Case against Suspension of the Insolvency and Bankruptcy Code amidst COVID-19 Lockdown
[Arnav Sinha is a fifth-year student at ILS Law College, Pune.]
The Government of India has recently cleared a proposal to amend the Insolvency and Bankruptcy Code 2016 (IBC) in order to add a new section-Section 10A. This proposal is currently awaiting the President’s approval. This move aims to act as a one-time measure specifically designed for the current COVID-19 pandemic to provide relief to companies facing an insolvency crisis due to factors attributable to the pandemic. Section 10A shall remain in force for 6 months or a year depending on the requirement but the term shall not exceed a year.
In effect, section 10A would suspend the operation of Sections 7, 9 and 10 of the IBC, essentially meaning that no new applications could be filed for 6 months before the National Company Law Tribunal (NCLT) for a corporate insolvency resolution process (CIRP). Section 7 of the IBC deals with financial creditors initiating a CIRP, Section 9 allows operational creditors to initiate action, and Section 10 allows a defaulting company to apply to NCLT to declare it insolvent. Thus, Section 10A will act as a blanket suspension of the IBC.
Main rationale behind the introduction of Section 10-A
Since no creditor or corporate debtor would be allowed to file a new application during the period of suspension, the corporate debtors suffering from the pandemic lockdown would find breathing space to revive in a business environment which is expected to get better after the lockdown on business activities is lifted. Additionally, when the risk of becoming a non-performing asset or defaulting on loans is removed, these companies would be in a better position to negotiate new loan deals with banks and financial institutions. They would also secure the necessary interim working capital and immediate finance by structuring other reliefs from their existing creditors.
This deferment period would be helpful especially for Micro, Small and Medium Enterprises (MSMEs). MSMEs tend to face increased pressures of insolvency in the near future and finding new financiers/buyers etc. may prove to be difficult in a stressed economy. The deferment period would allow the management of these companies to remain in control of the assets and administration of the company while they take key decisions to recover from setbacks of the COVID-19 lockdown. In the absence of such suspension of IBC, these troubled enterprises will face liquidation.
However, this amendment does raise concerns. In light of the legislative intent behind Section 10A, a blanket suspension on IBC poses a few challenges.
IBC represents a concrete system of debt recovery
Ever since its inception, IBC models a success story in allowing creditors to realize their debts by providing them with an avenue of debt recovery which is both time-bound and certain. This stems primarily from the fact that creditors can offer solutions at any stage of the CIRP. One such instance is under Section 12A which through its management or promoters facilitates the corporate debtor to agree upon the restructuring of debt with the consent of 90% of the committee of creditors. This creates an atmosphere of time-bound formal negotiations, recognized by law in a certain and predictable matter. This becomes crucial in a volatile and uncertain business environment by dissipating the concerns of banks and financial institutions in negotiating restructurings outside the framework of IBC.
The role of IBC as foreseen by the Bankruptcy Law Reforms Committee Report 2015 is to facilitate a sound bankruptcy system in case of a major macroeconomic downturn, something which grieves India’s economy presently. Suspension of the IBC is not the best solution, but it is the need of the hour.
Shifting to a 'debtor-in-control' regime is risky
The basic idea behind the enactment of IBC was a shift to a 'creditor-in-control' regime. This aspect of IBC was a crucial factor behind its success. Section 10A essentially would deviate from this notion and put the mantel back in the hands of the debtors. This would be done in order to provide a financially stricken business time to recover from the loss of business due to COVID-19. However, it is merely an optimistic assumption that businesses would be able to thrive during the period of suspension of IBC even without any fresh applications filed against them. The business still would struggle in securing a flow of revenue income. Without securing a certain interim financial source, they would struggle to pay wages, raw materials for production etc. In reality, it seems unlikely that the Indian economy which is suffering due to the pandemic would recover in six months or even in a year. Section 10A would only postpone the problem and not solve it. NCLTs may soon find those stricken businesses or their creditors filing for insolvencies after the suspension on IBC is lifted but in a worse position. The value of their assets would get eroded and their operational creditors (i.e. workers etc.) would not be paid their wages for a long time. Therefore, the enactment of Section 10A can become counter-productive in solving India’s macroeconomic crisis.
Tricky position for banks
Arguably the biggest brunt of it all would be borne by the banks and financial institutions. When the remedy under IBC is suspended, it would put them in an inferior position in re-negotiating loans and other financial reliefs with the corporate debtor. The banks would be forced to concede to unfair terms under these negotiations since there would be no recourse available to them under the IBC to file an insolvency petition.
Furthermore, it is inevitable that certain corporate debtors may try to wriggle out their contractual obligations under the existing credit facility agreements by trying to invoke the 'force majeure' clause under those agreements. While the success of that recourse may depend from case to case, there would certainly be a rise in litigations between banks and corporate debtors around the horizon.
The way ahead: revisiting Section 29A
Many possible lacunae which Section 10A presents may be removed by temporarily amending Section 29A. Under Section 29A, the existing promoters or management of the corporate debtor are barred from bidding for assets or buying shares of the company as a part of a resolution plan. As held by the Supreme Court of India in Swiss Ribbons Private Limited v. Union of India, the main rationale behind the introduction of Section 29A is to prohibit the very management or promoters etc. from taking part in the process of reviving the corporate debtor which were responsible for its downfall in the first place. However, in times of a macroeconomic crisis, serious drawbacks emerge from this rationale.
Firstly, the resolution of insolvency under the IBC is done by the way of resolution plans which are presented before the committee of creditors for scrutiny. Each and every plan has to be evaluated and a rigorous due diligence exercise has to be undertaken, therefore slowing down the CIRP. Since a promoter has been in control of the corporate debtor for a long period of time, the rigorous due diligence needed to be undertaken may be reduced or eliminated entirely. This swift action would save the enterprise and prevent its assets from further deterioration.
Secondly, the application of this rationale of Section 29A becomes extremely unfair for promoters who have defaulted due to economic reasons stemming from the pandemic. This is because they would be prohibited from retaking control of their businesses. This drawback may have been addressed by the Finance Minister in the recently announced economic reforms. The Central Government is empowered to exclude ‘COVID-19 related defaults’ from the ambit of ‘default’ under the code in order to initiate a CIRP. However, this presents its own legal issues and would require clarity from the government regarding its practical implementation.
Therefore, a revisit of Section 29A would allow the defaulting promoters to take part in revival of the corporate debtor while keeping intact the prohibition in proposing a resolution plan on other categories in the section such as undischarged insolvents and willful defaulters.
The alternative way ahead: allowing voluntary insolvency applications
The government may also consider removing applications under Section 10 from the ambit of Section 10A. This would give the corporate debtor an opportunity to file a voluntary application under the IBC. Therefore, while the insolvency risk is significantly reduced by preventing creditors’ applications under Sections 7 and 9, the management of the business would still be able file for a CIRP under Section 10.
While Section 10A may be enacted to provide relief for financially stricken businesses, it seems to be a knee-jerk reaction to the current economic crisis. An in-depth analysis of the consequences of its enactment shows that it will not have the positive impact it seeks to achieve while also threatening to undo all the good strides the enactment of IBC made in improving India’s ranking in the ease of doing business index. There are many avenues available to the government which can make the insolvency regime better suited for the crisis that would not necessarily involve a blanket suspension of the IBC.