▪ The much-awaited ordinance suspending operation of the Insolvency and Bankruptcy Code, 2016 (Code) was promulgated on June 5, 2020. The Ordinance which comes into effect forthwith has introduced section 10A which suspends the operation of Sections 7, 9 and 10 of the Code for any default arising on and after March 25, 2020 for a period of six months and up to a maximum of one year. The amendment is expected to benefit corporate India which has been reeling under stress due to the lockdown as they can now focus on coming out of the red without the fear of bankruptcy proceedings looming large.
Impact of suspension of the Code
- Introduction of Section 10A: Provisions of Section 10A will be applicable only with respect to defaults that have occurred after the commencement of the lock down. Therefore, CIRP can be initiated by a
creditor for defaults which may have occurred prior to March 25, 2020.
- Suspension of Sections 7 and 9: This means that neither a financial creditor nor an operational creditor shall be entitled to initiate any action against any borrower under the Code for a year. The proposed amendment provides an opportunity to companies badly hit by the pandemic to focus on coming out of the red without the fear of initiation of bankruptcy proceedings. It is noteworthy that pursuant to section 29A of the Code, promoters of a corporate debtor are not eligible to qualify as a resolution applicant. However, in so far as MSMEs are concerned, disqualification of promoters as resolution applicants is not applicable. Thus, proposed suspension of operation of sections 7 and 9 helps in addressing the concerns regarding initiation of insolvency proceedings against companies where the lockdown has resulted in the financial stress and the promoter may end up losing control over the company even though the financial stress was due to reasons beyond his control.
- Suspension of Section 10: While there appears to be a case in favour of suspension of operation of sections 7 and 9, the reason behind suspension of operation of section 10 is not clear as such suspension cripples the ability of the corporate debtor to exit an unsustainable business, especially considering the remedy of winding up under the Act and the voluntary insolvency proceedings under the Code being available only to solvent companies.
- Impact on payment moratoriums: Pursuant to the Covid 19 regulatory package, financial creditors have been granting moratorium on payment due during the lockdown period. In the circumstances, a question that may arise is whether the protection of section 10A would be available when the instalment relating to the lockdown period becomes payable subsequently. It appears that the section intends to suspend the operation of CIRP only for defaults arising during the lockdown period. Where the default occurs after the suspension period, even if such instalment relates to the lockdown period, defaults in payment thereof should not come under the purview of section 10A.
- Impact on MSMEs: With most of the operational creditors being MSMEs, suspension of the operation of the Code puts them in a tight financial spot without the remedy of Section 9 proceedings available to them. The Government of India has also announced that a special resolution framework will be implemented for MSMEs under section 240A of the Code. It is expected that such framework may provide for pre-pack resolution mechanism where the debtor and creditor agree on the package beforehand.
- Impact on personal guarantors of corporate debtors: Suspension of the provisions of only sections 7, 9 and 10 will not prevent the creditors from initiation of insolvency proceedings against personal guarantors of corporate debtors as the same is instituted under section 95 of the Code, the provisions whereof do not intend to have been suspended. Considering the liability of a guarantor is co-extensive with that of a principal debtor, directors and promoters can continue to be subject to the Code notwithstanding the suspension of proceedings against the corporate debtors.
- While the main objective of the Code is maximization of value, if the operation of the Code is not suspended, it would result in the tribunals being inundated with insolvency proceedings and with the existing infrastructure it would be impossible to achieve timely resolution, thus resulting in huge value destruction.
- Creditors will continue to have recourse to alternate remedies such as the Securitisation of Assets and Enforcement of Security Interest Act, 2002, institution of recovery proceedings before the debt recovery tribunals and recovery cases under the Commercial Courts Act/Code of Civil Procedure and compromise and restructuring under the Companies Act, 2013. However, one of the key downsides of these alternative courses of action apart from the lack of timeliness is the unavailability of ‘creditor in possession' benefit which is available under the Code. Further the focus under these proceedings is recovery rather than resolution of distress which is the objective of the Code.
- Section 10A not only suspends operation of the Code for the period specified therein, it also provides that no application shall ever be filed for initiation of CIRP of a corporate debtor for any default which has occurred during the said period. That such defaults cannot be proceeded against even after the effects of lockdown have been negated is an over stretch and essentially entitles the debtor to default with impunity, especially considering the traditional modes of recovery have been far from effective. Therefore, the possibility of misuse of the provisions by a delinquent debtor cannot be ruled out.
- The primary concern in allowing IBC proceedings in times of Covid is that pursuant to the Code, the creditor assumes possession of the asset despite the default being for reasons beyond the control of the debtor. In view thereof, perhaps an amendment to section 29A by allowing promoters (other than wilful defaulters) to also participate as resolution applicant may have been a better solution as it would allow addressal of the stress while simultaneously providing promoters a fair opportunity to resolve the stress.
- While the amendment tries to balance the concerns of both lenders and debtors by restricting the operation of suspension only to defaults arising post lockdown as opposed to a blanket suspension, a temporary suspension rather than a permanent bar on action against Covid defaults and exclusion of section 10 from the purview of suspension would have better served the interests of the stakeholders.
Originally published 29 June, 2020
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