UK’s Corporate Insolvency and Governance Bill, 2020: A Model for India?

[Apurva Vats and Vishal Bijlani are 2nd and 3rd year students respectively of National Law University Odisha]

In the midst of a global pandemic, several nations have been working towards enhancing their insolvency regimes to mitigate the current situation. The Corporate Insolvency and Governance Bill published by the UK Government on 20 May 2020 is expected to be enacted as soon as possible if government indications are to be believed. The Bill is highly anticipated by businesses and insolvency practitioners alike as it forms the centerpiece to the UK’s post-pandemic business strategy. It contains both temporary measures to diminish the effects of COVID-19 as well as permanent measures that have been in the works for a long time but suffered delays due to Brexit. While the UK brings in big reforms to prevent the tsunami of insolvencies that have been predicted, the President of India has also promulgated the Insolvency AndBankruptcy Code (Amendment) Ordinance, 2020on 5 June 2020. Preceding the Ordinance was a slew of temporary changes to the Insolvency and Bankruptcy Code, 2016 (IBC), the two most notable being (i) raising the threshold for triggering IBC proceedings from Rs. 1 lakh to Rs. 1 crore, and (ii) the suspension of fresh insolvency proceedings for up to one year, providing relief to companies facing insolvency due to force majeure defaults.

The present post aims at examining the key components of the UK Bill alongside the corresponding measures taken by the Indian Government during this pandemic. The authors analyze the categorical approach adopted by the Bill. They suggest alternative measures that India could take that would help relieve companies on the verge of insolvency without adding pressure on the already stressed banking sector.

Permanent Changes

Moratorium

In arguably one of the most significant measures introduced by the UK Bill, an eligible company (as defined under schedule ZA1 of the Bill) may obtain a moratorium by filing relevant documents with the court. The documents include a statement given by the directors of the company as well as the appointed monitor who is an insolvency practitioner that the company is or will soon be insolvent, and that the moratorium is a necessary aid for the company to keep functioning as a going concern. The court, once satisfied, will grant the struggling entity a 20-day holiday period, extendable up to a year or more, from its pre-moratorium debts.

The authors suggest that India too, should follow the UK’s example and should look for practical solutions such as a forbearing approach to classifying assets instead of imposing a one-year blanket ban on fresh insolvency proceedings. Worse, defaults occurring subsequent to 25 March 2020 have been exempted from IBC proceedings, permanently giving willful defaulters an opportunity to circumvent the system. Moreover, the Reserve Bank of India (RBI) has extended the moratorium on loans by six months. It seems a precarious idea, as the pandemic may turn out to be a longer affair.

Restructuring Plan

Similar to the existing scheme of arrangement in the UK, a distressed company may choose to restructure its assets and liabilities conjointly with its members and creditors by proposing a restructuring plan under this procedure. The proposed plan will require the approval of a minimum of 75 percent of creditors from each class. The approved plan would be binding on both secured and unsecured creditors, with the court having the power to ‘cram-down’ on dissenting classes of creditors (in opposition to minorities within the class).

The authors appreciate the Indian Government’s move to allow conversion of working capital borrowings into funded-interest term loan (FITL), providing much needed relief to small and medium sized companies. However, small aids such as these feel utterly inadequate when compared to mammoth relief providers like pre-pack sales. A blanket ban on the IBC without any substitute measure in place is a recipe for widespread confusion. It is high time that the Indian Government seriously consider bringing in a pre-pack regime in these extraordinary times. Alternatively, companies in distress should be advised to go for debt restructuring under chapter XV of Companies Act, 2013.

Supplier Termination Contract

COVID-19 has affected the chain of supply and has led to individuals as well as companies approaching the courts for retracting their contractual obligations. To counteract the arising situation, the UK Bill introduces certain changes to the application of termination clauses in supply contracts. According to the Bill, once an insolvency or a restructuring proceeding is initiated against a company, the suppliers of that company would not be able to invoke the termination clause or novate the terms of supply by varying the payment, quantity or quality. Additionally, while the supplier is entitled to receive monthly payments for the services provided during the moratorium from the customer, it cannot recover the outstanding due.

