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Moratorium On Insolvency And Bankruptcy Code, 2016: Is It A Cure-All Or Only Help A Few

P. Nagesh & Akshay Sharma
22 May 2020 7:15 AM GMT
Moratorium On Insolvency And Bankruptcy Code, 2016: Is It A Cure-All Or Only Help A Few

On 17.05.2020, the Finance Minister of India while announcing the fifth tranche of the stimulus/relief packages to mitigate the consequences of COVID-19 on the Indian Economy, also announced that there will be no fresh insolvency filings under the Insolvency and Bankruptcy Code, 2016 ("IBC"). The Finance Minister informed that an ordinance will be brought to this effect. Undoubtedly, the business across the country requires relief but an absolute embargo upon the fresh insolvency filings doesn't seem to be a wise step. Further the lock down has virtually ensured all insolvency proceedings under sections 7 and 9, be it of less than one crore or more than one crore in cold storage.

The question then arises is can someone file a fresh case under section 7 and 9 for a default committed of more than one crore prior to the lock down and before the promulgation of ordinance. If such an application is filed will it be accepted. The immediate answer is yes. However it may also be possible that the ordinance could state that its applicability is retrospective by stating that defaults committed during Covid 19 having being declared as no default, even filings of cases under section 7 and 9 during Covid 19 and prior to the ordinance are also prohibited . We need to see the exact wordings of the Ordinance.

While there is no gainsaying that COVID-19 will have a devasting impact upon the industries especially the Real Estate and Micro, Small and Medium Enterprises (MSMEs), the Government has announced enough safeguard measures for both of these and consequently, the suspension of fresh insolvency filings for a period of one year seems hasty if not unwarranted.

Coming to the measures addressing the plight of Real Estate companies, it is important to note that Default under IBC by Real Estate companies occurs mostly due to the non-delivery of flat/unit/apartment to the homebuyers. The Govt. has already stated that the COVID-19 will be treated as a natural calamity and further advised the state government to invoke the force majeure clause under RERA. Also as a major relief, the Govt. has extended the compliance and completion of all registered projects under RERA for six months with a further extension of three months. Therefore, Real Estate companies are effectively absolved from default for nine months. These safeguards are enough and go on to highlight the futility of the suspension of fresh insolvency proceedings.

Furthermore, on 24.03.2020, the Govt. had increased the threshold amount for default to One Crore to protect the MSMEs. While debates were still on as to whether this threshold will be applied retrospectively or prospectively, on 13.05.2020, the Govt. introduced a new definition for MSMEs by amending Section 7 under the MSME Act. The new definition increased the minimum turnover to Five Crore for a "micro-enterprise"&a hundred crore for a "medium enterprise", thus making the decision of increasing the default threshold short-sighted and unnecessary. Furthermore, the Govt. has also kept out any COVID related debt from the definition of "Default" under the code. What will be the definition of COVID related debt & which time period will be covered is yet to be finalized. Also, a special resolution framework for MSMEs is also going to be notified under Section 240A of IBC . Taking all these safeguards into consideration, it seems out of place to suspend the fresh insolvency filings under IBC.

It also must be borne in mind that the total Govt. dues to MSMEs stood at 5.5 lakh crore at the end of March 2020. Insolvency proceedings under Section 9 was an effective way of debt recovery for MSMEs and Operational Creditor to recover their dues. Most of the corporate debtor settled their debts before admission fearing of initiation of Corporate Insolvency Resolution Process (CIRP). It is also pertinent to mention that more than 50% of the CIRPsare initiated on a petition filed by the Operational Creditors. Operational Creditors are already neglected in the resolution process under IBC and are kept at the lowest pedestal in the distribution process.

Taking away the right to file fresh insolvency proceedings will act as a boomerang for these operational creditors.Thisis because these Operational creditors, who will be unable to recover their debts due to suspension of IBC, will most likely default on their debts and therefore, disrupt the whole economy.Therefore, their interest needs to be taken care of by the Government. An alternative mechanism which is less time consuming and less expensive either in the form of Mediation or in the form of payment of some percentage of the debt to the creditor,the moment the mediation commences should be identified.This will help MSMEs recover their debts without following the route of IBC. Otherwise it will set into motion a chain reaction where all MSMEs will postpone their payments resulting in a slowdown of the economy.

Moreover, it is also suggested that the fresh insolvency filing under Section 10 of IBC will also be suspended. A Company can voluntarily file insolvency under Section 10 considering that its financial position is not viable anymore. Since, the enactment of IBC, 243 companies have voluntarily including companies like Aircel filed for insolvency under Section 10. As the freedom to trade and business is a fundamental right and as a necessary corollary freedom of not to do trade and business is also a fundamental right, companies cannot be forced to continue business when they are voluntarily filing for insolvency as has also been done by Gold Gym in the USA. This embargo under section 10 of IBC is really unnecessary.

At this juncture, it is pertinent to mention the observation of Justice Nariman in the case of Swiss Ribbons v. Union of India,(2019) 4 SCC 17, that

"27. As is discernible, the Preamble gives an insight into what is sought to be achieved by the Code. The Code is first and foremost, a Code for reorganization and insolvency resolution of corporate debtors. Unless such reorganization is effected in a time-bound manner, the value of the assets of such persons will deplete…. When, therefore, a resolution plan takes off and the corporate debtor is brought back into the economic mainstream, it is able to repay its debts, which, in turn, enhances the viability of credit in the hands of banks and financial institutions….Timely resolution of a corporate debtor who is in the red, by an effective legal framework, would go a long way to support the development of credit markets. Since more investment can be made with funds that have come back into the economy, business then eases up, which leads, overall, to higher economic growth and development of the Indian economy."

A debt stressed company must not be forced to continue its business during this pandemic and all avenues of resolution of its debts should be kept open. A secured financial creditor can still recover its dues by taking recourse to SARFEASI but the operational creditor is only left with the option of protracted litigation which includes arbitration and civil suits as the earlier remedy of winding up due to the inability to pay debts under Companies Act, 2013 was also taken away after the enactment of IBC.

Thus, while the ordinance concerning suspension of fresh insolvency proceedings is yet to come out,itprima facie seems that the blanket suspension on the initiation of fresh insolvency filings is needless and creates more problems than it aims to address..

Views Are Personal Only.

(P. Nagesh, Delhi Based Advocate & Akshay Sharma, law student, National University of Study and Research in Law.)

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