Suspension of IBC Sections in Pandemic: An Attempt to Vaccinate the Corporate Debtors
Introduction:
The fundamental purpose of the IBC code is to introduce a systematic code to consolidate the laws relating to the reorganizing and insolvencies of the companies. The objective of the code is to introduce a system that brings the various business on a viable track and to ensure that such companies repay their debts very efficiently.[1]
The present economic slowdown accompanied by Covid-19 has thrown at us various challenges and difficulties, which are very imagined in the history of Insolvency laws. The slowdown has initiated a huge crisis in the industrial world and has created a panic situation among the investors as well as promoters. The situation is getting more worst with the passage of time in this economic slowdown. Various top minds, as well as organizations, have proposed to implement certain relief mechanisms in order to save the collapsing economy. [2] In lieu of such predictions, the suspension of IBC sections for a particular period of time has brought a great extent of relief to the minds of affected parties as well as concerns for the other half. This suspension prohibits the initiation of fresh insolvency proceedings against a company, during this period of economic suspension. It is an attempt to save the corporate debtor from the spectra of IBC laws, who is already suffering at great length in the present situation. This step would also help in reducing the burden of pendency from already overburdened NLCT. However, this step may backfire as there would be a flood of IBC proceedings in front of NCLT once the situation is brought back to normal.
This move would provide great relief for a short span of time, but its long term effect is never imaginable and may prove very lethal for the industrial world and other transactions functioning during and after the Covid-19.[3]
Insolvency and Bankruptcy (Amendment) Act, 2020
A global pandemic that leads to the closure of worldwide commercial activity, has literally broken the spine of the business world. Various enterprises were shut down due to a huge amount of insolvency. Small and medium-sized enterprises were also not spared. There were many enterprises that were already fettered with the shackles of abundant scale insolvencies. This amendment was a step to hold the broken spine of the small business. To make the insolvency resolution process more efficient and effective, parliament passed this amendment. It was a pursuit in regards to minimising the deadlines, making the process more transparent and striving to improve the realization through this process. Basically, the amendment was introduced mainly to make the insolvency resolution process more efficient and effective. This amendment abrogated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019. The Finance Mistry was also looking forward to scrapping out Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code[4]
FEATURES OF THE AMENDMENTS:
- Initially, the minimum amount of the default was Rs. one lakh. Now the power has been vested in the hands of central government vide section 4 of IBC, specifying that default of higher amount to be not more than Rs. One Crore. [5]
- Insertion of section 32 exempted the corporate debtors and made them subjected to no liability if the offence is committed before the commencement of CIRP.
- The proviso of Section 23(1) of the IBC adds that even if the CIRP passé is terminated, the working or the operation of the debtors will be carried on by the RP before the coming of an order where the NCLT authorizes a resolution plan or wants to appoint a liquidator.
The amendment, however, disregards the interest of financial creditors and focuses mostly on the favour of Small and medium-sized enterprises. It is disadvantageous and baleful for the creditors as they are also very small and similar to Small and medium-sized enterprises. Hence their rights are as mentioned in the objective of the Insolvency and Bankruptcy Code are violated. However, it can be said that it is a step in the right direction because in such a pandemic situation where all the courts and tribunals are not working properly and their functioning has been more or less restricted this amendment could help a large amount of small business population. It may not solve the problem of the entire country but would definitely help in accelerating the economy of the country. And improve the efficacy of the code.
Significance and objectives of the amendment
The outbreak of COVID-19 has increased the number of distressed businesses as the apparent lockdown hindered day to day business activities, creating a huge amount of disorientation and puzzlement in the matters which weren’t in their hands. The entire business world underwent a wave of tension and confusion. They couldn’t find a proper resolution system for their problems. Therefore, the amendment was brought. The first and foremost impact of this amendment is that it has restricted the initiation of more insolvency proceedings in India. Amidst the worldwide pandemic, this step is considered appreciable and creates a sense of security in the business world. This would also restrict the operating creditors to file cases. It has been mentioned that such suspension will not be applicable to the defaults which were made before a certain date (25 March 2020)[6]. The Insolvency and Bankruptcy Code’s main purpose is to restore financially distressed enterprises and build a new way for them to re-enter the market efficiently and effectively. There existed no gestation period because of such suspension. Section 7 and 9 played a very crucial role in the upliftment of drowned, distressed and bankrupt companies. But according to this suspension, these sections will become dormant and would be taken away during the insolvency proceedings.