This equips the distressed company with tools to sail through the revival process, thereby increasing the odds of surviving in a recession-hit market. The creditors benefit since either the company survives and the whole debt is recovered or the company is sold as a going concern, thus recovering a substantial amount of debt via the resolution plan passed by the adjudicating authority.

The IBC under section 14(2) provides for an exception to the moratorium by allowing the inflow of ‘essential goods or services’ to the corporate debtor during the insolvency process. The scope of ‘essential goods’ has been a point of contention for a long time, affecting the revival of a corporate debtor. In the times of a global pandemic, the pressure on such corporate debtor increases with the business being affected due to non-completion of the contracts because of the suppliers reneging on their commitments. At this point, the legislature needs to step up and consider making amendments to suspend the supplier termination clauses in India as well, keeping in mind the best interests of the parties and the impact on the economy.

Temporary Changes

Statutory demands

The initiation of fresh insolvency proceedings is barred if the ground for initiating such a proceeding is the company’s inability to meet statutory demands. The aim is to safeguard entities already suffering due to the pandemic and, hence, no petition can be filed in the UK on or after 27 April 2020. Further, a winding up petition cannot be filed unless there are ‘reasonable grounds’ substantiated by the creditor namely, that the COVID-19 situation has not had a ‘financial effect’ on the corporate debtor’s company and the business has not been directly or indirectly hampered otherwise. Although the Bill does not provide an explanation with regard to the ambit of a ‘financial effect’, the same has to be interpreted on a case-to-case basis.

The Indian Government, on the other hand, has inserted section 10A in the Code. It states that no new corporate insolvency resolution process (CIRP) will be initiated for defaults occurring after March 25 for six months, extendable up to a year. Further, COVID-19 related defaults are exempted from the IBC permanently. This move is discriminatory towards those creditors who do not come under the RBI moratorium, as it gives willful defaulters an opportunity to dodge the system. In addition, businesses wishing to resolve their debts voluntarily would be unable to do so as section 10 stands suspended. This defeats the very purpose of the amendment, which was to protect corporate persons experiencing distress due to the pandemic and prevent them from going insolvent.

A categorical approach needs to be adopted by introducing provisions in the IBC that differentiate between companies seriously affected by the pandemic and those that are not. This will provide a fair ground to affected entities helping them survive in the market, while also being non-discriminatory to the creditors of the company.

Suspension of wrongful trading

The market disruptions caused by COVID-19 and its uncertain continuance has put company directors on the front line. They have been tirelessly trying to keep the wheels of their businesses running by taking adequate short-term and long-term measures to survive and mitigate losses. To their relief, the Bill suspends wrongful trading with a retrospective application starting 1 March 2020 until 30 June 2020. This provision empowers the court to assume that a director is not liable for the worsening of the company’s financial or commercial standing during the said period. The power is restricted exclusively to wrongful trading offences and, hence, the director would still be liable to perform other duties as expected to lawfully run a company. The provision, however, does not provide clarification on whether the assumption can be challenged or the grounds to substantiate such assumption by the court, thus leaving a loose end for further discussion over the same.

The Ordinance in India has inserted sub-section (3) to section 66. It suspends a resolution professional’s right to file an application for wrongful trading if the initiation of such CIRP is suspended under section 10A. The legislative intent behind the insertion of section 66(3) in the IBC, as well as the UK Bill, is not clear: how does a scenario arising out of the pandemic justify the act of fraudulent or wrongful trading during the period for which initiation of CIRP remains suspended?

Conclusion

The uncertainties surrounding the economy warrant a more fundamental change in the IBC than inserting section 10A in the IBC. The authors argue that this move will only result in an increased number of non-performing assets, with the creditors being left with no possible way to recover their money. Taking into consideration the UK Bill, India could implement a series of similar measures such as pre-packs, forbearance to classification of assets, differentiating COVID-19 related debt from overall debt and selective restructuring, thus finding a way to work along with the existing provisions in the IBC.

Apurva Vats & Vishal Bijlani

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