This article is written by Priyanshu Agarwal and Vaishnavi Vyas, students of NMIMS KPM School of Law, Mumbai. In this article, the authors have explained the reasons for the suspension of Bankruptcy Code in India.
The Insolvency and the Bankruptcy Code, 2016 (“IBC”) was introduced with an objective to accelerate the winding up process of the company by taking into consideration the interests of all the stakeholders vis-a-vis finding the most efficient resolutions for the stressed assets. Primarily, it enhanced the credit culture in India by shifting the controlling power from debtors to creditors. However, owing to Covid-19 and persistent economic fallout, the Ministry of Finance announced major reform to the IBC by suspending Section 7, 9 and 10 for six months (extendable to one year) which triggers the insolvency proceedings against the defaulters. Effectively, it indicates that no new insolvency applications shall be filed before National Company Law Tribunal (NCLT) for the stipulated time period. Secondly, it has been notified to exclude Covid-19 defaults from the ambit of IBC. Lastly, in order to insulate the Micro, Small and Medium Enterprises (MSME) sector, the Centre has proposed to establish a special insolvency framework under Section 240A of IBC. In lieu of the same, the minimum threshold to initiate insolvency proceedings against MSME has been increased to INR 1 crore from the existing INR 1 lakh. This has been done to prevent the storm of insolvency proceedings caused due to economic distress on account of pandemic. Additionally, a collateral free automatic loan worth Rs. 3 lakh crore has been announced as part of the economic stimulus package for MSME’s.
Although the changes would allow various debt ridden and financially fragile companies to revive themselves, the consequences of the same are surely not measured satisfactorily. Subsequent amendments and developments to IBC have been vaguely put forth and may not be able to guard the interests of the stakeholders in long run.
Flattening the Bankruptcy Code: Key Issues and Challenges
In pursuance of the announcement, an ordinance has been issued by the Ministry of Law & Justice on 05th June, 2020, and the same is effective immediately, allowing the government to extend the suspension up to one year. The ordinance surely fills many dents left by the announcement. Furthermore, the banking sector has welcomed the suspension of IBC as it is anticipated that companies would take longer time to heal form the economic blow caused due to Covid-19.
The key clarifications that the ordinance has brought is regarding the enforcement of the suspension. It makes it crystal clear that the suspension stands effective from 05th June, 2020 for a period of six months (extendible up to one year). Additionally, on the point of uncertainty with respect to the application of suspension, the ordinance elucidates that it shall be applicable to any default accruing on or after 25th March, 2020, keeping the pre pandemic insolvency proceedings outside its ambit.
These amplifications were very necessary and awaited post the announcement of economic stimulus package. However, the ordinance failed to address some significant issues which needed definite answers. It is uncertain on whether it will apply to cases where the default has accrued during suspension and continues beyond the disruption period. Further the explanation appended to Section 10A could be proven troublesome in the cases where the default has accrued before 25th March, 2020 and the debtor has been unable to generate the revenue in subsequent six months due to economic impact of the lockdown. In such cases, debtor would not qualify for an exemption under ordinance neither can he take the defence of economic duress. There is no justification on date of enforcement of such suspension. Hence, the true purpose of ordinance may be lost for the corporates/ entities committing default prior to initiation of Lockdown.
Moreover, suspension of Section 10 of IBC falls short of justifications. Primarily, section 10 affords an opportunity to the company/individuals to initiate a CIRP against itself in cases of irreparable economic distress. In such a scenario, when the management is itself in favour of resolution through IBC, any delay will only further depreciate the condition of the Corporate. Furthermore, introduction of Section 10A shifts the system to a debtor in control from a creditor in control regime which is very risky and can act counter-productive in solving India’s economic catastrophe. The IBC’s basic feature of a creditor driven mechanism is defeated due to this. It may take us back to the pre-insolvency era. Lastly, the phrase Covid-19 default has not been defined adequately and thus leaves a vagueness to its meaning. The exclusion of aforesaid phrase from the definition of ‘default’ casts a doubt if the benefits of the same can be reaped after the suspension is lifted. Surprisingly, the language of the ordinance reflects that in case the debtor does not regularise the default post the expiry of the six months’ periods, the creditor will never be able to initiate insolvency proceedings against such debtor. The ordinance may certainly lead to rise in host of new litigations on the issue of “date of default”. In light of such glaring issues it is imperative that the Ordinance provides clarity on the mode of restructuring transaction during the period of suspension.
Further, the amendments will have a deep impact on MSME’s. This sector has been distressed time and again by policies-such as demonetization, change in taxation regime. etc. which limits its business capabilities. Hence, it is not just in deep misery but also heavily indebted. Offering them more loans will further add to their debt problems and such lending’s might be used by the banks as a way to funnel out the money back to themselves to bail out the bad loans they have already given in the past. Additionally, the special insolvency framework u/s 240A is yet to be decided and raises concerns as the objective to bifurcate insolvency proceedings for MSME companies from that of Non-MSME’s is unclear. The provision is a toothless tiger which leaves the fate of MSME’s to be decided by the Centre. Such developments are neither healing the sector nor do they prove beneficial to the economy.
