IBC suspension: A path to economic revival or prolonged endangerment?

Although the executive intent behind temporarily suspending the Code is understandable, shutting down a working system without creating a buffer mechanism isn’t reassuring.

The Union Government has issued The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 to amend the Insolvency and Bankruptcy Code (IBC) and provide relief for loan defaults by companies occurring on or after March 25th 2020, the day of initiation of the nation-wide lockdown. The Ordinance grants relief on defaults initially for a period of 6 months which may be extendable to one year. This move has enabled debtridden corporate borrowers to gain some respite, in the present climate of economic distress, aggravated by the crippling lockdown. The Ordinance, however, does not impact the ongoing proceedings before the NCLTs.

The IBC has been one of the most dynamic pieces of legislation, evolving periodically with the demands of the market and aiming at bringing resolution to firms in financial distress, by emphasising on ‘value preservation’ of the debtor and focusing on maintaining the Corporate as a ‘going concern’. Resolution is the keyword. Processes include engagement of a Resolution Professional, restructuring of the debt etc. Landmark judgments have helped settle several contentious, conceptual and practical issues, thus bringing in clarity and predictability.

Insolvency and Bankruptcy are within the ambit of Entry 9 of the Concurrent List in Schedule 7 of the Constitution of India. Does this enable the Union Government to bring drastic amendments in the legislation, even those extending to suspension of statutory provisions, and thereby statutory rights, for a given period? Maybe it does.

However, several questions arise on whether this Ordinance enables the Corporate Debtor to survive or would it prove to be counterproductive in several ways.

Firstly, the Code enables a stressed debtor, under section 10, to initiate voluntary insolvency proceedings if the management opines that such a procedure would be in the best interest of the Company to preserve its value. The Ordinance is thus a hindrance to the Company to enable a restructuring and stop further value deterioration. The letter and spirit of IBC are based on the primary pillars of ‘value preservation’ of the Corporate debtor- either by the same management or by a new investor.

Secondly, the initiation of Corporate Insolvency Resolution Process is not necessarily a death-knell for every Company. The law contemplates the engagement of Resolution Professionals who take over the Company to keep it as a ‘going concern’. Value preservation is the key mantra even if resolution fails and liquidation begins. Suspension of IBC may reduce the inherent value of some Companies which are capable of regeneration but. Alas, would have no option to continue under management which has neither been able to resurrect it nor find suitable investors.

Thirdly, initiation of IBC kicks in a period of Moratorium under Section 14 of the Code wherein no judicial proceedings for recovery, enforcement of security interest, sale or transfer of assets, or termination of essential contracts can be instituted or continued against the Corporate Debtor.

Suspension of IBC may hamper the recovery prospects of those Companies whose ‘value’ could have been preserved. Of course, financial creditors would have to deal with increasing volumes of non-performing assets–a situation which the Government was relentlessly trying to overcome in the pre-lockdown phase. The Proviso to Section 2 of the Ordinance allows blanket prevention from initiating insolvency proceedings against the debtor for any loan default that occurs after March 25th, 2020 till the suspension lifts. This is especially disconcerting since now there is no requirement for unscrupulous debtors to prove ‘default’ in connection to COVID19 affected lockdown and they can wilfully default for any reason they wish without recourse for the said period.

Furthermore, Section 3 of the Ordinance extinguishes the right of Resolution Professionals under Section 66 of IBC to apply for establishing the liability of directors of the corporate debtor in cases of wrongful or fraudulent trading. This would apply for the time of suspension as well, thus reaffirming the idea that defaults made on the most illegal grounds have been absolved from the application of the Code. In a scenario where banks and NBFCs are severely leveraged already on account of the RBI-issued moratorium on loan payments, the inability to initiate insolvency proceedings will simply push them into the brink of insolvency themselves. Creditors have not welcomed this move as they feel it would affect the credit culture, which has improved in the last couple of years on account of the fear of IBC.

On the other hand, some relaxations of IBC proceedings may benefit entities who honestly desire to pull themselves out of a financial pitfall but are unable to do so on account of both the global lockdown as well as the global economic crisis which may delay the entry of foreign investors from taking over stressed assets.

The solution seems to lie in a midway approach. Complete suspension of IBC proceedings for a period of 6 months, extendable to a year, maybe counterproductive in some cases. Surely it would not align with the spirit of IBC to ensure that there is value preservation, and the Company continues to be a going concern. Many such going concerns may ultimately hit the death-knell making their resurrection after a year near impossible.

The Government may consider- (1)permitting Companies to undertake voluntary resolution if the management is of the view that such a move would save the Company from deterioration; (2) suspending the provisions of 29A for one year to enable some promoters to work on the resolution of the Corporate actively.

 The Government may also consider introduction into the Code of a pre-pack sale, a known concept in the US and UK, where the Company and the Creditor negotiate and settle the terms for restructuring the Corporate Debtor in advance of filing for insolvency.

Pre-pack sale, as defined by the Association of Business Recovery Professionals is, “an arrangement under which the sale of all or part of a company’s business or assets is negotiated with a purchaser before the appointment of an administrator, and the administrator effects the sale immediately on, or shortly after, his appointment”

There are several advantages to a PPS. Firstly, it ensures better ‘continuity’ of the business which has been the core principle of the Insolvency regime. It saves on the overhead administrative costs of the insolvency process which the Company could ill afford. It helps reduce the burden from the already overburdened NCLTs. The Creditors would benefit and the Nation too, would benefit from a reduction in the volume of NPAs.

On the other hand, there are several disadvantages too. The PPS should not be used as a tool by the directors of a stressed Company to shed their liabilities. Another danger that the law has to plug is that it should not facilitate the protection of interests of the managers and secured creditors ahead of those of the unsecured creditors. The speed and secrecy of the deal between the secured creditors and the Corporate Debtor could leave the unsecured creditors in the lurch.

Although the executive intent behind temporarily suspending the Code is understandable, shutting down a working system without creating a buffer mechanism isn’t reassuring. The increase in threshold limit to initiate insolvency proceedings in MSMEs to Rs. 1 crore will facilitate several debt stricken Companies.

Likewise, the Government could conceive alternate action-plans, for example, empowering the Tribunals with discretion over admitting cases.

The impending amendment to insolvency framework of MSMEs is also a laudable and long-awaited proposition. The ultimate focus must be to boost the financial health of companies and format the law to pull the sinking economy out of the pandemic-stricken abyss.

 Dr. Poornima Advani is Partner, The Law Point and has served as Chairperson, National Commission for Women.