Amendments to IBC in times of Pandemic: Whether self-defeating?

The spread of COVID-19 has had a deep impact on India Inc. in terms of liquidity, stalling of ongoing projects, investments, etc. How to come out of this unprecedented phase is what the industry is trying to figure out now. With labour forces having migrated to their home states and towns, the task of resuming commercial activities at the earlier scale is a rather difficult task.

During such testing times, with a view to prevent triggering of the provisions of Insolvency and Bankruptcy Code, 2016 (Code) mainly against the Micro, Small and Medium Scale Enterprises (MSMEs), the Central Government, vide Notification dated March 24, 2020, increased the threshold for invoking the provisions of the Code from Rs. 1 lakh to Rs. 1 crore.

Thereafter, the President has promulgated an Ordinance on June 5, inter alia, to insert Section 10A in the Code, which reads thus:

“10A – Suspension of initiation of Corporate Insolvency Resolution Process:

Notwithstanding anything contained in Section 7, 9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed for any default rising on or after 25^th March 2020 for a period of six months or such further period, not exceeding one year from such date, as may be notified in this behalf:

Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.

Explanation.- For the removal of doubts, it is hereby clarified that the provisions of this section shall not apply to any default committed under the said sections before 25^th March, 2020.”

Cumulative implications of both amendments

On plain reading of the said Amendments, it becomes clear that no Application under Sections 7, 9 or 10 of the Code can be filed for a period of 6 months (if extended up to 1 year) for any default occurring after March 25. Even after such period, an Application can be maintained only if the amount of debt is above the threshold of Rs. 1 crore. The intent behind these amendments is to low value realization of assets. The question that needs to be addressed is while these Amendments have been brought into place to aid India Inc., are these self-defeating to some extent?

Firstly, what seems to have been lost sight of is the fact that the increase in the threshold for invoking provisions of the Code may also equally hurt the MSMEs as much as it aids them. The dues owed by major corporates to MSMEs is usually less than Rs. 1 crore. With the increased threshold, the MSMEs are deprived of their right to drag these major corporates to NCLT, if not for resolution of the corporate debtor, at least for recovery of their debt. Although the provisions of Code are not supposed to be invoked for recovery of debt, that is what has precisely happened in these initial years of the Code having come into force.

As per the data available, till December 2019, as against 2838 cases admitted by NCLT, 9653 cases were disposed of at pre-admission stage. In terms of value realization as well, against Rs. 1.56 lac crore realizable by Resolution, Rs. 3.74 lac crore has already been realized by settlement. Thus, in terms of numbers and value both, the creditors have realized much more by way of settlements as compared to the resolved cases. Also, till June 2019, about 49.95% of IBC Applications were filed by Operational Creditors. Majority of the settled cases at the pre-admission stage are filed by Operational Creditors. The increase in the threshold would, whilst protecting the MSMEs against being dragged to NCLT, also take away the route of easy recovery of the debts owed to them by major corporates.

Moreover, the Notification for increase in threshold is not a time limited measure with an expiry date; but is permanent. Thus, even after the impact of the pandemic and lockdown subsides, this limitation on threshold will stay, which will have a long term impact on the MSMEs in realizing their debts owed by major corporates. The time consumed and litigation costs involved in realizing the debts by Civil or Arbitration proceedings with multiple levels of Appeals is much higher as compared to the IBC proceedings and therefore, not desirable. The increase in threshold ought to have been restricted to Applications filed against MSMEs and not those filed by MSMEs. Since a new mechanism for resolution of MSMEs is already being introduced to IBC, this provision ought to have been brought in with limited applicability and/or with an expiry date.

Now turning to the Ordinance of June 5, the Amendment has not taken into consideration sector-wise distinctions. While various sectors are heavily impacted by the spread of virus and consequent lockdown, certain sectors such as medical and essential service providers/manufacturers have done business as usual. Extending the benefit of such amendments to the sectors unaffected by the pandemic also amounts to treating unequals, equally; thereby rendering the provision to be arbitrary and consequently violative of Article 14.

Also, the ‘One size fits all’ approach is not desirable without application of mind, more particularly when the effects are so far-reaching. Unless an entity is able to show that the default is a resultant effect of the pandemic, should such umbrella of protection be extended? Rather than suspending provisions in the Code for initiating the Corporate Insolvency Resolution Process (CIRP) altogether, would it not be a better approach to include the effect of pandemic as a defence to any IBC Application, resultantly granting the protection only to those entities, which have defaulted solely on account of the pandemic?

Viewing things from a different angle, the major object behind the Amendment to suspend Sections 7, 9 and 10 of the Code is that ‘it is difficult to find adequate number of Resolution Applicants to rescue the defaulting corporate persons’ during these times. From the move, it is palpable that the Government intends to protect the industry by ensuring that the assets may not be under-realized on account of no / less availability of Resolution Applicants. The intent behind the Amendment is commendable, however, it is not discernible as to why the applicability of this provision is limited to only those defaults, which have occurred after 25^th of March. The date of default, whether prior to or subsequent to 25^th March is not at all material when the concern is to find adequate number of Resolution Applicants. Does the restricted applicability of the provision not defeat the purpose of highest value realization in those cases where default occurred prior to 25^th March but is being admitted to CIRP during this 6 months (If extended, 1 year) period? These cases would also find it difficult to attract considerable offers from Resolution Applicants, consequently defeating the object of high value realization. If the purpose is to avoid Resolution or Liquidation by realizing lesser asset value, the protection needs to be extended to defaults even before the lockdown.

What also does not appear to be thoughtful is suspending Section 10 Applications, which enables the Corporate Applicant (Corporate Debtor, Member/Partner of Corporate Debtor, Person in charge of managing the operations and resources of Corporate Debtor, Person having control and supervision over financial affairs of Corporate Debtor) to refer the Corporate Debtor to Resolution Process. This is akin to the voluntary winding up provisions contained in Section 439 of the erstwhile Companies Act, 1956. Although it may be difficult to find Resolution Applicants during the present times, the Corporate Applicant cannot be compelled to run its operations while facing numerous recovery proceedings. In fact, during such turbulent times, the Section 10 Applications would be required to be dealt with in a more careful manner. Suspending Section 10 does not result into smooth running of any entity, which is otherwise defaulting and facing recovery proceedings at various forums. If the lenders are Banks or Financial Institutions, they may anyway refer such companies to DRT proceedings and gain effective control of the entity and its assets.

Though the intent of the Amendments is laudable, removing these anomalies would be desirable for the law to achieve the set objectives; otherwise it creates more problems than it solves. These Amendments are likely to be challenged before the Courts and it would be interesting to see the final outcome.

The author is an advocate practicing at Gujarat High Court and an Associate partner at Nanavati Associates, Ahmedabad.