The seemingly low threshold of Rs. 1,00,000 for the initiation of insolvency proceedings has been a persistent concern given the possibility of its exploitation by frivolous actions. While rumours about raising the threshold limit for initiating insolvency process have long been swirling, the recent outbreak of Covid-19 came in as a window for introducing the same. The minimum default requirement now stands increased a hundred times; from Rs. 1,00,000 to Rs. 1,00,00,000.
Applicable from 24 March 2020, the Government of India, in exercise of its powers under section 4 of the Insolvency and Bankruptcy Code, 2016 (“Code”), has specified by way of a notification S.O. 1205(E) (the “Notification”) Rs. 1,00,00,000 (rupees one crore) as the minimum amount of default for the purposes of triggering insolvency. The authors have attempted to analyse its implications from a broader perspective, and consider whether at all such an increase would be welcome in absence of ongoing crises.
Triggering Insolvency: Before and After the Notification
Section 4 of the Code earlier stated that the prima-facie threshold to file any application under the Code was a minimum default of Rs 1,00,000/-. However, the proviso to the section conferred upon the Government the right to alter the said amount at its own discretion. The proviso is ad-verbatim produced below:
“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.”
While this threshold seemed to be creditor-friendly during the nascent stages of the Code, it signalled otherwise, as more and more creditors, mostly operational, dragged companies into insolvency only with a motive of recovery of claims. The amount of Rs. 1,00,000, being a meek sum from a commercial viewpoint, gave the creditors an upper-hand, which was mostly misused. Further, the fact of whether or not an application is filed with the motive of recovery can only be determined after the passage of considerable time and on hearing of the matter by the adjudicating authority. This required that a solution be found. While the present measure has been taken in view of the disruption caused due to the Covid-19 crisis, there may be several issues around it, as we discuss in this post.
Questions Surrounding the Notification
Determining the threshold
According to the explanation to section 7 of the Code, in case of an application by a financial creditor, a default includes a default in respect of a financial debt owed not only to the applicant but to any other financial creditor of the corporate debtor. That is to say, a financial creditor may satisfy the minimal requirement either individually or along with defaulted debts of other financial creditors. In any case, the sum included for meeting the threshold shall include ‘defaulted sums’ only and not otherwise.
However, there is no such leeway for including other creditors’ dues when an operational creditor files an application. Such a creditor is required to meet the threshold individually. Having said that, it is important to note that, owing to the very nature of their dues, it becomes seemingly impractical to expect a single operational creditor to have an outstanding default as high as rupees one crore. The immediate impact of such a high threshold would practically be to undermine the interest of operational creditors which, as a matter of fact, is in contrast to the Code’s objective of balancing various interests.
Here, we seek to analyse the implications of the Notification by means of a series of illustrations.
Illustration 1
XYZ Pvt. Ltd. is a private limited company. It has committed default in repayment of loan of Rs. 2 crores taken from a bank A Ltd. Can another financial creditor B, who is owed Rs. 10 lakhs from XYZ, which is not yet defaulted, file an application against XYZ?
Yes. Section 7(1) of the Code provides that a financial creditor can file application towards its own claims or aggregated claims of financial creditors. Further, the Final Report of the Bankruptcy Law Reforms Committee states:
“5.2.2. …financial creditor must submit a record of default by the entity as recorded in a registered Information Utility (referred to as the IU) as described in Section 4.3 (or on the basis of other evidence). The default can be to any financial creditor to the entity, and not restricted to the creditor who triggers the IRP…” [emphasis added]
Hence, in the given case, creditor B can approach the National Company Law Tribunal (“NCLT”) since XYZ as an entity has defaulted on claims exceeding Rs. 1 crore, and thus satisfied the revised threshold under section 4 of the Code.
Illustration 2
Following from the example above, consider in this case that XYZ Pvt. Ltd. has defaulted to Bank A Rs. 50 lakhs and to other financial creditors a total of Rs. 75 lakhs. Can Bank A still approach the NCLT?
Yes. Section 7(1) of the Code provides that a financial creditor can file an application towards its own claims or aggregated claims of financial creditors. Hence, in accordance with section 7(1) read with section 4, A meets the minimum the threshold.
Illustration 3
Now, consider that XYZ Pvt. Ltd. has defaulted to Bank A Rs. 50 lakhs and owes other financial creditors a total of Rs 75 lakhs, of which Rs. 45 lakhs is defaulted. Can Bank A still approach NCLT?
No. Although section 7(1) allows financial creditors to file claims for aggregated claim, the outstanding claim must be defaulted. In the given case the total defaulted amount is Rs. 95 lakhs and, hence, the requirements of section 4 of the Code are not met. Thus, application cannot be filed.
Illustration 4
In the example above, consider that XYZ Pvt. Ltd. has defaulted to Bank A Rs. 50 lakhs and to other financial creditors a total of Rs. 40 lakhs. Also, the company has defaulted on operational creditors to the extent of Rs. 60 lakhs. Can Bank A still approach the NCLT?
No. While section 7(1) allows financial creditors to file application towards financial debts on an aggregated basis, it must also be noted that it cannot include operational debts in such aggregation. Hence, since in the instant case, the total financial debt is Rs. 90 lakhs, A cannot file an application before NCLT as threshold as per section 4 is not met.
