the Covid-19. As a precautionary measure, the Central Government in India, announced a nationwide lockdown starting March 24, 2020, which has deeply impacted the business and economy. Almost every sector is hit by the unprecedented shutdown, due to which all kinds of activities and movements have ceased to operate in compliance with the rules & regulations of the closure, excluding essential services.
Several business houses are not only laying off its employees, but are also resorting to pay cuts for the retained ones due to cash crunch and stagnant financial activities. Many companies have been facing financial constraints and are now on the verge on going insolvent.
However, the Government of India has devised an Economic Task force and put forward some concrete plans for recovery and stability of the economy. This post discusses the changes brought in to the IBC Code and provides a critical analysis of the same.
Increase of threshold limit for Initiation of CIRP:
Insolvency laws in India, which is governed by Insolvency and Bankruptcy Code, 2016, provides for settlement of insolvency cases by protecting the interests of the creditors. To ease off the economic distress caused due to Covid-19, the Government of India released a notification, on 24.03.2020, exercising its power under Section 4 of the Code, wherein the minimum amount of default for initiation of Corporate Insolvency Resolution Process (CIRP) was increased to Rs. 1 Crore from the existing threshold of Rs. 1 Lakh.
It should however be noted that this Notification deals with Part II of the IBC which is concerned with Insolvency Resolution and Liquidation for Corporate Persons. The threshold limits pertaining to personal guarantors specified under Part III of the IBC, namely, Insolvency Resolution and Bankruptcy for Individuals and Partnership Firms continues to at Rs. 1000 for initiation of insolvency resolution.
Analysis:
Section 4 of the IBC specifies Rs 1 Lakh as the minimum default amount for filling a petition under the IBC. This section also provides that the Government of India has the ability to increase this threshold amount to any higher amount up to Rs 1 Crore. The Central Government has in lieu of this power has increased the limit, and therefore, petitions under the IBC cannot be filed in respect of payment defaults below Rs 1 Crore. This is a move that will probably help Micro, Small and Medium Enterprises (MSME’s) that have been under constant pressure. However, the notification does not specify if this threshold limit is only for the ongoing lockdown period or beyond that also.
Exclusion of time for the period of Lock-down:
The Insolvency and Bankruptcy Board of India (IBBI) has also introduced Regulation 40C, which states that the period of lockdown, shall not be counted for the purposes of the time-line for any activity that could not be completed due to such lockdown. Further, Regulation 47A was also inserted to the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016, to provide a similar exemption of the lockdown period,
Analysis:
These measures can be seen from a positive angle, as it has provided more relaxations for any activity to be completed because of the disruptions that arose during the shutdown period and would discourage unnecessary legal proceedings, as well will also provide relief to the ongoing liquidation proceedings as this lockdown period will be excluded from the 330 day timeline prescribed under the Code for completion of the Insolvency process.
Insolvency and Bankruptcy (Amendment) Ordinance, 2020:
The, President of India, using his powers under Article 123 of the Constitution of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2020 on 05.06.2020, which introduced two amendments to the Code. The Ordinance is a part of Atmanirbhar Package, which was announced by the Finance Ministry on May 17, 2020, to provide relief to the Companies, who are on the verge of insolvency.
Amendments incorporated to the Insolvency and Bankruptcy Code, 2016 by virtue of Ordinance:
Insertion of Section 10A:
Section 10A has been inserted in the IBC, which restricts filling of any application, for initiation of corporate insolvency resolution process (CIRP), with respect to default arising on or after 25.03.2020, for a period of six months i.e. September 25, 2020, which may be extended upto a maximum of one year from such date i.e. March 25, 2021 as may be notified.
Analysis:
The explanation to Section 10A also adds that no application shall ever be filled for initiation of CIRP of a corporate debtor for any default occurring during this specified period. This means a CIRP can never be filled, even if the default is continuing, after the specified period is done with, which effectively also suspends the operations of Section 7,8 and 9 of the IBC Code.
This ordinance also has a retrospective effect in the sense that any application filled for CIRP on or after 25.03.2020 till the date of notification of this ordinance i.e. 05.06.2020 will also get dismissed as it is now barred by law. However, the provisions of this section shall not apply for defaults committed before March 25, 2020.
