Pandemic Pandemonium: Suspension of Fresh Insolvency Cases

[By Ritik Khatri and Aanand Sanctis]

The authors are students at National Law University Odisha.

Prefatory

The Insolvency system in India has made considerable progress since its inception; it has been continually tried and has grown altogether over due course of time. Due to this pandemic, the Indian Economy has endured a severe effect and will eventually prompt its phenomenal breakdown. As indicated by IMF, this worldwide pandemic recession will be ‘way worse’ than the 2008 financial crisis, the pandemic will monetarily overburden the companies and send them to the brink causing the businesses, little or enormous go bankrupt.

The Finance minister while announcing the fifth tranche of the relief packages to mitigate the consequences of COVID-19 on the Indian Economy, also announced that there would be no fresh Insolvency filings under the Insolvency and Bankruptcy Code, 2016 (Code). Further, the President on 5th June exercising its power under article 123(1) of the Constitution promulgated an Ordinance which suspended Sections 7, 9 and 10 of the Code. The Ordinance suspends initiation of CIRP for any default arising on or after 25th March for a period of six months but not exceeding one year. The Ordinance inserts sub-section 3 to Section 66 which bars the Resolution Professional from filing application for the default which have stipulated under Section 10A. The amendment gives a buffer period of at least six months which will act as a breather to both creditors and debtors. This is a welcomed legislation when the Indian Inc. is hit by a plummeting economy in the Pan-India lockdown and saves them from the Insolvency proceedings.

Tracing the need for imminent succour

With the flow of revenue taking a significant hit throughout the last two months, the survival of MSMEs today is very much at stake. The shelving of Insolvency proceedings would be helpful especially for Micro, Small and Medium Enterprises (MSMEs). MSMEs will in general face expanded weights of Insolvency in the future and finding new financiers/purchasers and so on may end up being troublesome in a focused economy. The delayed time frame would permit the administration of these organisations to stay in charge of the assets and administration of the organisation. Without such suspension in the Code, these grieved endeavours will confront liquidation.

These MSMEs are majorly the operational creditors who do not have a claim in significant volumes. Their operations are mainly based on services and amidst lockdown they are experiencing an inflexible slowdown. MSMEs are not able to get their debts resolved due to the absence of the Code and further they will delay their payments bringing about log jam in the Economy.

The Government’s helping hand

The government had given ease when it came with the first notification which excluded the period of lockdown from the Corporate Insolvency Resolution Process (CIRP) and the second notification which excluded the period of lockdown in relation to any liquidation process. On the same day, the Government in the exercise of its power under Section 4 of the Code increased the threshold of default from ₹ 1,00,000 to ₹ 1,00,00,000. It was observed that a single financial creditor was able to bring a healthy company down to its knees due to such low threshold and this was also the reason that NCLT was struck with frivolous litigation.

Section 7 of the Code provides for financial creditors to initiate the CIRP proceedings against the corporate debtor, they are major entities like banks and financial institutions. The RBI declared an augmentation of the moratorium on loan EMIs by a quarter of a year, i.e. August 31,2020 hereby taking the EMI holiday to a time of a half year which was started on March 1st , 2020. The Hon’ble Supreme has also upheld the validity of the RBI circular dated 27.03.20 in the recent writ petition filed and directed the implementation of circular in letter and spirit.

With a rationale to build Aatma Nirbhar Bharat Abhiyaan, Finance Minister announced measures for alleviation and credit bolster related to businesses, especially MSMEs to support Indian Economy’s fight against COVID-19. As per the new definition of MSME any firms turnover upto ₹ 5 crore will be classified as “Micro” and upto ₹ 100 crore as “Medium”. Covid-19 related debts shall be excluded from ‘default’ under IBC.

Severe Consequences of the Suspension

The data as of December 31st 2019 reflects that, of the total number of cases filed for CIRP, 49.21% have been filed by an operational creditor which implicates the dominance of Section 9 cases amongst Section 7, 9 and 10 applications. Denying MSMEs (almost all are operational creditors) the right to invoke the Code will curb their recourse to the most suitable and efficient debt resolution mechanism present today. This seems to be against the purpose and the objective of the code to promote entrepreneurship, availability of credit and balance the interest of all stakeholders, which was validated in the Swiss Ribbons Case.

