IBC (Amendment) Ordinance 2020: A Shot in the Uncharted Territory?
[Sumit is a student at West Bengal National University of Juridical Sciences, Kolkata.]
Unprecedented lockdowns have severely impacted businesses and financial markets and ravaged the foundations of the economy in the country as the corporate defaults have been on the rise. Amid this chaos, resolution applicants seeking to rescue defaulters are becoming difficult to come by. The concept of creditor-in-possession emanating from Insolvency and Bankruptcy Code 2016 (IBC) blended with continuous lockdowns have further imperiled the standing of corporate debtors. The government, in a bid to uplift the economy, has been coming up with several reforms and relaxations in the economic arena. As a result, while the government has been unveiling revival schemes for corporates, the uncertainty and the stress surrounding the corporate sector remain at the forefront of discussions for corporate pundits.
This article seeks to analyze the glaring ambiguities arising from the ordinance which suspends the initiation of insolvency proceedings. To begin with, this ordinance has restricted the autonomy of corporate debtor from voluntary initiation of the CIRP. Second, while it may be clear that the period of suspension begins from the commencement of the lockdown period i.e. 25 March 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. Third, the insertion of sub-section 3 in Section 66 of the IBC can give undue protection to willful and fraudulent transactions of the corporate debtors, partners or directors, thus attenuating the essence of Section 66. Lastly, this ordinance failed to suspend the other recovery laws through which the creditors can enforce their rights. Thus, the adoption of such sweeping relaxations is fallacious and is likely to encourage the willful accumulation of debts.
Incorporation of Section 10A and Section 66(3)
In a formidable and much-needed relief for the corporate debtor, the President, in the exercise of the powers conferred by Article 123(1) of the Constitution, promulgated an ordinance on 5 June 2020 (Ordinance). The Ordinance suspended Sections 7, 9 and 10 of the IBC. These sections provide for a market-linked and time-bound resolution process of stressed assets. The government has effectively suspended fresh bankruptcy proceedings against corporate debtors on default occurring on or after 25 March 2020, the day when the whole country grappled into lockdown due to COVID-19. The Ordinance inserted Section 10A in the IBC which suspended the initiation of corporate insolvency resolution process (CIRP) under Sections 7, 9 and 10. This means that no applications for corporate insolvency resolution process can be initiated by financial creditors, operational creditors and the company itself during the period of applicability of Section 10A starting from 25 March 2020. The Ordinance also inserted sub-section (3) to Section 66 of the IBC wherein it prohibited resolution professionals from filing an application under Section 66(2).
These reforms are seen as a relief for a corporate debtor that went into defaults due to country-wide lockdown starting 25 March 2020. The preamble to the Ordinance acknowledges the economic hardships faced due to the unprecedented lockdown and the practical difficulties of finding resolution applicants to rescue such corporate persons who may default in the discharge of their debt obligations. While the Ordinance aims to protect such corporate debtor from the rigors of the IBC, it has left various ambiguities arising therein.
Restricting the Autonomy of Corporate Debtor
The Ordinance restricts the fundamental freedom of the corporate debtor from voluntary initiation of the CIRP. The IBC has been seen as a tool for debtors to exit their investments in an orderly fashion. Such market-driven freedom to exit has ensured the release of resources from inefficient uses and has unlocked growth for the market. The Ordinance fails to take account of the interest of a company. In an event where a company believes that the best option available is to undergo insolvency process, the Ordinance impliedly restricts the right of the company thus not only jeopardizing the best interest of the company but also leaving a dent on the fundamentals of efficient and free markets.
The Curious Case of Continuing Default
The Ordinance completely disregards the void created due to continuing default. Continuing default is an event where a default has occurred and which has not been waived or remedied by the creditor. The proviso to the inserted Section 10A specifies that no application shall "ever" be filed for initiation of CIRP against a corporate debtor for the said default occurring during the said period. In a situation where after the expiry of the said period, the default continues, will a creditor be inhibited from initiating CIRP even after the corporate debtor has recovered monetarily? This leaves a grey area thereby conferring upon the corporate debtor an expendable immunity from continuing defaults accruing during the said period. A further question may arise: whether such corporate debtor should continue to enjoy the Ordinance's protection?
Insertion of Sub-section (3) of Section 66 - Encouragement to Willful Defaulters?
Insertion of sub-section 3 in Section 66 can open another pandora’s box. Section 66 of the IBC deals explicitly with ‘fraudulent or wrongful trading’. This section takes account of the transactions carried on with an intent to defraud creditors of the corporate debtor and to hold the involved persons liable for such fraudulent transactions. 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 willful intent of defrauding creditors or did not exercise requisite due diligence before the commencement of insolvency. Sub-section 3 of the Ordinance prohibits a resolution professional from filing an application under Section 66(2) of the IBC, thereby giving unbridled power in the hands of directors and partners of the corporate debtor. This faulty provision can act as a shield and provide undue protection to corporate debtors from being held liable for fraudulent transactions carried out during the time that this Ordinance is in force. This can make the adjudicating authorities toothless or even worse a mute bystander for adjudicating potentially fraudulent transactions carried during the said period.
Additionally, this insertion of sub-section (3) runs contrary to the principle envisioned through Section 66 of the IBC. The inclusion of provisions for fraudulent trading and wrongful trading was one of the most noteworthy change in the history of insolvency laws. Before the advent of IBC, there was little scope for recuperating the losses caused to creditors due to fraudulent transactions. Section 66 not only brought about a huge shift by making the liability of a director unlimited but also provided for a new dimension of imposing civil liability, where the losses caused by the misconduct and negligence of directors and partners can be made up by their contribution. Now, the corporate debtors, directors, partners and other persons involved can exploit this overriding provision of sub-section 3 of the Ordinance which supersedes sub-section (1) and (2) of Section 66 and provides that no application shall be filed by a resolution professional in respect of such default against which initiation of corporate insolvency resolution process is suspended as per Section 10A. This gives rise to some unsettling questions: whether this gives corporate debtors a free hand to carry out fraudulent activities against the creditors? Are the resolution professionals expected to turn a blind eye towards the above-mentioned illegalities, if committed?
Alternative Route for Creditors
Lastly, even taking the best-case scenario of enforcing this suspension with the best intention, this Ordinance is only restricted to the continuation and enforcement of IBC for the corporate debtor. It fails to provide any protection to the corporate debtor from other recovery laws. This Ordinance only prohibits the CIRP and adjudication of fraudulent transactions. Supposedly, if a creditor holds a mortgage over the immovable property of a debtor, then it has the power to initiate sale proceedings in the event of default. Further, the management of the debtor can be taken into the control by the creditors under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act 2002. Additionally, the Ordinance does not protect the rights of personal guarantors against insolvency process under Part III of the IBC. The creditors still have the power to initiate insolvency process against personal guarantors as the Ordinance does not cover Part III of the IBC. These will severely compromise the effectiveness of the Ordinance, thus giving ample space for loopholes.
While the intention behind the promulgation of the Ordinance is to protect the MSMEs and revamp the economy, this Ordinance can backfire, resulting in unintended grave consequences in the realm of corporate insolvency. The government must take account of all the possible loopholes arising from the Ordinance and put things into perspective before it gets too late.