The much awaited a m e n d m e n t s t o the Insolvency and Bankruptcy Code, 2016 (“Code”) were brought into effect on June 5, 2020 with the President promulgating the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (“Ordinance”). This Ordinance introduces two amendments to the Code to address the economic distress and disruption arising caused by the COVID 19 pandemic related lockdowns in India and abroad.
The first, and most critical amendment introduces Section 10A to the Code. This prevents an application from “ever” being filed for initiation of a corporate insolvency resolution process (“CIRP”) under Sections 7, 9 and 10 of the Code for any default occurring on or after March 25, 2020 up to September 25, 2020. This period may be extended to any day up to March 25, 2021) (“period of suspension”). An Explanation to Section 10A also provides that the provisions of this section shall not apply to “any default committed under the said sections before 25th March, 2020”. It appears that this amendment has been introduced inter alia, to ensure that distress caused by the pandemic is resolved with forbearance on part of lenders, and that premature recourse to insolvency proceedings is avoided; to ensure that we ‘flatten the bankruptcy curve’ so that institutional infrastructure, particularly the National Company Law Tribunal is not overwhelmed with fresh cases and to prevent a situation where a large number of assets are made available for sale under the Code, and have to be sold at lower values during a period of macro-economic distress.
The second amendment introduces a new sub-section (3) to Section 66 of the Code. This prevents an action for wrongful trading from being filed against a director or partner of a corporate debtor in respect of a default against which initiation of the CIRP is suspended under Section 10A of the Code.
These amendments are in addition to two previous measures taken in response to the pandemic i.e. the notification of a higher default threshold of INR 1 crore (revised from INR 1 lakh previously) and the relaxation of timelines to complete any activity under the regulations for CIRP and Liquidation. All four measures, particularly the introduction of Section 10A, are likely to have significant implications and impact on the resolution of corporate distress going forward.
Analysing the amendments to the insolvency framework
Section 10A of the Code provides for suspension against initiation of CIRP for defaults committed after March 25, 2020. The section introduces an objective criteria i.e. of a cut-off date of March 25, 2020, for treating defaults post this date as pandemic induced defaults and hence, grants relief of suspension. The defaults prior to March 25, 2020 that are unlikely to have been caused by the pandemic for being defaults prior to the first day of lockdown, have been kept out of suspension. Therefore, fresh filings and pending applications for defaults prior to March 25, 2020 are permitted. This lays to rest the uncertainty caused by previous announcements of the Finance Minister, which had indicated that initiation of CIRP could be suspended for all defaults. It is also clear that this suspension does not prevent recourse to remedies against personal guarantors (under Part III of the Code) or remedies for debt enforcement including under the Recovery of Debts and Bankruptcy Act, 1993 and SARFAESI Act, 2002.
The increase of threshold from Rs. 1 Lakh to Rs. 1 crore for initiation of the CIRP, just like Section 10A, is to make it more difficult to initiate CIRP. This measure, however, appears to have been contemplated by the Government even before the onset of pandemic as well. The Insolvency Law Committee for instance, had already identified that the threshold of INR 1 lakh to initiate default may be too low, due to which a large number of applications were clogging the NCLT infrastructure and increasing the chance of even solvent debtors being pushed into CIRP which would lead to sub-optimal outcomes. As such, the revision of the default threshold is a permanent measure as against suspension undersection 10A, and is likely to have a long-term impact, particularly on operational creditors, who often have recourse to the Code at lower levels of default and use this as a bargaining mechanism to reach out-of-court settlements with the debtor.
In addition to these, Section 66(3) also makes it harder to hold directors responsible for wrongful trading. Generally, an application for wrongful trading can be filed when directors/ partners do not act to minimise the loss to creditors when they know insolvency commencement is unavoidable. While the section is not very clearly drafted, it essentially, prevents an application for wrongful trading from being filed against a director or partner if they did not take measures to minimise loss to creditors when they knew a default for which initiation of CIRP could not be avoided. While the section prevents an application for wrongful trading from being filed, and the consequence (i.e. passing of a contribution order), it does not suspend the duty of directors/ partners to minimise loss to creditors when they know that the company may not be able to avoid insolvency. This is particularly the case for directors, since under common law, their primary duty shifts from shareholders to creditors in the zone of insolvency.
In other jurisdictions, measures similar to Section 66(3) have the effect of ensuring that directors do not feel duty-bound to initiate insolvency resolution processes, and essentially contribute to reducing the number of cases that enter formal insolvency processes unnecessarily. However, in the Indian context, it is less clear what the purpose behind this section is given that initiation of CIRP is already suspended.
Finally, regulation 40C and regulation 47A to the regulations relating to CIRP and liquidation, respectively also provide flexibility in the timelines for the conduct of ongoing processes. These regulations exclude the period of lockdown imposed by the Central Government in wake of the pandemic for the purposes of calculating the time-frame of any activity in the CIRP or liquidation process prescribed under the regulations that could not be completed due to such lockdown. However, this exclusion is subject to the time limits provided under the Code, which include time limits for activities such as formation of the Committee of Creditors and the period of CIRP being limited to 180 days or 270 days, if extended; and overarching timeline of 330 days for the completion of CIRP including legal proceedings. Given this anomalous situation, the National Company Law Appellate Tribunal (“NCLAT”) has in suo moto cognizance also passed an order on March 30, 2020, holding that the period of lockdown shall be excluded in calculating the period of CIRP. However, on a technical view of the matter, questions can be raised as to whether NCLAT, as a Tribunal, has the inherent jurisdiction to pass such an order or not.
