[By Urmil Shah]
The author is a third year student of Auro University, Surat.
Introduction
The Ministry of Corporate Affairs on 24 March, 2020 raised the minimum threshold requirement for initiating a Corporate Insolvency Resolution Process (“CIRP”) under Section 4 of the Insolvency Bankruptcy Code (“IBC” or “the Code”) from existing Rs. 1 lakh to Rs. 1 crore by way of Notification S.O. 1205(E) as measure for combating the Covid-19 pandemic. Among other relations and exemptions to companies from routine disclosures and compliances announced by the Government in wake of the recent pandemic, the increase in threshold comes as controversial as the measure has the effect of spurring a conflict between Corporate Debtors (“CD”) and Financial Creditors (“FC”). A similar debate arose when the Central Government reduced the pecuniary jurisdiction of the commercial courts under the Commercial Courts Act, 2015 from Rs. 1 crore to Rs. 3 lakhs in wake of making it more accessible to common people.[i] The effect was that it led to multifold increase in litigation in these courts which was earlier being settled or resolved through alternate modes of resolution. Similarly, the change of threshold requirement for determination of default and triggering insolvency for corporates in the IBC follows both affirmation and depression in itself.
The Finance Minister mentioned that such a step is taken due to limited functioning of the MSME sector on account of pan-India lockdown and to avoid large-scale insolvencies as a result of financial distress to such small companies and MSMEs. Such a legislative reform is a welcome relief due to the virtual shutdown of the economy and suspension of business is bound to have domino-effect across contracts entered into between parties and trigger the force majeure clauses in the contracts resulting in either frustration or non-performance of such a contract. Resultantly, the Ministry of Finance announced that the pandemic can be treated as a natural calamity and the force majeure clauses maybe invoked as consequence when required. The critical question to be addressed is whether the change is temporary in nature on account of the pandemic or permanent as it may well be counter-productive to the interest of certain class of small yet significant creditors like MSMEs and home buyers and may defeat the purpose of safeguarding the interest of MSMEs.
MSME Sector – A Bouncing Bouncer?
The Micro Small and Medium Enterprises Development Act, 2005 (“MSMED Act”), although does not provide for a specific mode for recovery on account of insolvency for the MSMEs but addresses the issue by alternative mode of resolution to delayed payments and offers a handsome rate of interest at 18% for such delay. The present notification in no way benefits the MSME sector as 97% of the sector operates as either proprietorship or partnership, the insolvency provisions for which have not been notified yet.[ii] Even the remaining 3% of the MSME sector which are companies, a majority of them are Operational Creditors (“OC”) [iii] themselves[iv] and have utilized the mechanism as a means to find resolution of their dues and not that of the defaulter, thereby going against the legislative intent behind enactment of the Code to have a resolution mechanism in place for insolvent businesses.
MSME as creditors: Since the companies within the sector operate at a miniscule level with limited capital requirements, their offerings are not as huge as FCs of other sectors and accordingly the debt rendered by them will be classified as operational debt. The notification of increased threshold will have the effect of nullifying the benefit that these creditors earlier obtained as actionable claim against the default which would have previously been qualified to initiate CIRP as it is impractical to expect a single OC to have a claim as high as Rupees 1 crore,[v] considering the fact that OCs triggered almost 53% of the CIRPs for the quarter Oct-Dec, 2019.[vi] Such a reform goes against the spirit and letter of law as decided in the Swiss Robbins case[vii] to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders.
MSME as debtors: The amendment comes as knight in shining armor for the limited MSMEs who are CDs as it has been discoursed that the Code does not offer the most effective regime for the insolvency resolution of smaller CDs.[viii] It is in concurrence with the spirit envisaged by the Insolvency Law Reforms Committee that the sector is key driver of economic growth, entrepreneurship and financial inclusion in the country.[ix] The selected CDs of this sector will be benefitted for the time being from unnecessary and excessive insolvencies due to the increased threshold limit.
Homebuyers – The Active Creditor Class?
An important consideration for homebuyers is that the Real Estate (Regulation and Development) Act, 2016 (“RERA Act”), provides for refund of amount received for carrying out the project including compensation in case of withdrawal by the allottee and monthly interest for delay in possession by the promoter in case of non- withdrawal from the project. Considering this remedy for homebuyers, approaching the insolvency court is only a mode of forum shopping and liquidating happy-going businesses for a meagre sum of default, considering the quantum of claims received by NCLTs and NCLAT, the adjudicating authority and appellate mechanism envisaged under the Code.
