11 Jun 2020 7:58 AM GMT
Natural calamities - Australian bushfires, cyclone Amphan, locusts, proximity asteroids, earthquakes in New Delhi; civil rights protests – Shaheen Bagh in India resisting the Citizenship Amendment Act, 2019 the black rights movement protesting racist police brutality in the United States; and last but not the least, the global pandemic – the novel coronavirus, (" COVID-19") that...
Natural calamities - Australian bushfires, cyclone Amphan, locusts, proximity asteroids, earthquakes in New Delhi; civil rights protests – Shaheen Bagh in India resisting the Citizenship Amendment Act, 2019 the black rights movement protesting racist police brutality in the United States; and last but not the least, the global pandemic – the novel coronavirus, (" COVID-19") that has gripped the world. Safe to say that 2020 has gotten off to a rocky start.
COVID-19, in particular, due to its global nature has had far reaching consequences that administrations across the world are struggling to tackle. The delicate balance between social distancing efforts in a bid to flatten the curve and preserve medical infrastructure versus stemming the toll of economic inactivity on a country's fiscal health, is one that no country has found the magic formula to. Every country has deployed its own unique iteration of stimuli packages, labour law reforms, and exemptions to blunt the impact of the virus on economic health.
The Narendra Modi led NDA government too has announced a slew of actions to assist India gain some sense of normalcy, subsequent to the two-month+ lockdown that was imposed due to the COVID-19 outbreak. One such area that Indian government has focused on has been the Insolvency and Bankruptcy Code 2016 ("IBC" or "Code") and has through a series of economic reforms made certain temporary changes to the IBC.
Three major reforms to the IBC that have been undertaken since the lockdown imposed on March 25th, 2020 are:
Increase in the Default Threshold Limit
On March 24th, 2020, the government announced that it had increased the threshold limit from Rs 1 lakh to Rs 1 crore for defaults under the IBC. One of the requirements under the IBC is that for an applicant to invoke the provisions of the Code with respect to insolvency and/or liquidation, there needs to a minimum amount of default. The threshold limit determines this minimum amount of default beyond which an insolvency proceeding can be triggered under the IBC. Prior to this change, Section 4 of the IBC stated that
"4. Application of this Part. – (1) This Part shall apply to matters relating to the insolvency and liquidation of corporate debtors where the minimum amount of the default is one lakh rupees: Provided that the Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than one crore rupees."
As stated above, the threshold amount has now been increased to Rs. 1 crore and Section 4 of the IBC has accordingly been amended. This increase in the threshold amount for defaults was undertaken with the aim of safeguarding the interests of micro, small, and medium enterprises ("MSMEs"). COVID-19 and the consequential lockdown severely threatened the operations of MSMEs across the country and has led to a fear-mongering of a spike in the defaults by such MSMEs.
The increase in the limit has been brought about with the aim of insulating MSMEs, who face the highest risk of insolvency. While this may be an appreciable step in the direction of helping companies that are being forced into the insolvency proceedings due to disruptions caused by COVID-19, the flipside is the cost borne by operational creditors.
Covid-19 Related Debts Exempted from the Definition of Default
On May 17th, 2020 as part of the Atmanirbhar Bharat package, the Indian Government also announced that all COVID-19 related debt will be excluded from the definition of "default" under the IBC for the purpose of triggering insolvency proceedings. It was also declared that an enabling provision would be part of the ordinance to be notified which would in effect amend the IBC. It was anticipated that the ordinance may define the term COVID-19 related debts.
Suspension of Section 7, Section 9 and Section 10
On March 24th, 2020 Finance Minister, Ms. Nirmala Sitharaman also suggested in her briefing that dependent on the prevailing situation in the country as on April 30th, 2020, the Government may also consider suspending Sections 7, 9 and 10 of IBC for the next six (6) months extendable to one (1) year.
Thereafter, on May 17th, 2020 it was announced that any fresh IBC proceedings would be suspended for one (1) year, a proposal that had been cleared by the Union Cabinet. This was being done by suspension of IBC Sections 7, 9 and 10 which relate to the triggering of insolvency proceedings by a financial creditor, operational creditor, and debtor (voluntary insolvency), respectively. Once again, the change was to be brought about by an ordinance which would have the fine print regarding the suspension.
The Ordinance and its Analysis
On June 5th, 2020, the Ministry of Law and Justice, India notified the ordinance to amend the IBC ("Ordinance"). The Ordinance stated that the COVID-19 pandemic has created uncertainty and stress for businesses beyond their control. Further, the nationwide lockdown had added disruption to normal business operations, as a result of which it was difficult to find adequate number of resolution applicants to rescue a corporate debtor. For these reasons, the Ordinance had been promulgated to suspend fresh insolvency proceedings. A new Section 10A was to be inserted in the IBC. Section 10A was the enabling provision that suspended Sections 7, 9 and 10 of IBC for any default arising on or after March 25th, 2020 for a period of six (6) months. The six (6) month period could be extended further up to an upper cap of one (1) year.