Further, Section 230 of the Companies Act read with the Companies’ Compromise, Arrangement and Amalgamation Rules 2016 establish a scheme of compromises and arrangements with the creditors and members. The scheme is introduced to increase the productivity and profitability of the company. There has been a change from the concept of the creditor in control towards the debtor in possession. As per a circular dated 11 February 2020, the RBI has set a deadline for micro, small and medium enterprises to benefit from One-time restructuring. This will help all the stressed industries to continue with their functions while strengthening their assets and liabilities.
Scope for Ambiguities
The Insolvency and Bankruptcy Code’s main purpose is to restore financially distressed enterprises and build a new way for them to re-enter the market efficiently and effectively. However, it can be said that it was introduced and presented in a hasty and haphazard manner. There exist numerous amount of ambiguities in the amendment itself. It vocally talked about the suspension period from March 25th 2020 but miserably failed to discuss the enterprises which were already distressed and became more vulnerable because of the pandemic. Also, it disregarded those companies which became distressed after the occurrence of COVID- 19 and which may continue to be the same even after the end of the same. The amendment remained silent on both these issues. [7]
They should also take into consideration the amendment of section 29A of the IBC as it allows and positively promotes the participation of promoters in a resolution process apart from those who are willingly defaulting. This section particularly prohibits existing promoters from retaining and withholding the control of the debtors. [8] Scraping out of section 7 is not worth applauding as it negatively affects the financial institutions which is the backbone in handling the public money. Thus the blanket ban and embargo will affect the lenders from recovering the debt owed to them.
Due Diligence Under IBC
Due diligence is one of the most critical aspects of the merger and acquisition agreement. Simply put, it analyses the target company in terms of assets and liabilities and also gives a perfect image of the financial state and market position of the company. It is often recommended to be vigilant when taking due diligence. Following the suspension of the corporate insolvency resolution process. Board of directors of the company concerned and the insolvency practitioners at the forefront of the operational and fiscal management of the company as an ongoing concern[9]. Certainly, the main purpose of the code is to revive struggling businesses. During the settlement process, the creditors’ committee plays a vital role in assisting the due diligence process. Assets and liabilities are calculated in compliance with Section 36(2)(a), the most recent financial report shall be drawn up, and this financial statement shall be audited.
Impact on Merger & Acquisitions
COVID – 19 is expected to result in the buyers undertaking heightened due diligence exercises with substantial control over market continuity and the following key organisational, financial and contractual risks:
Operational risks: information technology, security, integrity and reliability of the disaster recovery plan and the ability to provide remote network access.
Solvency and liquidity: the ability to pay suppliers, working capital, the general risk of insolvency and liquidity and measures taken or to be taken for the protection thereof.
Contractual performance – review termination of rights and obligations or suspension of performance obligations due to an event of a force majeure or insolvency.
In the case of sale and purchase agreements concluded prior to the outbreak of COVID – 19, where the termination has yet to take effect, the warranties should be closely checked to assess the effects of COVID – 19 on the factual circumstances of the target company. In the case of agreements that are still under negotiation, the seller is likely to insist on the inclusion of a wide variety of warranties covering the effect of COVID – 19 on the company and operations of the target, both in relation to its employees and in terms of health and safety compliance. The buyer may also consider seeking specific indemnities where significant risks have been identified. From a seller’s perspective, broad COVID-19 exclusions and disclosure are likely to be requested, including business interruption losses.[10]
Alternatives to IBC
1. Upon termination of the duration of the suspension, banks may wish to regain their duties under the SARFESI Act. This other alternative, however probable it may be, has its misfortunes. This was a major challenge due to the contribution of arbitration and litigation procedures. Corporate debtors and promoters will continue to battle long-term litigation research practises, rendering it an exceedingly inadequate tool. In addition, the SARFESI Act only offers assistance to such a group of creditors delivering it inaccessible for different classes, accordingly making it a deficient strategy for recovery. The notice shall offer only partial relief to the debtor and may be affected by the recovery action taken by other creditors who are not bound by the terms and conditions of the resolution agreement. Furthermore, the demands of the operating creditors will not be fulfilled; who would then choose to recreate their cases once the IBC has returned or take their chances with litigation and arbitration.
2. Creditor scheme under section 230 of the Company Act will be regarded as a viable choice for resolution under IBC. This requires the binding existence of the parties involved and the restricted grounds for judicial review.
3. Sale of Exposure of Banks to Asset Reconstruction Companies: this arrangement would enable private equity firms to engage in debt restructuring by investing in the security receipts provided by ARC. They enter into an agreement with the proponents of the stressed debtors to resolve the tension. This provides greater flexibility in coping with the strained assets.[11]
Is the Suspension of IBC reasonable?
