On March 24, 2020, the Finance Minister. citing the stress faced by companies due to the COVID-19 situation, announce the increase in monetary threshold for initiating insolvency proceedings from INR 1 lakh to INR 1 crore. She concluded her speech by announcing that if the lockdown continues beyond April 30, 2020, the Government would consider suspending section 7 (initiation of corporate insolvency resolution process by financial creditor), section 9 (application for initiation of corporate insolvency resolution process by operational creditor) and section 10 (initiation of corporate insolvency resolution process by corporate applicant) of Insolvency and Bankruptcy Code, 2016 (“IBC”) for a period of 6 months ‘to stop companies at large from being forced into insolvency proceedings in such force majeure causes of default’. Now after over 70 days of deliberation, Government of India passed an ordinance on June 5, 2020 (“Ordinance”) that suspends these provisions of the IBC for a period of 6 months (extendable up to 1 year). In simple terms, a creditor can never initiate IBC proceedings against a debtor on account of payment defaults that occur on or after March 25, 2020 and up to September 25, 2020 (which date can further be extended up to March 24, 2021). The rationale given for promulgating the Ordinance is that due to COVID-19 there has been disruption since March 25, 2020 (i.e. date of initiation of the lockdown), businesses have been seriously impacted and ‘it is difficult to find adequate number of resolution applicants to rescue the corporate person who may default in discharge of their obligations’.
Given the extensive time frame between the announcement of this proposal and its official roll out, one would presume that considerable thought would have been put behind it. However, the overarching text of the Ordinance seems to suggest otherwise. As a starting point, some of the reasons provided for rolling out the suspension seem generic and do not appear to be based on an in-depth analysis or empirical science. Reasons such as there not being enough number of resolution applicants fall squarely in such domain.
More substantive is the likely impact on financial institutions in India, which have been facing the brunt of the economic impact of the pandemic. At a time where there was already a liquidity crunch, inter alia on account of the NBFC crisis, the ongoing moratorium saga and inherent inability of borrowers to make timely repayments in such times have only made the situation worse for them. Following all this, the Ordinance could well be a final blow that could arguably lead to a systemic meltdown, something that should be avoided at any cost. Another huge impact could likely be on foreign investments, specially through debt. The IBC had given much needed comfort to foreign investors by providing certainty in terms of the debt crystallization and enforcement process in India which was hitherto lacking under previous legislations. This almost arbitrary suspension of key provisions of the IBC is likely to be a key concern for foreign investors in the near future.
In addition to the above, the language of the Ordinance raises some technical questions as well. Since defaults arising on or after March 25, 2020 have been ‘safeguarded’, it’s unclear if IBC proceedings can be initiated if a contractual default occurred prior to March 25, 2020 but a default was called by the lender only after March 25, 2020. Ideally, the answer should be in affirmative, though the language does provide enough room for interpretation. Additionally, suspension of section 10 i.e. the provision for voluntary initiation of proceedings by the debtor itself, does not seem to be rational! The Ordinance has also amended the law retrospectively, nullifying proceedings which may have already been initiated. This is only likely to imbalance the equation more.
While the increase in the monetary threshold for initiating IBC proceedings appeared to be well thought out by the Insolvency Law Committee and documented in its report released earlier this year, ironically the Ordinance appears to be imposed in haste, albeit the timeline for its notification.
A much easier solution would have been to revisit the powers of the National Company Law Tribunals (“NCLT/s”) while admitting an application to initiate IBC proceedings. In any case a NCLT has the power to reject applications on merit (which the tribunals have carefully done over the years). Extending the ‘merit criteria’ to allow the NCLTs to exercise further judicial and commercial scrutiny could have been considered. A number of parameters could have been introduced to ensure that the right cases are taken up for resolution. This coupled with pure financial measures to increase liquidity and adjustment of equities, which experts have rightly pointed out, should be the focus areas to insulate the financial institutions and businesses alike.
It would be imperative to emphasize that essence a bankruptcy resolution process is to resurrect good businesses. Suspending the process when cash flows are crunched and valuations are low, seems misplaced. On one hand, the IBC ushered a mindset change where promoters realized that they may lose their businesses if they don’t act prudently, and on the other the IBC also protects businesses by imposing a moratorium, once IBC proceedings have been initiated. In the current times, the moratorium under IBC gains heightened importance as it insulates a business from sudden shocks while the trinity of creditors, resolution professionals and NCLT work together to salvage the situation.
In these unprecedented times the Government has been quick to respond and has introduced wide ranging initiatives to stabilize the environment. Regrettably, the Ordinance may fall short of the requirement. The fate of the IBC continues to be marred with a plethora of amendments, which for a path breaking legislation is rather unfortunate and undermines investor confidence.
– Dipanshu Singhal (Co -Founder, Bombay Law Chambers) and Karan Kalra (Founder, Bombay Law Chambers)