Suspension of IBC: A Confounding Endeavour?
[Dharmi is a student at NMIMS School of Law, Mumbai.]
On 5 June 2020, in the wake of the COVID-19 pandemic and the subsequent lockdown and with an aim of shielding businesses from being pushed into insolvency proceedings, the much-awaited ordinance suspending initiation of corporate insolvency resolution process (CIRP) was promulgated. The Insolvency and Bankruptcy Code (Amendment) Ordinance 2020 (Ordinance) inserted Section 10A to the Insolvency and Bankruptcy Code 2016 (Code) that prohibits financial creditors, operational creditors and corporate debtors (CD) from initiating a CIRP for a default arising on or after 25 March 2020 (specified date). The said suspension is to remain in effect for 6 months, till a further notified period, but not exceeding a year (suspension period). The Ordinance also inserts sub-section (3) to Section 66 of the Code, technically creating an exception to wrongful trading.
Although the Ordinance is a welcome move, providing some breathing space to corporations (companies and limited liability partnerships) and is effectively in pursuance of a policy recommendation given by the World Bank in its recent blog, there are certain shortcomings that outweigh the benefits that the Ordinance intends to deliver. First, the Ordinance blanketly suspends initiation of CIRP for any defaults within the suspension period. Second, it takes away the option of a CD to voluntarily initiate CIRP. Third, it suffers from indelible drafting flaws that create ambiguities. Lastly, it protects directors/partners from wrongful trading. This article discusses all the aforementioned points in seriatim and concludes by highlighting the need to reorient the Ordinance.
'Any default' in the suspension period is assumed as a default on account of the COVID-19 pandemic and the lockdown
The Finance Minister, in her recent announcements, indicated exclusion of the debt related to COVID-19 from the definition of 'default'. In its preamble, the Ordinance recognizes exclusion of defaults arising on account of the COVID-19 pandemic situation. However, the meaning of the word 'default' has not been mentioned in the Ordinance, and in the absence of an amended definition, the definition under Section 3(12) would be applied to interpret default. Against this backdrop, Section 2 of the Ordinance assumes any default that occurred on or after the specified date is necessarily a default that arose due to COVID-19 pandemic and the lockdown, without any carve-outs to determine if COVID-19 had a substantial financial effect on a corporation that culminated into a default.
Thus, the promulgation of the Ordinance has happened in complete ignorance of the circumstances wherein a company was nearly on the brink of insolvency due to prolonged failures in business that had nothing to do with COVID-19 or the lockdown, but since the date on which the said default occurred was 25 March 2020 or after, no insolvency proceedings could 'ever' be initiated. In corollary, defaults which occurred before the specified date, on account of the pandemic have not been insulated, essentially discriminating and depriving those businesses that were hampered on account of the global outbreak of the pandemic.
Perpetual bar on initiation of CIRP for defaults falling in the suspension period
The proviso in the Ordinance uses the word 'ever' to stipulate that no CIRP can be initiated for defaults arising in the suspended period, as mentioned in Section 10A. In addition, the preamble to the Ordinance states that defaults arising on account of the unprecedented situation are to be excluded for the purposes of insolvency under the Code. Therefore, the cumulative effect of both these factors leads us to conclude that the Ordinance essentially creates a perpetual prohibition to initiate CIRP for defaults in the suspension period. It is imperative to note that Section 10A specifies a limited period of 6 months extendable to a year, but the proviso enlarges this scope by using 'ever'. The proviso is, therefore, substantive in nature, granting willful defaulters an opportunity to circumvent the law and garner undue advantage. Furthermore, it creates confusion in cases of continuing defaults.
