The Authors, Amar Gupta is amongst the founding members of J Sagar Associate's Dispute Practice and Pallavi Kumar is an Associate working in JSA. The The authors have vast experience in Insolvency and Bankruptcy Code, 2016. They regularly appear before NCLT, NCLAT and Supreme Court in relation to insolvency matters on behalf of resolution professionals, financial & operational creditors, real estate companies, etc.
Introduction
The disruption in business operations following the outbreak of the COVID-19 pandemic has caused huge financial stress. As a result, payment defaults are likely, at least in the short term. The Government has announced several measures to provide relief to companies, and dilution of provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”) is amongst them.
Amendments to IBC so far
To address the emerging financial distress of smaller companies, the Government has, by a notification dated March 24, 2020[1], raised the threshold of default for filing an application for initiation of corporate insolvency resolution process (“CIRP”) under IBC from Rupees One Lakh to Rupees One Crore. This step will prevent the triggering of CIRP especially against micro, small and medium enterprises (“MSMEs”) who have been impacted the most by the crisis. Some reports also mention that a special insolvency resolution framework for MSMEs under Section 240A of the IBC will be introduced.
Further, to overcome the delay due to the disruption in functioning of the Tribunals, Regulation 40C of Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016[2] has been introduced. This new Regulation provides for exclusion of the period of lockdown from the timeline for any activity that could not be completed due to the lockdown.
On June 5, 2020, the Government promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (“Ordinance”)[3] to suspend provisions for initiation of insolvency by financial creditors, operational creditors and by the company itself under Sections 7, 9 and 10 respectively, for any default arising after March 25, 2020, for a period of six months, which may be extended by up to one year by insertion of Section 10A to the IBC.
Suspension of Sections 7, 9 and 10 – An Analysis
In the current scenario where companies are facing huge financial stress, and borrowers’ default on a large scale is inevitable, suspension of rights of creditors to seek initiation of CIRP is being advocated as an important relief measure for distressed companies.
Suspension will provide relief to the such companies; it will allow them to recover and resume normal operation and fulfil their debt obligations once the crisis is over, without lurking fear of insolvency. In the current economic situation, insolvency process is unlikely to succeed due to lack of enthusiasm amongst the bidders, and therefore there is higher risk of liquidation of companies. This measure will also reduce that risk.
At the same time, it is important to remember that the insolvency ecosystem in India is at a nascent stage. It is therefore necessary to ensure that the steps taken are measured rather than excessive to avoid damage to it. Few words of caution as regards the current approach are, therefore, in order.
First, suspension of Section 10 of IBC was unnecessary. This Section provides an option to a company to initiate CIRP and is fundamentally different from creditor’s action under Sections 7 and 9. There is no justification to take away this option from companies who may want to voluntarily resort to CIRP for resolving debt.
Second, the Ordinance suggests that the suspension may be operative till one year. It may, however, not be practical to continue a blanket suspension on the right to trigger insolvency beyond a period of six months. The Government could, alternatively, consider giving power to Tribunals to determine if the default has occurred on account of the crisis. This will require an amendment to Section 3(12) of IBC i.e. the definition of ‘default’.
Going strictly by the definition of ‘default’, Tribunals are only required to determine if the debt is due and payable in fact and in law[4]. However, it may be useful to temporarily give power to Tribunals to assess the reason for the default. If it is found that the default has occurred solely on account of the crisis, insolvency may not be initiated. An amendment to this effect will enable Tribunals to identify the companies which have defaulted on account of the pandemic and grant them protection from creditors’ actions. In fact, the intent of the Ordinance seems to be the same. It suspends Sections 7, 9 and 10 for any default that has arisen after the nationwide lockdown was announced by the Government (March 25, 2020), so that the benefit of the amendment is only available to companies that are affected by the lockdown.
No doubt, suspension of creditors’ rights will have negative implications, and creditors may suffer in the short run. The banking sector, which is already offering a three-month moratorium on loans, will be heavily impacted, thus increasing the stress on India’s financial system. There is also high likelihood of abuse by unscrupulous borrowers to delay and defeat the objects of IBC. In the long run, however, suspension will benefit creditors who would have eventually been forced to accept huge haircuts, with resolution applicants being reluctant to infuse funds to take over a stressed debtor in the current economic scenario. Suspension will provide sufficient time and opportunity to such companies to recover, thereby increasing their realisable value.
