[Rongeet Poddar is a graduate of West Bengal National University of Juridical Sciences and Sayak Banerjee a 3rd year student at National Law University, Jodhpur]
The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 was promulgated on June 5, 2020 and came into force immediately. The amendment acknowledges that the Covid-19 pandemic has harmed businesses around the world following a demand deficit in the economy. The amendment to the Insolvency and Bankruptcy Code, 2016 (“IBC”) is the culmination of several structural reforms in response to the volatile environment. On March 24, 2020, the minimum amount for default under section 4 of the IBC was raised to one crore rupees from the prior threshold of one lakh. Regulation 40C was subsequently introduced in the Insolvency and Bankruptcy Board of India (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (the “IBBI Regulations”) to exempt the period of lockdown following Covid-19 from being considered under the timelines prescribed in the IBC in relation to a corporate insolvency resolution process (“CIRP”). Furthermore, regulation 47A was inserted to the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 to provide a similar exemption of the lockdown period in relation to the timelines prescribed under the liquidation process.
The Reserve Bank of India (“RBI”) has instituted a Covid-19 regulatory package to mitigate the burden on companies to servicing outstanding debts. Lending institutions have been provided with the leeway to grant a three-month moratorium in respect for all term loans on the payment of instalments which are due between March 1, 2020 and May 31, 2020. The moratorium has been further extended by another three months. However, the RBI has added that the interest would continue to accrue on the term loans and be required to be paid at the end of the moratorium period.
Debtors appear to be concerned by the burden of accumulated interest, especially with the payment of EMIs. Petitions have been filed to seek the Supreme Court’s intervention on this issue. The RBI has announced that the 90-day non-performing asset (NPA) norm would also exclude the moratorium period. The emphasis on additional provisioning under the RBI’s prudential framework on the resolution of stressed assets dated June 7, 2019 is likely to contribute to low credit growth due to delayed implementation of resolution plans. Subsequently, the impact will be felt by bondholders or companies taking inter-company loans for investment purposes as they would be left in the lurch.
Addition of section 10A and section 66(3)
Section 10A has been inserted into the IBC by the Ordinance. It provides for a blanket suspension of the initiation of CIRP for ‘any default arising on or after March 25, 2020 for six months or such further period, not exceeding one year from such date’. The safe-harbour clause can be extended further upto a year. Financial creditors or operational creditors cannot file for CIRP initiation under sections 7 and 9 of the IBC respectively during the period. The corporate debtor also cannot initiate a CIRP under section 10. An explanation to section 10A clarifies that it will not have any application for default committed by the company before March 25, 2020.
Furthermore, subsection (3) has been added to section 66 of the IBC. Section 66 (2) of the IBC imposes a liability on the director or partner of the corporate debtor to contribute to the debtor’s assets on an application initiated by the resolution professional if they carried on business with the wilful intent of defrauding creditors or did not exercise requisite due diligence before the commencement of insolvency. The addition of sub-section (3) insulates the director or partner from liability in the event of such default when the CIRP is suspended under Section 10A.
Scope for ambiguities
The recent amendment to the IBC appears to have been made in haste to safeguard businesses. It suffers from glaring ambiguities. While it may be clear that the period of suspension begins from the commencement of lockdown period, i.e. March 25, 2020, it fails to take into account continuing defaults that may have arisen initially before the lockdown date and can be attributed to the impact of the pandemic. Likewise, certain defaults may have arisen during the lockdown period and continued beyond the period of suspension. In the latter scenario, the language of the provision can be reasonably construed in favour of the corporate debtor.
The impunity offered to debtors under the ordinance appears to be counter-productive. In the absence of an obligation to demonstrate a material adverse effect of the pandemic, promoters of companies are likely to take advantage of the amendment to evade their obligations even when a possible default has no reasonable nexus to the pandemic. The goal of the IBC to ensure resolution of debts in a time-bound manner would thus suffer a setback. Interestingly, the Ordinance ignores the plight of personal guarantors and leaves scope for initiation of CIRP against them. Critics have highlighted that blanket suspension of CIRP may not spur economic revival following the pandemic.
Restriction on borrower autonomy
The Ordinance revokes the autonomy of the distressed company to restructure its debt. It can no longer seek the initiation of a CIRP to resolve their debts under section 10 during the exemption period and make a fresh start. The amendment negates the objective of the IBC to offer an exit-route to struggling debtors by obstructing the existing market-mechanism under its ambit. The spiral of inefficient utilization of resources would continue and companies would continue to bleed in the absence of an alternative rescue mechanism.