While the Ordinance makes no mention of what debts would be categorized as COVID-19 related debts, the proviso to new Section 10A perpetually prohibits initiation of insolvency proceedings on account of a default committed by an entity during the six (6) month suspension period (or any longer period if the suspension is extended). The Ordinance uses the word 'ever' and states that no application shall ever be filed for initiation of a corporate insolvency resolution process ("CIRP") against a corporate debtor for the said default occurring during the said period six (6) months or extendable up to one (1) year). This raises a vital question as to whether an application to initiate CIRP can be made after the expiry of the suspension period, if the default is a continuing one. It is not made clear whether the corporate debtor will be protected by this proviso regardless of whether the corporate debtor is financially stable. Section 10A does however, clarify that it would not be applicable to any default committed before March 25th, 2020, thereby making the determination of the date of occurrence of the default extremely important.
The new clause overrides sections 7, 9 and 10 of IBC. Section 7 deals with a financial creditor initiating an insolvency action, Section 9 deals with an operational creditor initiating action and Section 10 allows a defaulting company to voluntarily approach the National Company Law Tribunal ("NCLT") to declare itself insolvent. The Ordinance also provides for insertion of Section 66(3) which states that resolution professionals will be barred from initiating a fraudulent trading or wrongful trading application against directors of companies where the IBC process is suspended.
Demand contraction and supply chain disruptions caused due to external variables, namely the nationwide lockdown necessitated by COVID-19, has resulted in several entities defaulting in servicing their debt obligations. The Ordinance aims to shield such entities impacted by the outbreak of COVID-19. The Ordinance may be seen as a laudable move to protect these entities from being driven into insolvency due to such circumstances.
It is to be noted however that the suspension is almost co-terminus with the loan moratorium offered by banks and NBFCs to borrowers, during which a borrower is not obligated to make its scheduled payments. This greatly reduces the chances of the occurrence of a financial default. This would mean that the suspension would not affect creditors who have offered this loan moratorium. Other financial creditors as well as operational creditors will be more significantly impacted by this move. Conversely, the suspension and any extension thereof will increase stressed debts of banks and NBFC as well as balloon liabilities of these institutes and other creditors, thereby paving the way for a potential rise in Non-Performing Assets; which banks in India are already weighed under; post the lockdown.
The Insolvency and Bankruptcy Board of India chief Mr. M S Sahoo, prior to the Ordinance, shared his views on the suspension stating that in the current COVID-19 times, there are not enough 'White Knights' to rescue the firms in distress. He also felt that the IBC announcements were quite significant in the sense that these provide a breathing time to firms to recalibrate their operations and business to an all new normal, while ensuring the continuity of business operations and enabling the debtors and creditors to work out a resolution of their choice and liking. In response to the recourse that is now available to creditors, he stated that the recourse to the IBC was never meant to be the last resort. In his view - nothing stops a debtor and creditor to sit across a table and work out a solution. He further suggested that parties may also work out a solution under the Prudential Framework for Stressed Assets of the Reserve Bank of India or could look to use the route of compromise and arrangement under the Companies Act, 2013.
Along with above reforms that have been discussed, on May 17th, 2020, the Government also announced that a special insolvency resolution framework for small business and MSMEs under Section 240A of the IBC would also be notified soon. Small businesses till now were largely on the same footing as their larger counterparts with respect to the IBC. This framework is still to be notified and remains much awaited by such businesses.
Needless to say, that the suspension of fresh IBC proceeding will decrease the burden of the already overburdened NCLTs. However, with COVID-19 induced insolvencies on the rise and debtor-creditor relations disrupted, suspension of the IBC may well only put such matters on the back burner for the time being or turn the spotlight on other alternate regulations. Creditors may now be required to revisit other viable regulations to enforce and recover their claims. The provisions of the Companies Act, 2013 with respect to compromise and arrangements is one such alternative. Though the provisions have been widely used for mergers, demergers and amalgamations, they have very scarcely been used for debt restructuring and could now be considered. Other such alternate regulations are suits under the Commercial Courts Act, 2016, arbitration proceedings, a summary suit under Order 37 of the Code of Civil Procedure, 1908, Securitsation and Restrucuring of Financial Assets and Enforcement of Security Interest Act, 2002 for secured creditors etc.
The question that remains to be answered is whether this cookie cutter solution will benefit all – an MSME as well as a big corporate, a creditor of entities in the medical or the essential services sector (that have worked through the lockdown) as well as creditors of entities in the automobile sector. Will it benefit MSMEs or be another thorn in the flesh for MSMEs? Are the changes to the IBC, though commendable, just a half-baked solution for the Indian economy or will they provide the desired relief to all?
Ashima Obhan is a Partner and Vrinda Patodia is a Principal Associate at Obhan and Associates. The author's views are personal.