This article has been written by Vishesh Jain and K. Amoghavarsha, 3rd year B.B.A. LL.B. and B.A. LL.B. students respectively from National Law University, Odisha.
The COVID-19 pandemic has brought India’s economy crumbling down to its knees, while businesses and individuals are struggling to be afloat; legislations are also going through unprecedented changes. The Insolvency and Bankruptcy Code, 2016 [Hereinafter “Code”] has been a game-changer for the Indian insolvency regime as well as for ease of doing business since its inception. With the prevailing situation of COVID-19, a new ordinance has been brought in the code to protect corporate debtors from falling into insolvency during these uncertain times and keeping them as a going concern. The ordinance provides for the incorporation of section 10A to the code which barred filing of new insolvency application by the Financial Creditor [Section 7], Operational Creditors [Section 8] and by the Corporate Debtor himself [Section 10] for the period of six months which can be extended up to one year. Furthermore, the definition of default under section 3(2) of the Code will be amended to exclude the default related to COVID-19. Additionally, a special resolution framework will be enacted for the Micro Small and Medium Enterprises [MSME]. Earlier the government had increased the threshold limit for initiating insolvency proceeding by Rs. 1 Lakh to Rs. 1 Crore trying to protect these MSME from high junk of insolvency proceeding. This ordinance poses a question whether the policymakers truly understand the purpose of the code, as the changes seem to cause more harm than good.
In this article, we intend to discuss the existing lacunae, which are present in the ordinance and some alternatives that can be brought in the code which might overcome the present loopholes in the ordinance as well as keep the intent of the code intact.
Existing Ambiguity in the Present Ordinance
The objective that sought to be achieved through this ordinance during this pandemic is to mitigate the adverse economic impact posed by the pandemic on the distressed corporate debtor; some consequences of the suspension seem rather inadequately evaluated.
- Suspension of section 10- Creating new problems instead of solving them
The amendment introduced section 10A to the code, which suspends initiation of the new insolvency proceeding under section 7, 9 and 10. Section 10 enables the corporate debtor to submit himself to the insolvency proceeding if the financial and operational viability of the company is not sound. With the prevailing situation, if the section 10 is not excluded from the ordinance introduced then it will take away the very right of the corporate debtor of hassle-free and timely exit from the market who in their assessment believes that they are not capable to operate efficiently in the market, thereby affecting all the stakeholder involved.
- Continuance of the other Debt Recovery Fora
The intent of the policymakers behind these steps remains farfetched as other debt recovery fora such as Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002[“SARFAESI Act”] and Recovery of Debts Due to Banks and Financial Institutions Act, 1993 have not been suspended. The backlog of the case and subdued functioning of these recovery tribunals are well documented. In a case where the lender holds a mortgage over the assets of the corporate debtor, the lender may initiate the sale process of the mortgaged assets with minimal court interference under SARFAESI Act. This makes suspension of proceeding meaningless and deprive both creditors as well as debtors certain benefits such as the implication of moratorium under section 14 of the code, which barred any coercive recovery action against the company and put an uncalled burden on the already burdened recovery tribunals.
- Disregarded Creditors
The recently added section 10A provides for suspension for filing of Corporate Insolvency Resolution Process for the default committed after 25th March under section 7, 8 and 9 of the code for the period of six months which can be extended up to one year. Furthermore, the proviso to the section provides that no application can ever be filed for the default committed during the said period. This poses a question as to its application as the main section provides for a limited period, the proviso enlarges its scope, providing the corporate debtor advantage over the creditors regarding the repayment of the debt. The practical impact of this will be felt by the operational creditors and financial creditors who are outside the framework of the RBI and the only option left with them will be to file a civil suit for the recovery of the debt which in itself a time taking and burdensome process against the codes timely and effective resolution. The policymaker needs to come up with such a framework, which balances the interest of these class of creditors and corporate debtor.
Plausible Alternatives to solve the Existing Lacunae
The present ordinance attempts to solve the foreseeable issues looming on insolvency, but it has left some glaring loopholes which make it against the intent of the code itself. Some suggestions to solve them are-
- Reassessing section 29A
This outbreak followed by the nationwide lockdown has adversely affected the cash flow of the prospective resolution applicant. The affected cash flow, in turn, decreased the number of resolution applicants who are willing to bid for the distressed companies. In this scenario, if section 29A that debars the defaulting promoters of the distressed companies from bidding again for the assets continues to operate, would negatively affect the corporate debtor. As the rationale behind the section was that the management, which was responsible for forcing the company into insolvency, in the first place, could not be allowed to take part in its resolution to provide a backdoor entry to its promoter in the company. However, owing to the current situation, there are possibilities that the company might face insolvency because of the macroeconomic disruption caused by the pandemic and not because of its faulty management. Moreover, if section 29A is suspended during these time, it will lead to a reduction in time taken for completion of the resolution process of the distressed company, preventing its assets from further deterioration. Therefore, the same management should be allowed to take part in the resolution process during these uncertain times.
- Operation of section 10 with section 66(3)
The ordinance has inserted section 66(3), which in effect suspends section 66(2). Section 66(3) of the Act has removed the danger of the personal liability, which is to be incurred by directors on their failure of initiating insolvency proceedings if there was no due diligence on their part, which caused a delay in initiating the proceedings. This action will not have a full impact if section 10 is also suspended as it is right now.
As per the present ordinance, section 10 remains suspended, which in itself has a huge amount of risk attached to it. The reason being, that businesses, which are no longer viable to even break, would have to continue functioning, which in turn will have negative consequences for all the stakeholders concerned. Therefore, an alternative approach could be to temporarily suspend section 66(2) instead of section 10 and allow section 10 to function normally.
Additionally, if section 10 were in operation, a company would still be having an opportunity to make an informed decision about its functioning and to file for insolvency under section 10 of the Act, without an obligation under section 66(2) of the Act to do so. It is extremely important to preserve the right of the companies to initiate insolvency proceedings for an efficient market even during the circumstances as they are right now. Therefore, section 10 must be allowed to operate to ensure the intent of the ordinance is satisfied.
- Pre-Packs – A Rational Solution for MSME
Pre-Packaged or a pre-arranged insolvency process [Pre-Packs] is a mechanism where the resolution plan is formulated and finalized before the commencement of the formal proceeding against the corporate debtor. Pre-packs offer an out of court and cost-effective mechanism for resolution, protecting the assets of the corporate debtor from further deterioration and maintaining it as a going concern. Unnecessary litigations will be avoided in the process and prospective bidders for the resolution plan of the corporate debtor will see a substantial increase. It would lead to the efficient trading of stressed assets in both local and foreign markets and will have a positive impact on the ease of doing business, improving the Indian economy as a whole.
The Pre-packs in the Indian context are of great concern owing to its “debtor in control” approach as opposed to the Codes “creditor in control” approach. However, owing to the current scenario of COVID-19 Pre-packs offer a middle path for balancing the interest of both creditors as well as debtors.
The situation that we are facing due to COVID-19 is one that has never been seen before and the ordinance to enact section 10A was with the intent of providing respite to the struggling companies. A deeper analysis shows that it might be a very unplanned reaction to the current situation. The loopholes in the ordinance must be addressed as the present ordinance might do a lot of harm to the positive work done by the code in the few years and threaten India’s position in the Ease of doing business index.