The creditors can no longer pursue a resolution plan that results in maximization of asset value. Lending institutions would be forced to absorb the shock as time-bound debt resolution becomes improbable. Instead, it would have been fruitful to amend the definition of default to exclude lockdown-related debt obligations from its purview and retain the operation of section 10 of the IBC. The amendment is thus likely to facilitate the abuse of the resolution system.
Impunity for fraudulent conduct
The addition of section 66(3) also appears to be ill-conceived. The management of the corporate debtor is safeguarded from the consequences of their deliberate acts of transgression. The pandemic must not be construed as a blanket defence for fraudulent conduct. It is quite likely that the culpability of the borrower’s management may be independent of the unique challenges posed by the pandemic. The adoption of such a sweeping relaxation is therefore fallacious and is likely to encourage the wilful accumulation of debts. In fact, the predilections of the management to siphon off company resources or manipulate the books of account may further lead to the diminution of asset value and deprive creditors in the process. The pandemic calls for an enhanced standard of corporate governance to limit financial chicanery.
Alternative route under company law
The suspension of IBC is expected to alter the resolution landscape with the exploration of alternatives. Creditors outside the scope of the RBI moratorium would be deprived of the opportunity to invoke IBC and seek resolution of debts. The banks and non-banking finance companies (“NBFCs”) which had utilized the moratorium will not be impacted. Corporate restructuring schemes under the Companies Act, 2013 offer a feasible alternative. Unlike the IBC, it is an example of a ‘debtor-in-possession’ model of resolution.
The approval percentage by creditors needs to be attested with a written creditor responsibility statement. Such a collective process has the potential to be effective and value-oriented and is monitored by judicial oversight. However, the absence of an automatic moratorium leaves scope for enforcement of security by the creditors. Furthermore, the 75% approval threshold from classes of creditors and shareholders is onerous to fulfill. The National Company Law Tribunal (NCLT) should be afforded the power to dispense with the meetings of shareholders to exclude those having no economic interest in the schemes such that they do not hold the restructuring process to a ransom. The NCLT can also dispense with any post-filing meetings of creditors, to increase the effectiveness and speedy disposal of cases such that there is no substantial erosion in asset value. The other alternatives for debt recovery such as summary suits under ordinary civil procedure or special laws such as the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 or the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 also continue to be in vogue.
The way forward: Pre-packs
Pre-pack insolvency can be explored as a feasible option during the period of disruption when the company does not have the necessary leverage to maintain itself as a going concern. It offers scope for an out-of-court debt restructuring with the suspension of the formal insolvency route. Experts have pointed out that the introduction of a streamlined framework for pre-pack resolutions could be supplemented by a temporary dilution of section 29A of the IBC. The objective of section 29A was to prevent promoters or related parties from submitting a resolution plan to re-acquire their business at discounted value when they had failed to service debt obligations in the first place and contributed to the default.
The company may already be reeling from economic losses in the aftermath of the pandemic without the promoter’s ostensibly incapable intervention. A short-term immunity offered to promoters or related parties in the event of pre-pack insolvency to participate in the resolution process has to be strictly attributed to the pandemic and verified by the adjudicating authority. However, the effectiveness of pre-packs can be compromised by concerns of a lack of transparency as the management retains control over the debtor company. Thus, the committee of creditors and the adjudicating authority must be empowered to maintain oversight to ensure that there is no overvaluation of assets or fraudulent conduct.
Prospect for MSMEs
The increase in the minimum insolvency threshold is expected to offer relief to MSMEs in the immediate future while the resolution of stressed firms will have to take a backseat. The Insolvency and Bankruptcy Board of India’s data from March 2020 suggests that insolvency proceedings were pending mostly against MSMEs. The Finance Minister had also announced a stimulus package as a subordinate debt scheme for promoters of stressed MSMEs. It implies that banks would have to ensure higher provisioning.
As a consequence of the IBC amendment, MSMEs cannot invoke section 9 as operational creditors even if the default breaches the increased threshold. Thus, the MSME sector remains susceptible to wilful non-payment by their debtors. A parallel regime of debt resolution must be explored in this regard. The MSMEs already enjoy the benefit of exemption under section 29A of the IBC. It remains to be seen whether a sui generis insolvency resolution framework for MSMEs would be introduced as a pre-packaged mechanism under section 240A of the IBC. It would allow timely resolution of debts at reduced costs.
– Rongeet Poddar & Sayak Banerjee