The suspension of fresh Insolvency may prove the major setback amid liquidity crunch in the financial sector. MSMEs are not able to get their debts resolved due to the absence of the Code and further they will delay their payments resulting in a slowdown in the Economy. The embargo on the initiation of fresh Insolvency proceedings tends to uncertainty in the Insolvency regime. The definition of Covid-19 debt for the default and the time period it will cover is still unknown. The World Bank Ease of Doing Business Index 2018 recognised India’s effort as in the year 2018, India became one of the top 10 improvers amongst the World. The ban on fresh Insolvency will reduce the reforms taken by the government in regards to Insolvency laws in India. The banks and financial institutions would bear the biggest brunt as it would subordinate them while re-negotiating loans with the corporate debtor.

 The objective behind the enactment of the Code was to shift the focus from debtor-in-control to the creditor-in-control regime. This was the primary reason behind the success of the Code. The incorporation of Section 10A will put back the onus in the hands of debtors. The introduction of Section 10A will increase the duty of existing directors of the company from equity shareholders to debtors. In present circumstances, the debtor who cannot meet the obligations of the creditor would indulge in defrauding the creditor and thereby diminutive the value of assets.

Complete restraint on the Section 10 application will deny the companies an opportunity for debt resolution and could lead to the closure of business of the company. A debt stressed company must not be forced to continue its business during this pandemic and all avenues of resolution of its debts should be kept open.

The Ordinance fails to differentiate between the debt that has occurred due to Pandemic and that could have naturally occurred without the COVID hit, this could have been achieved by altering the definition of default u/s 3(12) of the Code. The Ordinance was anticipated to include a special insolvency framework for MSMEs u/s Section 240A of the Code but fails to find any mention. The Ordinance provides a blanket protection u/s 66(3) of the Code which makes the management of the corporate debtor immune from fraudulent transactions which are very evident in such situation.

The Way Forward

It is high time when the government looked forward to reviewing Section 29A of the Code which prevents the management of the company from proposing a resolution plan in the CIRP proceedings. The current situation demands the shift from the presumption against the management and promoters as wrongdoers. There is a cash crunch in the market and because of low liquidity other promoters in the market may not propose a resolution plan for the company. The pandemic asks for faith in the current owners and management of the company for the maximum valuation of assets and optimal allocation of losses.

With the unavailability of the Code India will shift to the pre-IBC regime for the restructuring and resolution of debts. The parties may informally and mutually arrive at a solution in the form of Mediation, keeping it time-bounded. Secured Financial creditors can recover their debts through SARFEASI but the operational creditor is left with only recourse to prolonged litigation such as civil suits. The parties also can work out a solution under the prudential framework of RBI. The way forward should be by strengthening existing provisions by prescribing the stricter penalty for fraudulent and preferential transactions. Section 13 of the SARFAESI entitles the secured creditor to take over the management of the stressed asset of the creditor. The Companies Act provide for the restructuring wherein the company goes internal changes by the issuance of share capital, change in equity structure, buyback of shares et cetera. The other way round could be the merger of two or more companies and their resources and liquidity as given in Chapter XV of the Act (Section 230 to 240).

The Hon’ble Supreme Court has already upheld that there is an “intelligible differentia” in the classification of financial and operational creditors and has also said that the Code is beneficial legislation for operational creditors, the government could have provided different threshold for every class of creditors to keep the liquidity rolling instead of suspending fresh Insolvency cases. The BLRC report of February 2020 recommends “the operational creditors to be allowed to have recourse to CIRP on a minimum default of ₹ 5,00,000.”

Conclusion

While Section 10A might be sanctioned to give alleviation to monetarily annihilated businesses, it is by all accounts an automatic response to the current financial crisis. A top to bottom investigation of the results of its institution shows that it won’t have the desired effect it tries to accomplish. There are numerous roads accessible to the administration which can improve the bankruptcy system appropriate for the present crisis that would not really include a sweeping suspension. The suspension of the fresh Insolvency has several outstanding implications not just in the near future but also in the long course of years.

Leave a Reply

Your email address will not be published. Required fields are marked *

*
*