There is no doubt that this move will benefit companies who are undergoing stress following the lockdown. However, many companies may lose an opportunity of resolving and restructuring themselves through the regime under IBC. After all, the very purpose of the IBC is reorganisation and insolvency resolution for maximisation of value of assets of distressed companies. It is thus important to have a balanced approach rather than a ‘one-size-fits-all’ solution.
Internationally too, Governments have opted for judicious reforms. While Germany[5], Spain[6], Czech Republic[7] and Italy[8] have given effect to suspension of creditors’ right to file insolvency petitions, the approach in other jurisdictions is different. Instead of a blanket suspension, Singapore[9] has opted for a moratorium against commencement of insolvency of only an affected debtor. This means that if a debtor is affected by the crisis and asks for a temporary relief of its contractual obligations, its creditors cannot initiate insolvency petition against that debtor. In Russia[10], the benefit of moratorium is granted only to companies acting in areas of business that are recognised as affected by COVID-19[11], or companies that can be described as having strategic meaning. It may be useful for India as well to adopt a more balanced approach, with a combination of reforms aimed at benefiting stressed companies, while keeping the objectives of IBC in mind.
Need for Balanced Approach
Business community has argued that suspension of creditors’ rights to initiate CIRP by itself may not be enough to tackle the challenges which will arise from the crisis. A case is being made for further measures, some of which are analysed below.
- Suspension of IBC for companies undergoing insolvency:
The Ordinance has clarified that the suspension will not apply to any default committed before March 25, 2020, which means that there is no relief for companies already undergoing insolvency. However, suspension of the provisions of IBC for such companies may also be necessary.
The rationale put forward is that in the current depressed market, the liquidation value of companies under insolvency will be substantially lower than what it will be under normal market conditions. A company with low liquidation value will not be able to attract a resolution plan that maximises the value of its assets and may be forced into liquidation. Suspension of IBC for a few months will enable such companies to maximise the value of their assets in an improved market. This, it is argued, will be in creditors’ interest too. But then, should that decision be not left to the creditors themselves, in keeping with ‘creditors in control’ principle- the basic premise of IBC?
- Relaxing timelines:
IBC aims at time bound resolution of companies by providing strict timelines for completion of CIRP. In the current scenario, it may be useful to grant Tribunals the discretionary power to permit relaxation of the time for completion of CIRP in appropriate cases. This will benefit not just companies undergoing insolvency, but also its creditors and resolution applicants.
This discretion should, however, be exercised judicially as strict adherence to the timeline is at core of the current insolvency regime and is fundamental for its success. Any compromise on that principle has the potential of unravelling the current framework.
Conclusion
There is a general consensus that many companies will be massively affected by the crisis caused by the COVID-19 pandemic. The decision of the Government to amend IBC will certainly provide relief to these businesses. However, the Government must tread cautiously. The new insolvency regime has been largely successful; it has begun to change the way India does business. It must take care that the gains made so far are not lost, and its interference with the current insolvency regime is minimal.
References:
[1] https://ibbi.gov.in//uploads/legalframwork/48bf32150f5d6b30477b74f652964edc.pdf
[2] https://ibbi.gov.in/uploads/whatsnew/be2e7697e91a349bc55033b58d249cef.pdf
[3] https://ibbi.gov.in//uploads/legalframwork/741059f0d8777f311ec76332ced1e9cf.pdf
[4] Innoventive Industries Limited vs. ICICI Bank and Another (2018)1SCC407
[5] https://www.skadden.com/insights/publications/2020/04/covid-19-germany-update
[6] https://www.lw.com/thoughtLeadership/Spanish-Government-Approves-Urgent-Measures-COVID-19
[7] https://www.cliffordchance.com/content/dam/cliffordchance/briefings/2020/04/Client%20Briefing%20-%20Czech%20Law%20measures%20Insolvency%20law%20(EN).pdf
[8] https://www.schultze-braun.de/en/newsroom/newsletter-archiv/internationales-recht/coronavirus-crisis-italy-postpones-insolvency-law-reform-and-suspends-capital-maintenance-provisions-insolvency-applications-are-inadmissible-in-the-period-from-93-2020-to-3062020/
[9] COVID-19 (Temporary Measures) Act, 2020
[10] https://www.whitecase.com/publications/alert/covid-19-insolvency-filing-moratorium-russia
[11] The list of these areas is stipulated in the Resolution of the Government of Russian Federation No. 434 dated April 3, 2020. This list includes transport, entertainment, sports, cultural events, tourism, hotels, education, restaurants, etc.
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