Since the formation of Code in 2016, homebuyers have been the most active creditor class and have triggered several amendments, including the Second Amendment Act, 2018 which declared them as FCs.[x] However the controversial IBC Amendment, 2019 which introduced a minimum threshold limit of 100 or 10% of allottees in a project or class of investors to approach the Adjudicating Authority for initiating CIRP, is challenged before the Supreme Court. The interest of homebuyers from standpoint of both legislature and judiciary is clear to place their benefit over and above the other creditor class. The present notification however is not likely to have a major implication considering their status under the Code, as the claim of 100 or 10% of the allottees can easily amount to 1 crore. The critical consideration however is that if the Supreme Court declares the 2019 Amendment unconstitutional in nature, then the 2020 notification is going to have massive implications on the said creditor class as constituting an individual claim of at least 1 crore will become difficult.
Conclusion
The present change will indeed reduce the burden of insolvency application on the adjudicating tribunals as it will not just significantly curb the issue of frivolous petitions, but also reduce workload in light of Covid-19. The earlier threshold of Rs. 1 lakh presented numerous challenges to corporates, as aside from FCs, OCs including suppliers, distributors and employees can also trigger insolvency process for a meagre default. It must be understood that businesses are a going concern and in times of uncertainties or slowdown there may be situations of defaults on their part; however, initiating CIRP – taking away the management of the debtor, issuing a moratorium and a threat of possible liquidation on conglomerates only amounts to a colorable coercion. It also results in economic damage by way of loss of jobs and in no way improves India’s position in the Ease of Doing Business Index. Several alternatives have been considered, to replace the existing determination of default by way of minimum threshold, like a certain percentage of overall dues of the debtor.
The raising of the threshold limit is a much-needed reform, considering the clogging of cases at such specialized tribunals and alternative remedies available to both homebuyers and MSMEs for a relatively small debt resolution. There can be no denial over the significance of MSMEs in the economy and the value that homebuyers add to the overall infrastructure support of the country and the present notification is only a step forward in developing the nascent Code. The greater concern is the announcement that the Government is deliberating temporary suspension of Section 7, 9, 10 of the Code to aid the limited working of NCLTs and regulate unnecessary insolvencies on account of force majeure.[xi] However certain clarifications still remain about the operation of the notification and its implications on existing disputes, like OCs who have served default notice upon the CD; however, yet to file insolvency application before NCLT.
End Notes
[i] S. Sethuram, Speedy Resolution of Commercial Disputes in India: An Analysis of Recent Reforms, 2 Ico. Res. Eng. J. 1 (2018).
[ii] The FISME Factor, Fortnightly Bulletin of FISME, Vol. 7 Issue 188 (2019).
[iii] These are creditors who are owed operational debt in nature of provision of goods or services.
[iv] Insolvency Law Committee, Report of the Insolvency Law Committee. (2018). Para 27.3. http://www.mca.gov.in/Ministry/pdf/ 20 ReportInsolvencyLawCommittee_12042019.pdf.
[v] Megha Mittal & Shreya Jain, IBC Threshold Raised: Analysis and Implications, IndiaCorpLaw March 28, 2020 https://indiacorplaw.in/2020/03/ibc-threshold-raised-analysis-and-implications.html.
[vi] https://ibbi.gov.in/uploads/publication/62a9cc46d6a96690e4c8a3c9ee3ab862.pdf.
[vii] Swiss Robbins Pvt. Ltd. v. Union of India, AIR 2019 SC 73.
[viii] Shreya Prakash, Re-designing the Fast Track Insolvency Process in Insolvency And Bankruptcy Code: A Miscellany Of Perspectives, Insolvency and Bankruptcy Board of India (2019) https://www.ibbi.gov.in/uploads/publication/2019-10-11-191135-wv5q0- 2456194a119394217a926e595b537437.pdf.
[ix] Insolvency Law Committee, Report of the Insolvency Law Committee. (2018). Para 22.3. http://www.mca.gov.in/Ministry/pdf/ 20 ReportInsolvencyLawCommittee_12042019.pdf.
[x] The constitutionality of the provisions was affirmed by SC in Pioneer Urban Land and Infrastructure Limited Union of India, AIR 2019 SC 43.
[xi] https://pib.gov.in/PressReleaseIframePage.aspx?PRID=1607942.
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