India: Impact of Suspension of Insolvency & Bankruptcy Code, 2016

In a series of announcements, notifications, circulars, and an ordinance, the legislative stakeholders of the insolvency & bankruptcy regime in India have sought to introduce key changes with a view to deal with and contain the financial impact of coronavirus pandemic.

Amongst them, the most prominent and widely debated being - suspension of initiation of fresh corporate insolvency resolution proceedings (CIRPs) for an initial period of six months, extendable up to one year, commencing on 25.03.2020, originated via Press Conference convened by the Union Finance Minister on 17.05.2020 , and since formulized by way of Insolvency & Bankruptcy Code (Amendment) Ordinance, 2020 (the ‘Ordinance’) promulgated on 05.06.2020. This article examines the possible impacts these changes signal on different stakeholders. On one hand, the changes give a safe harbor to the businesses getting financially stressed on a perpetual basis, and on the other, they do not protect them from the long term effects of Covid-19 on the commercial fronts.

I. Positive Impact

The Government of India (GoI) seems to have kept the interests of Micro, Small & Medium Enterprises (MSMEs) on a higher pedestal and in consonance with the Prime Minister’s narrative of ‘vocal for local’. Initially, vide MCA’s Notification No. S.O. 1205(E) dated 28.03.2020 , the threshold of default for triggering the CIRP under Section 4 of the Insolvency & Bankruptcy Code (the ‘IBC’ or ‘Code’) was touched upon by increasing it to Rs. 1 Crore from Rs. 1 Lakh, and the move was subsequently branded as ‘largely insulating MSMEs’ in the said press conference. The NCLT, Kolkata Bench, vide Order dated 20.05.2020 in Foseco India Ltd. vs. Om Boseco Rail Products Limited, interpreted this to have prospective effect, i.e., will only affect the applications filed on or after 24.03.2020.

However, later the Government decided to isolate the MSMEs from the mainstream framework of Insolvency Resolution Process, and introduce a special resolution framework tailored for them under Section 240A of the Code, which is yet to be formulized. Meanwhile, with the blanket suspension of provisions of Sections 7, 9 and 10 of IBC, the Government has taken a far-fetched stance presently shadowing the practical utility of the change in threshold as well as the proposed special MSME framework. Nevertheless, the changes provide a much needed breathing room to the financially distressed businesses for getting back on their feet.

The rationale behind the suspension also traces a push from the performance record of IBC as far as restructuring of businesses is concerned. Since the inception of IBC, amongst the tens of thousands of CIRP applications filed, only a handful witnessed Resolution Plans. As of March 2020, out of the 1,135 CIRPs disposed of, as many as 914 met the unfortunate fate of liquidation. The preamble of the Ordinance acknowledges aptly says that it would be “difficult to find adequate number of resolution applicants to rescue” the stressed Corporate Debtors, especially in light of the overall financial blow that the world economy is undergoing. The measure of suspension, for a time bound period, of the initiating provisions of IBC may well be the knight in shining armor.

Additionally, the Government proposed to take another tremendously important decision, though with a shadowed practical utility, of excluding the COVID-19 related debt from the definition of ‘default’ under Section 3(12) of the Code. However, the question whether the exclusion will cover only those debts which have occurred due to the reasons solely attributable to COVID-19 or will also cover the debts which have arisen owing to restrictions imposed by national laws of both the India and/or other jurisdictions remained open. In any case, suspension of the initiation of CIRPs for the defaults accruing on or after 25.03.2020 till the operation of Section 10A, added by the Ordinance, signifies a blanket exclusion of defaults, whether attributable to COVID-19 or not. The temporary suspension of the Code coupled with a moratorium on classification of businesses as NPAs under the COVID-19 – Regulatory Package by Reserve Bank of India (RBI) , does give a chance to the financially stressed businesses to avail the benefits and infusion of capital under the aegis of ‘Atmanirbhar Bharat Abhiyaan Economic Package’ on one hand, and a perpetual shield from financial persecution under IBC to commercially introspect on the future of their businesses, on the other.

