This article is written by Amay Bahri who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho.
On 25th March 2020, the government introduced an amendment to the Insolvency and Bankruptcy Code 2016 (hereinafter “IBC” or the “code”) in form of the introduction of section 10A to the code. This amendment was introduced in light of the heavy burden faced by businesses due to COVID-19 and governmental lockdowns. This amendment has barred any fresh filing of insolvency applications under sections 7, 9, and 10 of the code; and has further added that any COVID-19 related debts incurred during this period would not be used to trigger insolvency. The aim of such efforts is to ease the pressure on businesses so that they are not forced into insolvency for failure to discharge debts in times of such great uncertainty and stress surroundings. Even with such noble intentions, the amendment does not do much to relieve businesses of their plight. The amendment lacks foresight and clarity which are essential to any law, and such circumstances have raised a lot of uncertainties and impracticalities for businesses that need to be resolved at the earliest.
Suspension of Section 10 of the IBC
Firstly, one of the major flaws with the amendment is the suspension of section 10. Section 10 allows struggling companies to undergo voluntary insolvency and take the benefit of the moratorium period to reduce its liabilities and also ensure maximum benefit to all shareholders. COVID-19 has caused unprecedented effects to businesses and has put them in a tough spot with impacted demand and supply chain. Further, the effects of this pandemic will be felt for a prolonged duration, thus businesses have to reassess their viability considering such exceptional change in circumstances. In such situations where businesses may no longer be considered viable or have suffered irreparable damage due to COVID-19, they should be allowed to use the remedy of voluntary insolvency and take the benefit of a moratorium.
This would be beneficial for all the stakeholders as it would help in maximizing the valuation of the company. By closing the door on insolvency proceedings on such debt, other avenues in the form of summary winding up will be a route available, however summary winding up under section 361 of Companies Act 2013 is not available to all companies. A joint reading of section 361 of Companies Act 2013 and the Companies (Winding up) Rules, 2020 would show that for summary liquidation, the company shall have book value of assets less than INR 1 crore, and as per the latest audited balance sheet the company should have a turnover of upto INR 50 crores, or the paid up share capital should not be more than INR 1 crores, or loans should not exceed INR 50 lakh, or in case of deposits the total outstanding deposits should not exceed INR 25 Lakhs.
Thus, we see that this procedure is not open to all forms of companies and are usually used by start-ups and MSMEs because they fulfil this criterion. Further with the introduction of IBC, voluntary winding-up under chapter XX of Companies Act was shifted to IBC, thus now even that recourse of winding up is not available to the debtor. Through the introduction of section 10A, the government has taken away a crucial avenue that would have ordinarily been available for establishments, and they are now forced to continue operations and face further losses, as well as leave the assets of the business open to litigation. M. S. Sahoo, the IBBI Chairman, when explaining the IBC had said that “insolvency law provides a new lifeline for stressed companies to save them from premature death”; however, the present amendment has ensured that stressed entities do not have recourse to save themselves. In addition to this, the amendment even fails to fulfill the primary objective of reducing the burden on the debtor as it is only applicable to insolvency proceedings.
This means a business will not be forced to undergo insolvency, but any claims or other proceeding apart from insolvency can be instituted against the business in civil courts. Though business will continue to operate at subpar levels, the creditors would be able to claim recovery of the debt amount, even if such sum is a COVID-19 related debt. Thus, such an amendment only to the insolvency code is not going to reduce the burden for struggling businesses in such testing and unpredictable times.
Personal Guarantors still vulnerable
The amendment creates additional problems for the directors and promoters of the business because usually they are the personal guarantors to debts of the corporates. The introduction of section 10A has put a temporary stop to Corporate Insolvency Resolution Process; however, one major aspect that the Ordinance fails to address is that it does not cover insolvency applications against a personal guarantor. By the notification in 2019, the Part III of the Code was notified, which permitted institution of Insolvency against personal guarantors. Further, it has been clarified that the Insolvency Law Committee in its Report of 2020 that Section 5 applies to Part-II exclusively; hence, the suspension of CIRP vide section 10A only applies to Part II.
In addition to this, it has also been clarified by the Chairman of the IBBI that the suspension by the 2020 Ordinance applies only to CIRP. Therefore it is clear that section 10A does not apply to insolvency instituted against personal guarantors. There does not seem to be any reasonable explanation for this error by IBBI because the financial struggles that a Corporate is facing due to the pandemic are also faced by individual guarantors. The pandemic has invariably had a drastic impact on the finances of individuals, which has put them in a position to default on their guarantees. With these factors, only suspending insolvency against corporates and not individuals, is an enormous shortcoming of the Ordinance. It is a well-established principle under contract law that the liability of a guarantor and that of a debtor are co-extensive. This means that the creditor has an option of approaching either of them for recovery in no particular order, and the creditors can claim the amount from the guarantor before proceeding against the debtor itself. This is a cause of unease for personal guarantors because unlimited liability is attached to personal guarantors, unless contracted otherwise. Hence, the personal guarantors remain vulnerable due to introduction of section 10A.
Complete Immunity from COVID related debt
Finally, the amendment in its language is extremely unclear, which has triggered a lot of panic amongst the creditors. The amendment lays down that no application for initiation of CIRP shall ever be filed for defaults occurring during the pandemic period. A literal reading of it would mean that an application to initiate CIRP for defaults occurring during such period would not be entertained, even after the one year period from the effective date of the amendment. This would essentially clear the debtor of these debts and would be prejudicial to the interests of the creditors. Although other remedies are available for recovery of the amount, still an effective avenue of initiating insolvency proceedings seems to have been ruled out indefinitely. Without any clarification to this effect, once the period of suspension is lifted, this provision will cause a lot of unnecessary litigation.
This amendment is only a half-baked measure and needs to be fine-tuned to have any substantial effect. When something is half baked, it generally misses an integral ingredient in its preparation. The 2020 Ordinance is a similar bake where it fails to provide complete protection during these unparalleled times of COVID-19. The Ordinance of barring initiation of fresh CIRP under section 7 and 9 is a welcome step to protect stressed businesses from being forced to undergo insolvency; however, barring recourse to section 10 of the IBC is detrimental to businesses and goes against the explicit intentions of asset maximization mentioned in the preamble of the Code.
Further, the Ordinance neglects the plight of the personal guarantors as they are left open to abuse of the Code and are not given any protection. A case has been filed challenging the Ordinance; however, as explained above, section 10 is not the only issue with the amendment; there are other issues as well that have to be tackled by the legislature by way of further amendment or clarification.
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