It appears that this move has been introduced so as to keep a check on the number of fresh cases being filled in the National Company Law Tribunal (NCLT) and that the tribunal is not overburdened. Also, the Preamble of IBC, states as one of its objective, the maximization of value of assets of a corporate debtor during the insolvency process, but considering the recession and liquidity crisis, the assets of the corporate debtor would have to be sold at much lower values, and this would defeat the purpose of the act.
Even if an operational creditor was able to file for CIRP, the value of the sums realized by the creditor, would have been much lower in these times and have been disadvantageous to the creditors themselves, as they would have been forced to accept huge haircuts, and the resolution applicants being disinclined to infuse fresh funds to take-over a stressed debtor in the current downplay market. This cool-off period will provide sufficient time and opportunity to such companies to recover, thereby increasing their realisable value.
Overall, this amendment is seen as a measure, meant to provide relief to the borrowers from being dragged into insolvency amid the crisis they are already undergoing, and it will also be difficult to find reasonable number of resolution applicants for these insolvent corporates. Instead in the meantime, the debtors along with the creditors and the financers, can draft out a financing and restructuring arrangement.
Ambiguities in Insertion of Section 10A:
Every new set of rules and amendment attracts criticism also, so is with this amendment, as a complete blanket ban has been imposed on initiation of CIRP for a longer period. An alternate to this could have been, giving authority to the Tribunals to determine if the default has occurred on account of the crisis.
This ordinance restricts the fundamental freedom of the corporate debtor from voluntary initiation of CIRP, where the Company believes that the best and final option available is to undergo Insolvency.
The most determining concern about this ordinance is the wording of the proviso which says “no application shall be ‘ever’ filed for initiation of CIRP against a corporate debtor for the said default occurring during the said period of lockdown”. This leaves a void answer to the proceedings after expiry of the said period, that will the default still continue and allow the corporate debtor to get away with the ordinance’s protection forever.
This relaxation could also be used as an opportunity by the promoters to rub off their obligations even when they have the capacity to repay and the default has nothing to do with the pandemic.
This amendment has also, totally eliminated the rights of operational creditors without consultation, from the purview of the IBC and has not provided any protection to the operational creditors, which will also impact the banking sector negatively, and will increase the stress on India’s financial system.
The lenders would now have to resort on archaic recovery and enforcement mechanisms, such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), 2002, and Recovery of Debts Due to Banks and Financial Institutions Act, 1993, or settle for arbitration, wherever possible.
Insertion of Sub-section (3) to Section 66:
The Second amendment has added a new sub-section (3) to Section 66 of the Code, which bars filling of application u/s 66(2) of the Code, and stipulates that a resolution professional cannot initiate an application for fraudulent or wrongful trading against directors of companies, in respect of any default for which initiation of CIRP has been suspended under Section 10A.
Analysis:
Section 66(2) creates liability on director or partner of the corporate debtor, for failure to exercise due diligence, to avoid initiation of CIRP. That is to say, it imposes a liability on director or partner of the corporate debtor, to contribute to the debtor’s stand on an application initiated by the resolution professional, if they carried on business with the wilful intent of defrauding creditors, or did not exercise due diligence before commencement of insolvency. Now, with the addition of sub-section (3), the director or the partner would not be held liable in the event of such default, when the CIRP is suspended under Section 10A.
Ambiguities in Insertion of Sub-section (3) to Section 66:
The insertion of this sub-section enlarges the room for fraudulent conduct, which will go unchecked and the management of the corporate debtor would be shielded from the consequences of the intentional acts of misdeeds. The erroneous blanket ban relaxation given will also result in deliberate pooling of debts. This faulty provision will give undue protection to the corporate debtors.
Concluding remarks:
Although, all these measures may provide some temporary relief to the corporate debtors and this would also substantially reduce the number of cases before NCLT, but will hamper the future entrepreneurship and availability of credit to a large extent. Nonetheless, all these steps will be somewhat beneficial for the corporate debtor, as the key objective of the IBC is also to ensure that the corporate debtor keeps operating as a going concern.
On the other hand, due to the deferment in the timelines, another goal of the IBC to ensure resolution of debts in a time-bound manner would also take a back-seat. The Government should also take an account of the loopholes indicated in this ordinance and come up with more clarification, before the situation becomes too clumsy.