II. Negative Impact

During last three years, IBC has faced a multitude of critics and obstacles, and has even undergone a constitutional challenge. While surviving and overcoming all the hurdles, the Code has revolutionized the insolvency and bankruptcy framework in India, and has essentially acted as a catalyst in substantially changing the borrowers’ and creditors’ behavior. Within a short span of time, the Code is already supplemented by deep rooted jurisprudence, and is being considered by the stakeholders to be moving in the right direction. However, the limited yet blanket suspension of the Code, apart from its potential of disrupting the hard gained momentum of I & B regime, puts it back on multiple fronts by exponential deceleration and is fraught with undesirable consequences. Look at some of these: -

It could cause a set back to the credit culture should the wily corporates having capacity to repay force defaults during the suspension but never be held accountable under the IBC except in cases the lender finds a willful default.

• The suspension will essentially force the financial and operational creditors to resort to remedies outside the Code which are time consuming, thereby kicking their interest further down the lane.

Meanwhile the promoters may resort to manipulations such as siphoning or exiting the business.

• The suspension could also serves as a protection to the directors and partners on S. 66 of the Code which relates to fraudulent transactions done with intent to defraud the creditors.

• On the other hand, some operational creditors may resort to moving the date of “default” by delaying invoices till the end of the suspension period.

• As far as the Personal Guarantors to the Corporate Debtors are concerned, the suspension does not result in exclusion of the ‘default’ per se, but the ‘application for initiation of CIRP for such default against Corporate Debtor’ is excluded. In light thereof, and with the presence of a separate threshold under Section 78 of the Code, the Personal Guarantors have essentially been left behind bleeding in the sea full of sharks. Moreover, the blanket suspension also does not make any sense from a ‘voluntary insolvency’ perspective, as with the suspension of Section 10 of the Code, the already unviable businesses, or those in industries witnessing overwhelming covid-19 setbacks, will be forced to either operate or resort to debt restructuring mechanisms under the [Indian] Companies Act, 2013 or the framework of the RBI. In any case, the fundamental option of closing a business, or effectively restructuring it, will be compromised; leading to major setbacks in terms of overall ease of doing business. Additionally, with no resort to any moratorium under IBC, and the forced operation, it is highly likely that a few defaults by troubled businesses will act as catalysts in triggering the chain of defaults, especially by MSMEs

• Furthermore, the strengthening of professions such as the Insolvency Resolution Professional (IRP) brought in by the IBC framework suffers a setback with even the voluntary insolvencies also suspended.
In light of the aforesaid, putting a halt on the initiation of fresh corporate insolvency resolution proceedings for a substantial period possibly for a year will essentially decelerate the hard gained momentum, and resultantly will put the entire regime on back foot.

III. Steps taken in International Jurisdictions

• Singapore

Unlike India, Singapore has taken a rather situation-tailored approach by introducing the COVID-19 (Temporary Measures) Act 2020 (The ‘Act’). The Act, inter alia, modifies the ‘thresholds’ and ‘statutory limitations’ under the respective legislations dealing with the Corporate Insolvency (vide Sec. 22) and Personal Bankruptcy (Vide Sec. 20), as well as the yet to be enforced Insolvency, Restructuring & Dissolution Act 2018 (vide Sec. 21 & 23). The default threshold modification from S$10,000 to S$100,000 for businesses, and from S$15,000 to S$60,000 for individuals is less pronounced. Also, the statutory limitation for complying with the demand of creditor has been modified from 21 days to 6 months.

Additionally, the underlying premise of ‘default’ is that the non-performance or non-fulfillment of obligations shall be due to reasons owning to the pandemic or any law made because of the pandemic. In the said case, the measures protect both the debtor and its guarantor(s) from the actions of insolvency & bankruptcy.

• United Kingdom

On 28.03.2020, the Business Secretary, Alok Sharma, announced the measures to be taken by the UK Government in insolvency and bankruptcy regime with a view of enabling ‘greater flexibility’ . The primary relaxation has been in terms of suspending the rules relating to ‘wrongful trading’, particularly under Section 214 of the [UK] Insolvency Act, 1986, for an initial period of three months with retrospective effect from 01.03.2020, and subsequently, by an extension on date 14.05.2020 , till 30.06.2020. This move is undertaken to remove the threat of personal liability of the Directors for taking risky decisions for the businesses to combat and contain the financial impact of COVID-19. However, to minimize the scope of wild rides, and strike a proper balance, the laws pertaining to fraudulent trading and director disqualification have been kept intact. In respect of Companies seeking rescue or restructure, the Government announced a short moratorium from the actions of the Creditors. Lastly, an option of new restructuring plan has also been introduced for binding the Creditors for ensuring their payments whilst a solution is sought.