Impact of the amendments In introducing these four measures, particularly the two in the Ordinance, the Government follows the approach taken by a large number of countries to prevent unnecessary insolvency resolution proceedings from being initiated at a time when there is widespread economic distress; to safeguard directors from wrongful trading actions; and provide more flexibility in insolvency resolution proceedings.
The success of the Government’s approach is that it prevents unnecessary insolvency resolution proceedings and applications against wrongful trading in a relatively objective and narrowly tailored manner. For one, the measures in the Ordinance are rightly limited to COVID 1 9 p a n d e m i c r e l a t e d defaults. This means that the amendments provide targeted relief to those businesses whose activities are impeded due to the pandemic. Such an approach prevents recalcitrant debtors from abusing the suspension on initiating CIRP. This also ensures that all creditors have access to the Code to resolve the insolvency of entities that had found themselves in default much before the COVID 19 pandemic had effect, and to that extent reduces the chances of financial sector distress arising from lack of an efficacious framework to resolve such insolvencies.
This approach also broadly ensures that the disruption to the insolvency ecosystem is comparatively lower since CIRP may be initiated where defaults have occurred unlinked to COVID 19 pandemic, meaning that institutional capacity of the nascent insolvency eco-system will not dissipate, with insolvency professionals and other specialist financers, lawyers and professionals continuing to invest in this eco-system.
This deserves special appreciation, since the Government seems to have refined its approach in response to feedback that it would be announcing a blanket suspension on initiation of CIRP on any default at any time for a specified period, which would have left creditors completely remediless for all defaults, and would have created a huge backlog of cases to be filed and dealt with once the suspension would have been lifted.
Second, by identifying COVID 19 related defaults based on an objective trigger of date, the Ordinance avoids unnecessary litigation on what defaults are induced by COVID 19 and therefore preserves systemic capacity.
Finally, by limiting the time of suspension, and not suspending other actions against fraudulent trading, it also has a strong signalling effect that gains of the Code, particularly the behavioural change in debtors should not be dissipated.
What more can be done? That said, there is scope to supplement the four measures already taken.
Need for mechanism to address pandemic-induced insolvencies & stress
The Ordinance sets out with the objective of preventing initiation of CIRPs for a specified period. This may be helpful to address those cases where default is temporary and can be cured within the suspension period. Understandably, this may also be helpful in those cases where there is a belief that the features of the Code, including change of control and Section 29A will prevent effective resolutions.
However, there may be many cases where COVID 19 pandemic induced defaults actually signal deeper distress that requires resolution. Ideally, such distress should also be tackled at the earliest possible time so that value is not lost.
In such cases, there is a need for a statutory mechanism that would enable such distress to be tackled today. This is necessary to ensure that all types of creditors can come together under a structured framework and be bound by the consequences of this framework.
This is not possible in the mechanism under the Reserve Bank of India’s (“RBI”) June 7, 2020 circular since it only applies to RBI regulated entities, and it does not bind all creditors till they sign an inter-creditor agreement, which many do not.
Having a statutory mechanism could also help provide a ‘breathing space’ to debtors, by preventing piecemeal (and often, value destructive) debt enforcement actions from being taken. This too is not entirely prevented at present, since recourse under debt enforcement legislation is not barred. Finally a statutory mechanism can also provide certain preferential treatment to new credit, which could enhance the confidence of current lenders to provide more finance, which too cannot be made available in an informal restructuring easily. As such, the Ordinance lost an opportunity to offer a solution to this constraint.
All of the above, however, can still be addressed by providing a tweaked mechanism within the Code to allow debtor in possession insolvency resolution process. This would create an alternative statutory platform for insolvency resolution of COVID 19 pandemic induced insolvency cases. This alternate platform can be designed retaining those features of the Code that are suitable for insolvency resolution in such a changed macro-economic scenario (particularly, the moratorium, priority to interim finance, cram down of creditors and binding effect of a resolution plan under the Code) and dispensing and/ or tweaking aspects which do not suit for such insolvency resolution processes.
Such a process can be created by either allowing debtors to take recourse to a modified form of CIRP under Section 10 or creation of another parallel process by amalgamating successful elements of current form of CIRP under the Code and leaving aside the more stringent elements (such as creditor in possession, Section 29A ineligibility norms etc). Certainly, drafting of such an alternate parallel process within the Code, has to ensure that this parallel resolution platform is not mis-used to dilute the deliberate stringent elements of the Code and creditor discretion to reject recourse of such alternate mechanism in non-deserving cases.
Addressing pending CIRPs
The above apart, one of the reasons for the Ordinance to provide for suspension is to deal with a situation where it is difficult to find an adequate number of resolution applicants to rescue corporate debtors. Regardless of the wisdom of this forward looking measure, especially in a scenario where the outlook for recovery is not clear, it is certain that the Ordinance does not do enough to deal with those CIRPs that are ongoing and where resolution plans are being sought or pending implementation. While case-by-case directions are being passed to deal with specific issues in such cases, it may have been helpful for the Ordinance tp create windows for special classes of investors such as ARCs or strategic stress debt asset players to help in resolving those cases that are already in CIRP, and/ or provide for mechanisms to deal with issues of implementation of resolution plans already approved by the committee of creditors or NCLTs in changed macro-economic environment. Supplementing the measu r e s a l r e ady t a ke n , through some or all means suggested above, would also have the benefit of rounding out the peculiarities of the Code in the long-term as well.
In conclusion, therefore, it is critical for the Government to keep working towards introducing measures to address COVID 19 related problems in insolvency law, and to view this also as an opportunity to strengthen the framework of insolvency resolution in India, so that it can be a reliable all-weather framework, that can deal with a COVID 19 like economic shock without intervention in the future.
[Misha is a partner in the insolvency and bankruptcy practice, and Shreya Prakash is an associate at Shardul Amarchand Mangaldas & Co.]