Revision of threshold of default under the IBC: a bitter pill to swallow?

Recently, the Central Government through gazette notification dated March 24, 2020 specified one crore rupees as the minimum amount of default for initiation of proceedings under the Insolvency and Bankruptcy Code, 2016 (‘the Code’). This represents a hundred-fold increase from the current level of one lakh rupees.

This move comes in the backdrop of the Covid-19 pandemic and is ostensibly geared towards protecting Micro, Small & Medium Enterprises (‘MSMEs’) from being pushed into insolvency during these trying times. The Finance Minister has also announced that the government was considering the suspension of Sections 7, 9 and 10 of the Code, if the current situation continues beyond April 30, 2020.

The aforesaid moves appear justified when considered in the context of the present emergent situation. With the Government having ordered a lockdown across the nation and the economy virtually shut down, there are certainly going to be ripple-effects across every contract entered into between parties, particularly for time-bound transactions. We are inevitably going to see several instances of parties being unable to fulfil their contractual obligations due to the unprecedented nation-wide shutting down of economic activities.

Keeping the above in mind, the Ministry of Finance (Department of Expenditure Procurement Policy Division) had issued an office memorandum stating that the coronavirus pandemic was to be treated as a natural calamity and the force majeure clause may be invoked as a consequence wherever considered appropriate[1].

Under the Code, strictly speaking, a defence of force majeure would be difficult to raise in the case of operational creditors if there is no document from the side of the debtor specifically raising such a dispute with the creditor before the dispatch of a notice under Section 8 of the Code by the creditor. Similarly, in the case of financial creditors, the tribunals have been reluctant to allow debtors to raise such objections to resist petitions under Section 7 of the Code by banks for default in repayment of loans.

Therefore, in the aforesaid scenario, the raising of the threshold will definitely have a certain ameliorative impact inasmuch as it would ensure that a delay or default in the payment of relatively minor amounts will not push a company into insolvency in the current scenario, where such delays and defaults are likely to have arisen due to the Covid-19 pandemic. Suspension of Sections 7, 9 and 10 of Code may also help further in this regard and may be called for if the situation further aggravates.

However, there have been reports that the revision of the threshold may not be temporary and may be, in fact, permanent. Such a move would be counter-productive to the goal of protecting MSMEs. The reason why the Code has been so popular for operational creditors is due to the summary nature of the proceedings which provide a relatively speedy avenue for MSMEs to ventilate their grievances as to non-payment of dues as compared to other remedies available in law.

Another advantage under the Code, is that once an application for initiation of Corporate Insolvency Resolution Process (‘CIRP’) is accepted, there is tremendous pressure on the debtor to settle the matter if the debtor is unable to convince the appellate tribunal (‘NCLAT’) to grant a stay, as control of the corporate debtor is taken away from the current management. In other legal proceedings, most of the time, the creditor is unable to freely recover the money until the appellate proceedings are completed for one reason or the other. An over-view of the jurisprudence that has emanated from the NLCAT thus far would reveal that the NCLAT has been extremely circumspect in granting an order of stay on the initiation of the CIRP process, and the same has been resorted to only in exceptional cases.

As compared to the other remedies available in law, where there is no pre-existing dispute, the Code has shown itself to be a rapid remedy and also an overall cost effective one. The object of operational creditors has been for the most part to get the corporate debtor to settle the matter and recover the dues as they are on a weaker footing as far as recovery of dues by the process of resolution in the long run is concerned. The creditors have been quite successful in such an endeavour[2].

The effectiveness of the Code, may be seen from the fact that even banks, which have colossal resources at their disposal, have been making extensive use of the Code for recovery of loans in priority to other remedies available in law. However, the Code has especially been a blessing for small vendors, businesses, MSMEs and proprietorships which do not have the financial capacity to wage long-drawn legal battles. The debts owed to such entities are relatively minor amounts and, in many cases, do not amount to Rs. One crore or more. The summary nature of the proceedings under the Code reduces the legal costs involved and increases the likelihood of swift settlement of claims.

Previously, even in cases of debts which had not been disputed, such small businesses were unable to recover such debts as they could not afford to enter into full-blown litigation which would last years, and would result in eventual realization of the due sums only after the matter had attained finality all the way upto the Supreme Court. Even the Micro, Small & Medium Enterprises Development Act, 2006 (‘MSMED Act’) which sought to solve the problem of delayed payments to MSMEs has had limited effect partly due to the lack of availability of sufficient judicial infrastructure, and partly due to the non-summary nature of proceedings. Even though under the MSMED Act a generous rate of interest is awarded for the delayed payments, such small businesses, unlike large companies, do not have the financial capacity to engage in a time consuming legal process even if the end reward would compensate them for their troubles.

For such businesses, delayed justice is truly justice buried as they would silently bear the losses suffered instead of engaging in litigation. The Code has become the only source of relief for numerous such small creditors. This is notwithstanding the fact that the Code is principally not intended as mechanism for ‘recovery’. However, the intent of putting in place a legislation aside, the true test of its efficacy lies in how it is embraced and operationalized by a large set of litigants for a desirable purpose. It needs no gainsaying that the timely payment of admitted dues to a deserving entity is not only a desirable end-result for the entity concerned at a micro-level, but is also beneficial for the economy of the country as a whole at a macro-level.

If the increase in the threshold for initiation of CIRP under the Code by a hundred-fold is made permanent, then the message which would be sent would be that if companies default on payment to small scale vendors, individuals, MSMEs etc. wherein the default does not usually amount to more than Rs. One crore, they do not deserve to be pushed to insolvency, and only in case of default of more than Rs. One crore, do companies deserve to be pushed into insolvency.

As already pointed out hereinabove, such a move would be immensely deleterious to the interest of smaller entities. Either the threshold should be revised once the emergent situation has been resolved or a new and equally effective mechanism under the law has to be evolved for debts which have not been disputed, which provides for swift and cost-effective justice particularly for small scale enterprises, otherwise such small-scale creditors may be left with no practical legal recourse.

The author is an advocate practicing at New Delhi.

[1] https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf

[2] https://www.businesstoday.in/current/economy-politics/ibc-forces-companies-to-settle-rs-1-lakh-crore-debt-out-of-court/story/294673.html