On 17th May, 2020, Finance Minister Nirmala Sitharaman announced that the govt. will bring in an ordinance introducing section 10A to suspend applicability of section 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 (IBC) for one year to stop companies from being forced into insolvency as a result of defaults owing to the COVID-19 global pandemic. The ordinance also seeks to amend the definition of ‘default’ to exclude COVID-19 related debt. This move was preceded by increasing the insolvency initiation threshold to Rs. 1 Crore from the existing threshold of 1 Lakh. While the rise in threshold is seen as a breather for MSMEs to rescue them from economic emergency, the latter act of blanket suspension on filing of new insolvency applications seems to aggravate the problem rather than alleviate it. Industry experts in unison have warned about the pitfalls of ibc suspension.
Restricting Debtor’s Freedom to Exit
Section 10 of the IBC allows a debtor company to submit itself to the insolvency process which allows them to exit investments in an organized manner. Such market-driven autonomy provides debtors the freedom to move out the resources from inefficient uses which blocks growth.
None of the developed jurisdictions around the world which have restricted creditor’s ability to initiate insolvency, have curbed debtors from initiating insolvency. Thus, section 10 should be allowed to continue as it is crucial to an efficient market as the debtor may in his own judgment conclude that he is unable to operate business and provide resolution of distressed assets.
Debt Restructuring outside IBC
Apart from IBC, there are 3 routes to debt restructuring. First is RBI’s June 7 circular, second is recovery under SARFAESI Act and third is scheme of arrangement under section 230 of the Companies Act, 2013 which is rarely used in practice.
1. ICA (Inter- Creditor Agreement)
Currently, the lenders follow RBI Circular on “Prudential Framework for Resolution of Stressed Assets” dated 7 June, 2019 to restructure their debts and resolution through IBC. This circular is applicable only on RBI regulated lenders and mandates them to enter into ICA. Non- RBI regulated lenders like Mutual funds are not governed by it and thus may not cooperate.Thus, the RBI circular precludes the equitable treatment of all the creditors. SEBI and IRDAI should potentially come up with their regulations for debt restructuring of mutual funds and insurance companies. Alternatively, circular could be amended to incorporate the interests of all the stakeholders. Further, the framework restricts the restructuring of assets above Rs 1500 crore.
If the IBC process is paused, the RBI should urgently amend the June 7 framework by removing or reducing the threshold of Rs 1500 crore exposure for restructuring and also grant concessions on the provisioning of assets.
2. SARFAESI Act
Suspension of the IBC would compel banks and lenders to go back to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act to recover dues. Objective of IBC was not to recover dues but to resolve insolvency. But Suspension of IBC leaves out the option of resolution and automatically opens the door for recovery and this could be an unintended consequence of the blanket Suspension.
Accountability of Debtor in Possession
Introduction of section 10A will shake the foundation of insolvency laws which is the creditor in control of the business. As section 7, 9 and 10 will remain suspended, Resolution Professional(RP) will not get appointed and the Committee of Creditors (COC) will not get constituted. Control over the business’s assets will remain with the corporate debtor. When a debtor is in a situation where it cannot meet the obligations of its creditors, it could indulge in fraudulent, undervalued or preferential transactions during the period of suspension which will have serious consequences on creditors. If the debtor’s management tries to pump out the funds or assets, it will lower the realization value of the assets as the bidding procedure for enhancing the deal value will not be in place due to suspension.
Thus, to assuage the effect of a debtor in control, duty of the debtors should primarily shift towards creditors. ‘Corporate Governance Code’ should be introduced in the Companies Act, 2013 or some other interstitial law must be brought in place to balance the interests of both debtors and creditors. Also, rights of the creditors can be further protected by strengthening the provision of IBC under section 43, 44 and 66 by prescribing stricter penalties for promoters/directors of a company indulging in preferential or fraudulent transactions.
Anomaly of COVID- 19 Debt
Proposal to exclude COVID-19 related defaults for initiating CIRP seems unnecessary following the suspension for a year. If the idea behind exclusion was to ease the burden on borrowers then the subsequent move to suspend CIRP in its entirety doesn’t sound intelligible. Also, there is no clarification if the government intends to continue providing benefits of exclusion even after the suspension is over. Recent amendment to German insolvency laws warrants suspension only if the insolvency is due to covid crisis and there is no likelihood of overcoming insolvency. Thus, it remains to be seen whether the exclusion benefits will continue even after suspension of one year.
Way Forward: Pre-Pack Resolutions
This is the right time to introduce pre-packs which are popular in the west where the lender and the borrower agree to restructured framework and are blessed by the courts and are binding on all. Since the courts and tribunals are not functioning at full capacity, the process for any security enforcement and debt recovery is likely to be delayed. Pre- pack is a great alternative when the courts are already over burden. Backlogs of cases at NCLT have delayed the resolution of stressed assets and the covid crisis has only increased the delay. Hence, pre-packs will shorten the prolonged court process.
It is necessary to ensure that no undue advantage of the proposed law is taken. Thus, it is crucial that ordinance is coupled with other economic policies which will balance the interests of both the borrowers as well as lenders. Any amendment providing respite to the borrowers needs to have an equivalent relief to the lenders. Economic crisis due to global pandemic demands alterations but not suspension of IBC. regaining creditor’s confidence and infusion of liquidity is imperative to renew the Indian debt landscape and economy in the main.
IBC is not a one size fits all but if it is to be kept applicable, it needs to be reinstated soon.
Anukrati Mishra , 2020 Graduate from Institute of Law, NIRMA University, Ahmedabad (Business Law Hons.)