Illustration 5
XYZ also has some operational creditors, viz., M, N and O to the tune of Rs. 20 lakhs, Rs. 1.5 crores and Rs. 85 lakhs respectively.
- Which of the operational creditors can file an application in their individual capacity?
- Can there be an application for combined debt?
Illustration 6
XYZ also has total salaries outstanding to the tune of Rs. 5 crores. However, the dues of no single employee exceeds Rs. 1 crore. Can an employee file an application?
According to the Code, employees fall under the definition of “operational creditors” and, as such, can file an application. Considering that the individual dues owed to a single employee does not exceed 1 crore, an employee cannot file an application against XYZ individually. However, a combined application may be filed by the employees through their representatives.
The question of applicability
While no date for its applicability is explicitly mentioned in the Notification, the authors make the (arguably safe) assumption that the increase shall be applicable from the date of its issue itself, that is, 24 March 2020. However, having said that, the fate of pending cases cannot be ascertained as of now. Where, on one hand, it goes without saying that any application filed henceforth shall meet the increased threshold and those already admitted shall remain unaffected, what would be the status of applications filed but pending admission? In case of operational creditors, another step could exist, i.e., cases in which demand notice has been sent, but application has not been filed.
Where application is pending admission
There are several cases where application has been filed in terms of the earlier thresholds, but the same have not been admitted. In such cases, it may be unfair to propose that such applications shall be disregarded. In this light, readers may recall the recently imposed threshold in applications to be filed by real-estate creditors,[1] provided that the applications pending admission may comply with the revised thresholds within 30 days of amendment. Hence, on similar lines, it may be provided that the applications pending admission be given a 60 days’ window to comply with the revised thresholds, failing which the application shall be deemed to be withdrawn.
Further, in case where the operational creditor has sent a demand notice and application is not yet filed, the intent and tune of the Code seems to imply that the application can be filed only if the revised threshold is met, and not otherwise.
Illustration 7
A, a financial creditor of XYZ filed an application against XYZ for a defaulted loan of Rs. 20 lakhs. The said application was filed prior to the notification. What would be the status of the application?
(a) If the application is filed and admitted prior to the notification?
The application shall remain valid if it was admitted prior to the notification.
(b) If the application is filed, but pending?
We propose that the applicant may be given a rectification window of 60 days to meet the required threshold, failing which it shall be a deemed withdrawal.
Illustration 8
B, an operational creditor of XYZ has only served a demand notice as required under the Code, and is yet to file an application against XYZ for defaulted loan of Rs. 20 lakhs. The demand notice was served prior to the Notification. Can B proceed with the application?
No. Considering that no application had been moved prior to notification, B would not get the benefit of the transitional window, as in case of application pending admission. Considering that B’s dues do not meet the threshold limits, B cannot proceed with the application.
The Fate of Personal Guarantors: A Lack of Harmony?
Now that the provisions with respect to insolvency process against personal guarantors to corporate debtors have come into picture, maintaining harmony between the corporate and individual processes shall be inevitable. While the threshold has been notified for corporate debtors, there has been no such update with regard to the personal guarantors, meaning that the limit has been increased for companies, while applications against personal guarantors can still be filed based on the erstwhile limits, that is, Rs. 1,000.
In such a scenario, since filing of application against the corporate debtor has now become difficult, it may so occur that the burden of the corporate debtor’s creditors has to be borne by the personal guarantors. Hence, there are chances of a possible spike in the number of insolvency proceedings against personal guarantors, which is still in its developing stage. Hence, what is required is a corresponding revision in case of personal guarantors too.
Was this the Need of the Hour?
While the Indian economy is bound to considerable face financial distress due to the recent turbulence in the market due to the worldwide outbreak of Covid-19, was the recent notification at all required? In light of the ongoing crisis, it is only inevitable to recognize that companies are going to go through a rough patch and, hence, it can be reasonably said that the revision of threshold will indeed come as a saviour by small and medium sized companies, vulnerable to the wrath of lenders during these tough times. Further, in light of the present situation, the Government has further proposed a prospective suspension on filing of any fresh application under section 7, 9 or 10, if situation so demands.
However, another question is whether the revision in threshold would have anyway been introduced, whether there exists a crisis or not. As mentioned earlier, the Code has seen a dominance of operational creditors in terms of applications being filed. The latest data suggests that as on 31 December 2019, there are a total 3,312 case filed so far, out of which a whopping 49.21% (1,630) cases have been filed by the operational creditors. This only implies that a significant number of the cases are brought by operational creditors, who naturally have a lower quantum of claims against the corporate debtor as compared to the financial creditors.
With the increase in the default threshold limit, the filing of frivolous applications is expected to be curbed. Therefore, the corporate debtor may remain at peace, at least temporarily, while operational creditors may simultaneously have to bear some financial agony.
– Megha Mittal & Shreya Jain
[1] Introduced vide Insolvency and Bankruptcy Code (Amendment) Bill, 2020
Leaving the admitted cases under CIRP as valid, overlooks the construction of sub section (1) of sec 4. By its immediate operation the notification ousts the Tribunal from is jurisdiction of dealing with the case of corporate debtors where the amount of default is less than one crore rupees..
Sec 4(1) talks of entire Part II of IBC and not just sections 7,9 or 10.
There are no provisions for saving such cases pending at CIRP stage from operation of the notification.
Shall appreciate your views on this angle.