The absolute suspension of IBC without any alternative tool is an inadequate solution to redress the economic emergency caused by the pandemic. Likewise, the leverage offered to MSME’s without a restructuring mechanism digs a grave for itself and does not achieve the envisioned goal.
Though the intention behind amending IBC is to protect the corporate houses and individuals from the heat of pandemic, removing the inconsistent anomalies would be desirable to achieve the desirable objective. The ordinance is surely a ray of light for the entire country but it still leaves the nation in darkness due to its vague and irrational explanations.
Consequential Effects of Suspending IBC- Reviewing Alternative Mechanisms
The challenges posed by the outbreak of Covid-19 pandemic are immeasurable and unprecedented. The suspension of IBC is an undisputed move as the businesses across the globe are being disrupted massively. However, the government must supplement such suspension by concurrently strengthening alternative means of resolution.
Pre-pack arrangement is one of the substantial alternative tool. It is a deal whereby a stressed corporate, its potential buyer and creditors enter into an Inter-Creditor Agreement to negotiate the sale of all or part of the business, or draft a restructuring plan to resolve the debt crisis. Once a proposal is finalized, it is presented to NCLT for approval. The NCLT stamps the Resolution Plan after being satisfied that the same is just and fair. This guarantees a speedier and a mutually agreed resolution without any interference of the administrators to facilitate the process. With the current pandemic causing mayhem in the corporate sector, a well implemented pre-package deal would lead to smoother resolution plans, foster growth and ensure creditors receive their dues, thus yielding fruitful results.
A stressed asset management vertical by setting up of a structure similar to Bad Bank might act as necessary evil to resolve this crisis. The idea of a Bad bank is to clean up the pending debts of a financial institution by separating the NPA’s from the performing assets of the regular bank. While the stressed assets are offloaded into a bad bank (and further liquidated), the regular banks are recapitalized and are able to improve their normal course of business. Bad Banks have indeed evidenced as a successful instrument to restructure, recapitalize and recover the bad loans by liquidating across the world, and therefore establishing a proper Public-Private Funded Bad Bank during blanket suspension of IBC might be a blessing in disguise to reenergize the Indian economy.
RBI’s Stressed Asset Management Framework
The other substitute to IBC can be debt restructuring through bank led resolution process. The Reserve Bank of India (RBI) issued a Prudential Framework for Stressed Assets (through its June 7, 2019 circular) which allowed lending banks to attempt a resolution mechanism before filing for a formal insolvency proceeding. This shall ensure resolution at a bank level and prove a crucial tool in the absence of IBC. However, the circular only includes RBI- regulated creditors and therefore a revised framework which covers all forms of creditors is required.
Asset Trading Platform
A framework on Asset Trading Platform can be created as the same shall act as a secondary market for distressed assets and will enable mobility and greater price for such assets. It will also assist banks to offload large exposures and creates an exchange for trading troubled companies. It is noteworthy that such platforms are widely advocated in most of the developed countries.
Companies Act, 2013
Debt restructuring scheme u/s 230 of the Companies Act is as powerful as IBC. It allows a company undergoing liquidation to present the application before NCLT seeking approval for schemes of arrangement and compromise. Since section 10 of IBC has been suspended, distressed companies can channelize the liquidation proceeding under Companies Act. The extant law has been utilized for successfully restructuring companies across various jurisdictions. However, in order to be effective in present times, Section 230 will require certain modifications. Among other things, it would be ideal to reduce the existing time frame of liquidation process for a speedy resolution.
Traditional Resolution Mechanisms
While the IBC stands suspended, the creditors may adopt filing of suits under Commercials Courts Act, 2016 which would provide for a time bound resolution. Furthermore, instituting summary suits under Order 37 of CPC, 1908 and initiation of Arbitration proceedings will also aid the creditors in enforcing their claims. Lastly, in cases of secured liabilities and debt the creditor may chose to invoke the SARFAESI Act. Hence, the alternative remedies will ensure that rights of a creditor are fully realised.
MSMED Act- Relief for MSME’s
MSME’s have been targeted by the Government for number of years and massive cash flow has been injected into this sector. However, the same has always resulted into increased bad loans. The pandemic has even deteriorated the condition of the same. Therefore, a mechanism to restructure the debt ridden MSME’s needs to be created. Owing to the suspension of Section 7, 9 and 10 of IBC, the allied industries may take recourse under the MSMED Act, 2016 as it provides a mechanism for speedy resolution and temporary relief for recovery of dues. Given the situation, it will be prudent that MSME’s avail the benefits of extant legislation.
The ordinance passed by the Union Law Ministry is a half-baked solution to counter the economic crisis faced by the economy and thereby fails to achieve the intended success. Besides, it also threatens to undo India’s progress achieved by installing IBC regulatory framework in the past few years. The financial strain posed by the pandemic is extremely devastating and may flush out corporate entities out of business by the end of stipulated time period. Furthermore, the ambiguity surrounding the definition of covid-19 default and provisions of the ordinance has been left to judicial interpretation. Hence, in order to prevent deluge of insolvency proceedings post lockdown, it is imperative to establish a robust and holistic alternative debt restructuring mechanism to tackle the current economic catastrophe.
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