Subsequently, on 20.05.2020, the UK Government introduced the Corporate Insolvency and Governance Bill (the ‘Bill’), which aims to put forth comprehensive changes and measure of temporary nature, to essentially ease the financial and economic difficulties being faced by businesses.

IV. Discussion

In 3 years since its inception, the IBC consolidated the interests of four pillars of corporate restructuring. The Code brought in the “creditor in control” regime. The debtors got the opportunity to restructure their businesses in a legitimate fashion – MSMEs, on whom Section 29A embargo does not apply, to even buy back the business, and larger corporates got the opportunity to either hand over the business to interested parties and let them flourish by way of resolution plan or, in the alternative, participate during the liquidation by furnishing a scheme under Section 240 of the [Indian] Companies Act, 2013, and lending new lease of lives to their businesses themselves. The resolution applicants or the saviors benefitted by acquiring fresh assets and businesses to turn them around. The erstwhile promoters were also benefitted since they had the opportunity to rework their entire credit line by invoking CIRP on themselves under Section 10 of IBC, or in alternative, by proposing a scheme during liquidation. Overall, the Code has improved the credit culture; thereby advancing India’s ranking in the World Banks’ ease of doing business ranking.

However, the mandate of the GoI to prevent the axe of insolvency and bankruptcy from falling on those truly stressed by the pandemic has only led the entire framework of IBC coming to a pause. While the suspension appears as a boon for debtors who face loss of business due to multiple factors including but not limited to the supply and demand mismatch augmented by the disruption due to COVID-19, it also implies unintended set backs to what the Code has so far achieved. The attempt made by the GoI to balance out the situation between the debtors and creditors is falling short of what is truly required; merely by offering a year of protection from restructuring to corporates has failed to address the several challenges faced by the struggling banking sector. The NPA situation has mostly arisen due to the bad credit culture in the country due to absence of promoters’ discipline; this far outweighs genuine business failure.

The increase in threshold of default from Rs. 1 Lakh to Rs. 1 Crore, intended to protect MSME in respect of claims against them, may well be a double edged sword when it comes to claims by them – big corporates might delay their payments. Let us this gets addressed via the special resolution framework now under drafting. Widening the net of MSME Companies is indeed a good move.

V. Conclusion

The Ordinance has kept hopes alive and maybe a change every quarter in the invoking provisions of IBC by reworking sections 7, 9 and 10 to suit the current scenario and challenges faced by the economy as an aftermath of the pandemic will be thought of. Simultaneously, looking deeper into exemptions granted under Section 29A and further relaxation in modalities of Section 240 of [Indian] Companies Act, 2013 would be desirable.
Now, just like the I & B regimes in Singapore and United Kingdom, the Indian Code is capable of flexibility to deal with this unprecedented pandemic. As Injeti Srinivas, the former secretary, ministry of corporate affairs, GoI, says in a recent article, the time is ripe for initiating IBC 2.0 to “incorporate further enhancements such as simplified non-adjudicatory fresh start process (FSP), pre-packs, cross border insolvency and group insolvency”. This will serve the economy well.

Press Information Bureau’s Bulletin on Press Conference by Union Minister of Finance dated 17.05.2020

The Insolvency & Bankruptcy Code (Amendment) Ordinance, 2020 dated 05.06.2020

Notification by Ministry of Corporate Affairs dated 28.03.2020

In CP (IB) No. 1735/KB/2019

COVID-19 – Regulatory Package (Revised) dated 27.03.2020 by RBI

[Singapore] COVID-19 (Temporary Measures) Act, 2020

Common Research Briefings of the House of Commons Library, UK Parliament

Press Release ’Regulations temporarily suspended to fast-track supplies of PPE to NHS staff and protect companies hit by COVID-19’, Government of United Kingdom

Corporate Insolvency & Governance Bill, 2019-2021 before UK Parliament

ABOUT THE AUTHOR: Mr. Aashish Lunia and Mr. Gurdeep Singh Dang
Mr. Aashish Lunia is Deputy Practice Head Surana & Surana International Attorneys

Copyright Surana & Surana International Attorneys

Disclaimer: Every effort has been made to ensure the accuracy of this publication at the time it was written. It is not intended to provide legal advice or suggest a guaranteed outcome as individual situations will differ and the law may have changed since publication. Readers considering legal action should consult with an experienced lawyer to understand current laws they may affect a case. For specific technical or legal advice on the information provided and related topics, please contact the author.

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