The outbreak of COVID-19 and the subsequent lockdown have slowed down the economy and are a threat to industries, especially micro and small and medium-sized enterprises (SMEs). The Government of India has acknowledged their danger and has therefore decided to suspend sections 7, 9 and 10 of the IBC. These sections deal with the start of insolvency proceedings by the financial creditors, the operating creditors and the company itself. The goal of this move is to save companies from insolvency. A resolution specialist would then take over the company and its properties and set out the terms under which other firms could take over or support the sick company. Since this technique allows a third party to demonstrate an interest in taking over a sick corporation, it will not prove effective in the current scenario. This pandemic has sparked a financial crisis, which means that businesses do not have the money to fund troubled businesses. The lack of investors in a company would cause it to do so.
However, the resale estimation of the advantages has also decreased in the current economy, which means that the leasers would not have the option of recovering the due number. Against what may be expected, if the company is allowed to proceed, it is prepared to misuse its latent potential and fulfil its obligations. This would be a more satisfying advance later.
Conclusion
Although this move of the government has been supported by many, on the other hand, it has also faced certain criticisms. The goal of this move is to avoid a large number of companies from entering into liquidation due to non – payment of dues. However, this is considered unnecessary since the government has already raised the minimum amount of default to initiate the insolvency proceedings from Rs 1 lakh to Rs 1 Crore. By increasing the threshold limit, the government has ensured that a significant number of companies do not go into the liquidation in the absence of financial assistance. Therefore, both policies have the same net effect but the suspension of IBC invites a barrage of other issues with it.
Another criticism of this move was that it does not provide any safeguards from the other recovery laws. For instance; the creditor often holds a mortgage on the debtor’s immovable property. Thus, even if the creditor cannot initiate insolvency proceedings, he could decide to sell the property with minimal interference from the courts. The SARFESI act also allows the creditor to take over the management of the business of the debtor. In addition, in compliance with part III of IBC, if promoters and directors are provided with a personal guarantee, they can be present before the insolvency court. Thus, if such provisions are not amended, the government’s actions could prove to be counterproductive and futile.
Lastly, the suspension of section 10 of the IBC section 10 of IBC may hurt the companies more than aid them. Since then, the company has had no exit from the market, even though it can no longer carry out its operations effectively. The freedom to exit from the market means that resources that are not effectively exploited can be relocated to more successful endeavours. The government was then condemned for its lack of foresight and half–baked planning to help the distressed companies.
[1] IBC triggers M&A deals for distressed assets, https://mnacritique.mergersindia.com/insolvency-bankruptcy-code-drives-mergers-acquisitions/
[2] Suspension of IBC: A Slick Move or an Impetuous Hindrance? TaxGuru, https://taxguru.in/corporate-law/suspension-ibc-slick-move-impetuous-hindrance.html/
[3] IBC Suspension – More a Problem than Solution?, http://www.lawstreetindia.com/experts/column?sid=394/
[4] Increase in the threshold amount for Insolvency under IBC SCC Blog, https://www.scconline.com/blog/post/2020/04/17/increase-in-the-threshold-amount-for-insolvency-under-ibc/
[5] Section 4, Insolvency and Bankruptcy code, 2016
[6] Explained: Suspension of Insolvency and Bankruptcy Code Lexlife India, https://lexlife.in/2020/06/25/explained-suspension-of-insolvency-and-bankruptcy-code/
[7] The IBC (Amendment) Ordinance, 2020: Need to Iron Out the Creases IndiaCorpLaw, https://indiacorplaw.in/2020/06/the-ibc-amendment-ordinance-2020-need-to-iron-out-the-creases.html/
[8] Blanket Suspension of IBC- Will Hurt Genuinely Affected Lenders Samisti Legal, https://samistilegal.in/blanket-suspension-of-ibc-will-hurt-genuinely-affected-lenders/
[9] PHOENIX FROM ASHES: THE IMPACT OF IBC ON THE DISTRESSED MERGER & ACQUISITIONS MARKET, https://icsiiip.com/Portals/0/PHOENIX%20FROM%20ASHES%2C%20THE%20IMPACT%20OF%20IBC%20ON%20THE%20DISTRESSED%20MERGERS%20%26%20ACQUISITIONS%20MARKET_1.pdf/
[10] Mergers & Acquisitions in the context of COVID-19: The impact on SA deal flow and some key transaction considerations Fasken, https://www.fasken.com/en/knowledge/2020/05/1-covid-19-mergers-acquisitions-in-the-context-of-covid-19/
[11] Suspension of IBC: A Slick Move or an Impetuous Hindrance? TaxGuru, https://taxguru.in/corporate-law/suspension-ibc-slick-move-impetuous-hindrance.html/
Author Bio
