Critical Appraisal of Sec. 14(2a) of IBC: Essential Goods And Services

[By Samar Pratap]

The author is a student at the Institute of Law, Nirma University.

 

Introduction

The third parties are prohibited from terminating, stopping, or interrupting the supply of essential goods and services to the corporate debtor under Section 14(2) of the Insolvency and Bankruptcy Code (hereinafter referred as “IBC”). The Insolvency and Bankruptcy Board of India Regulations 2016 (CIRP Regulations) describe “essential goods and services” broadly, referring only to four types of supplies: (a) electricity, (b) water, (c) telecommunication services, and (d) information technology services. The four materials are considered basic necessities for any corporate debtor to stay in business, and they are not intended to be supplied in large quantities for commercial gain.

In fact, NCLTs have not only restored the corporate debtor’s supply of these goods but have also gone beyond the limits of this provision to order the continuation of other supplies that were deemed essential to the corporate debtor’s operations. The Insolvency Law Committee concluded in a report reviewing problems with the IBC’s implementation that the four listed supplies might not be sufficient to keep the corporate debtor operating as a going concern, and that other important supplies, such as input supplies, may be needed. Further, the Insolvency Law Committee noted that, during the CIRP, personal negotiations with providers to extend existing contracts were not every time effective, particularly when supplies are difficult to replace and suppliers who exist seek a large sum of money to retain supply.

The Insolvency Law Committee proposed that the IBC be revised to allow for more flexibility in determining the products and services that are essential for the corporate debtor’s operations. The IBC’s adoption of Section 14(2A) gives legislative effect to this viewpoint, allowing Resolution Professionals (RPs) to prohibit the termination of products and services that they consider ‘critical to protect and maintain the value of the corporate debtor and control the operations of such corporate debtor as a going concern.’ During the moratorium period, the suppliers, on the other hand, are not obligated to continue supplying if there is a default for the payment of supplies on the part of the corporate debtor. Although more information about how this amendment will be implemented is awaited.

Inconsistencies in Amendment

Both, the proposed CIRP Regulations or the Insolvency and Bankruptcy Code do not include any guidelines about how to assess which supplies are essential. If the corporate debtor is able to find alternative suppliers, can the supply be deemed critical? What if engaging alternative supply is inefficient in terms of time? Different stakeholders can interpret the term important in different ways. According to the Insolvency Law Committee, Resolution Professionals (RPs) should determine whether the supplies have a direct and substantial nexus with keeping the corporate debtor functional, as well as whether they can be easily replaced. These criteria, however, were not included in the revised legislation. As a result, the concept of vital supplies is vague, and its application is left to judicial discretion.

Although an extensive list of critical supplies would negate the amendment’s aim. Therefore, there is a need for simple legislative conceptual frameworks for determining the scope of critical supplies. Suppliers and mediation experts would be able to decide if a specific supply can be terminated without resorting to formal adjudication processes with the help of such guidelines, such as – determining that supplies must have substantial and direct nexus with keeping the corporate debtor functional or supplies should be such, so as to maintain a balance between both the interest of supplier and the corporate debtor. This would reduce the amount of time and money spent on the resolution process, as well as the number of cases handled by insolvency tribunals. Such measures will bring uniformity and predictability to adjudication when parties approach insolvency tribunals for a formal decision.

No guarantee of reward & No guarantee of payment

Section 14(2A) allows the corporate debtor to pay for products and services rendered during the CIRP as a way of protecting essential suppliers. Suppliers have the right to stop providing services if the corporate debtor does not make timely payments. Although this offers a solution in the event of a payment default, suppliers are not given any specific guarantee of payment in order to maintain supplies. As a result, critical suppliers have no choice but to bear the dreadful chance of corporate debtor default. This risk is amplified if the contract calls for payment of products following delivery or performance of a service.

If we see at the laws in UK and US, they have more concrete provisions for essential suppliers, such as payment assurance in the form of guarantees or other agreed-upon means and personal responsibility for payment of materials by the insolvency representative. Essential suppliers should also be granted statutory protection, according to the UNCITRAL Legislative Guide on Insolvency Law. It states that a policy in this area should consider a variety of considerations, including the value of the contract to the proceedings, the expense of providing the requisite security to the proceedings, whether the debtor would be able to fulfill the obligations under a continued contract, and the effect of requiring the counterparty to bear the risk of non-payment. These features ensure that essential suppliers are paid regardless of the corporate debtor’s insolvency, and during the resolution phase, they have protected from financial liability if the corporate debtor experiences business or operational setbacks.

Incorporating essential supplier rights will not only provide the necessary comfort to those suppliers but also enable non-critical suppliers to continue doing business as normal, improving the corporate debtor’s value and efficiency. From a legal standpoint, it may be worthwhile to consider using the IBC’s creditor-driven system to pursue payment assurance. A financial creditor in the Committee of Creditors may provide security in the form of a surety, letter of credit, or other agreeable means on behalf of the corporate debtor if the COC tasked with pioneering the CIRP believes the corporate debtor is a sustainable organization. The financial creditor does not have to bear this risk alone; COC members will share the cost of such a guarantee in proportion to their voting rights. Any costs incurred as a result of invoking such payment assurance can be recouped as part of the ‘Insolvency Resolution Process Costs’, which are considered senior debt and charged ahead of all other dues owed by the corporate debtor.

This framework, in particular, maybe more feasible for a COC made up of banks and financial institutions. It could be difficult to arrange for such a guarantee to maintain supply for a small business with little to no financial creditors on the COC. As a result, in cases where formal means of payment assurance are not feasible, the IBC may consider other statutory safeguards, such as a requirement for advance payment for critical supply procurement.

Need for an Exception to Supply Continuation

Continuing to supply products and services to the corporate debtor, may not be economically viable for suppliers, especially small businesses, in some cases. For example, if payment terms were agreed at a discount based on projected forecasts like – the corporate debtor’s annual rise in purchase volumes, so, those projections would no longer be valid. The supplier will have to re-evaluate the deal to ensure that continued supply at reduced rates would not jeopardize its own economic viability. A similar analysis may be needed if the supplier is experiencing other difficulties, such as the effect of the COVID-19 pandemic on its market. The IBC, on the other hand, makes no exceptions to the mandate for essential supply continuity. It puts vital suppliers at risk of insolvency by putting pressure on them to succeed. Suppliers will be able to renegotiate key contract terms with the RP as a last resort, as renegotiations of existing contracts are not prohibited under the IBC. However, this is simply a statutory recourse, and any talks will be conducted at the RP’s discretion.

Conclusion

This emphasizes the importance of enacting legislation that allows for the suspension or termination of essential supplies in unusual circumstances. Insolvency tribunals can be empowered under the IBC to suspend or terminate a vital supply or issue other relevant directions if the supplier can demonstrate that continuing to supply will cause distress. The IBC has yet to prepare for these possibilities or conduct a similar balancing of interests. This ensures a balance of interests between the corporate debtor’s ability to continue operating and the level of resistance by the counterparty in order to achieve this aim.

The addition of Section 14(2A) to the IBC would undoubtedly assist corporate debtors in maintaining a steady supply of products and services from key suppliers. However, the amendment’s ambiguous wording and the lack of sufficient safeguards for essential vendors necessitate further legislative amendments

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