Ambiguity in cases of continuing defaults that are in parts and phased over a time-frame
A default is said to have occurred when a part or whole of the amount of debt has become due and payable but the same has not been paid by the debtor. Such a default continues until it has been remedied or waived. While the Ordinance is unclear if a waiver has been granted to defaults in suspension period (two reasons, one- proceedings against personal guarantors can be initiated for defaults in the suspension period, suggesting defaults have not been waived per se but only CIRP initiation has been prohibited; two- definition of default has not been amended, granting a waiver), it does not even attempt to clarify if defaults that continue post the suspension period can be remedied. For instance, a CD defaults twice- first, for an installment of INR 75,00,000 in the suspension period (within Section 10A of the Code) which continues even once the suspension period is over, and, for another installment of INR 35,00,000 outside the suspension period (not within Section 10A). The default that occurred later (INR 35,00,000), alone is not sufficient to fulfill the threshold requirements for triggering the Code (i.e. INR 1 crore), but on combining both the defaults, the threshold is met. The question that arises herein is whether Section 10A will be attracted in cases of one-time default only or even to defaults that continue after the suspension period is over. Further, one wonders if the defaults can be combined to meet the threshold and trigger action. An absence of clarity in this regard makes the Ordinance confusing.
Considering another example, if a CD defaults in payment of multiple installments of INR 50,00,000 (two defaults of INR 25,00,000 each over 2 months) before 25 March 2020 and again defaults on other installment payments of INR 50,00,000 (2 defaults of INR 25,00,000 each over 2 months), but the latter default happen in the suspension period and the former defaults continue throughout the suspension period, will such CD be in a position to defend the initiation of CIRP for the former defaults by relying on the Ordinance?
Voluntary initiation of CIRP by the corporate debtor suspended
The Ordinance inter alia suspends voluntary filing of applications under Section 10 of the Code by the CD. This could prove counter-intuitive, primarily in 2 situations - first, for those businesses who genuinely require restructuring of intractable debt caused on account of the pandemic, and second, in other conditions where the debt has snowballed on account of continuous poor performance in previous financial years with pandemic adding the final blow. In both scenarios, the CD will either be forced to continue operations in an unviable state or eventually shut down perpetually by voluntarily liquidating. Furthermore, the CD cannot even avail a statutory moratorium which otherwise could have helped them to get a waiver on interest. Debtor-induced insolvency proceedings can aid to good commercial solutions, but the opportunity for the same has been lost with suspension.
Ambiguity in the calculation of the suspension period
A plain reading of Section 10A, with the placement of the words 'such date' and 'as may be notified in this behalf' right next to each other, may raise confusion regarding commencement of the suspension period. However, a closer, logical and contextual examination reveals that the words 'such date' in the section evidently refer to 25 March 2020 and the words 'as may be notified in this behalf' actually refer to the Central Government’s power to extend the suspension period beyond 6 months.
Another drafting flaw in the Ordinance is the lack of an explicit mention about its retrospective effect on applications filed before the Ordinance was notified, that is between 25 March 2020 and 5 June 2020, concerning defaults that had arisen in the said period. The flaw creates a dilemma if the Ordinance would bar such applications or not. Fortunately, this dilemma was resolved by the Chennai bench of NCLT in Siemens Gamesa Renewable Private Limited v Ramesh Kymal on 9 July 2020. The Tribunal purposively interpreted the Ordinance in light of its preamble and held that the Ordinance would have a retrospective effect to the extent of applications filed between 25 March 2020 and 5 June 2020. However, it is important to note that such indelible drafting flaws could have been easily eliminated with cautious drafting, which would have saved precious judicial time.
Exception to wrongful trading
The Ordinance inserts a non-obstante clause to Section 66 of the Code (fraudulent trading or wrongful trading), granting protection to the directors or partners (as the case may be) of a CD. Therein, a resolution professional is barred from filing an application for wrongful trading under Section 66(2) in respect of defaults under Section 10A. In the absence of specific conditions to avail protection under this section, rash behavior of directors/ partners of a CD prior to the specified date resulting in default in the suspension period may go unpunished.
The Ordinance was promulgated to help corporations steer through an unprecedented crisis beyond their control. However, inherent lacunae such as suspending voluntary initiation of CIRP by the CD, ambiguities on account of poor drafting, lack of clarity in cases of continuing defaults, and blanket suspension that fosters discrimination, scar the very object for which the Ordinance was promulgated. Perhaps, judicial intervention will help answer a few questions and clear some of the confusion. Nonetheless, there exists a need to reorient the Ordinance in a manner that it substantially benefits the ailing corporations and, at the same time, safeguards the legitimate interests of their creditors and other stakeholders.