Restructuring in Covid: Reinventing the old wheel


The recent notification of Insolvency and Bankr uptcy Board of India has clarified that no application for a CIRP can be filed under IBC, for any default arising on or after March 25 for six months or such further period as may be notified for this purpose. Though the notification states that this facility cannot exceed one year, companies are already looking for alternative ways to handle the financial stress that they are facing. It is highly likely that amidst the current crisis more companies will need to restructure their debts to address liquidity constraints and to rightsize their balance sheets.

 Interestingly, since its inception, IBC has been one of the most celebrated tools for debt restructuring. Now the fresh filings being suspended, there are two more routes i.e. June 7 circular which is an out of court restructuring method and is purely contractual in nature, secondly under Schemes of Arrangement which is a semi formal mechanism for restructuring under companies Act.

Scheme of Arrangements though popular for other forms of restructuring like mergers and amalgamation, has been scantily used as a debt restructuring mechanism in India. It is one of the oldest technique of debt restructuring and is still one of the most favored mechanism in other jurisdictions like UK and Singapore due to its inherent benefits. However, when it comes to India, purely contractual restructuring in form of inter-creditor agreement, currently under June 7 circular, has gained more acceptability amongst debtors and creditors despite of its own inefficiencies.

Between the two available options, Restructuring in June 7 Circular suffers from some inherent limitations. It has restricted applicability as this mechanism is only available to entities regulated by RBI. This leaves behind a myriad of other lending institutions such as foreign banks, bondholders and operational creditors such as suppliers and employees from its benefit.

On the other hand, the scheme holds more potential for debt restructuring as it is flexible and binds the parties once the court approves it. More flexibility has been added through a series of judicial decisions that given wide interpretation not only to the word “scheme” or “arrangement” but also to the word “creditors” wherein contingent creditors have also been brought under the definition of scheme.

Further, courts have generally interpreted the terms ‘compromise’ and ‘arrangement’ broadly to encompass various types of transactions that include financial restructuring, as well as corporate restructuring that might involve the sale of assets or business of the debtor company or its amalgamation with another company or a combination of both. This provides sufficient flexibility to the debtor company and its creditors to negotiate using various types of restructuring options.

Unlike purely contractual out of court restructuring mechanisms, schemes being semi formal in nature have inherent benefits of both formal and informal restructuring. Scheme has a binding effect on the debtor company as well as all the creditors who come within its purview, including the dissenting creditors.

This avoids the ‘hold out’ problem commonly faced in restructuring of companies with several small creditors, some of who may seek to realise a better deal by opting out.

Despite the advantages, schemes are not a popular method of debt restructuring in India. One of the main criticisms is that the process is cumbersome as it requires court approvals. Further, it has to withstand the test of fairness and reasonableness. Due to this reason, despite being of wide import, it has traditionally been regarded as “unsafe” and “tedious in practice. However, with transition of the scheme jurisdiction from the High Courts to the newly established NCLT under companies Act 2013 and significant increase in number of NCLT benches as well as judges, this drawback needs to be reconsidered.

The only considerable disadvantage of Scheme when compared to restructuring under June 7 Circular is the benefit of a contractual moratorium that enables parties to negotiate and effect a restructuring without the fear of enforcement actions by one or more creditors. The erstwhile companies Act of 1956, provided for provision for moratorium during scheme of arrangement, at the discretion of NCLT. The same was done away with the enactment of Companies Act 2013. It may be time to reconsider bringing back the old jurisprudence.

India is mulling over introducing a prepack mechanism to counter the benefits of suspension. Considering the fact that the efficacy of prepacks in several developed jurisdictions has been questioned, it will be better to focus on the existing mechanism of the scheme than introducing a new mechanism in haste. Policy makers should mull over methods through which the benefit of moratorium that creditors enjoyed under IBC can be extended in case of scheme. Such endeavor will help us act in time to counter the crisis of stress in business through tweaking of existing frameworks. Neeti Shikha, Head Centre for Insolvency & Bankruptcy, Indian Institute of Corporate Affairs.

Urvashi Shahi, Senior Research Fellow, Centre for Insolvency & Bankruptcy, Indian Institute of Corporate Affairs.