INSOLVENCY AND BANKRUPTCY (AMENDMENT) ORDINANCE, 2020: A SAVIOR OR A PROBLEMATIC ADDITION?
- Palak Nangru
The coronavirus pandemic has caused uncertainty and stress for businesses in India and around the world. Acknowledging the fact that the Coronavirus pandemic has created a demand deficit in the economy and harmed businesses, the Finance Minister of India introduced the Atma Nirbhar Bharat Abhiyaan to provide relief to the businesses which were on the verge of insolvency by suspending the fresh initiations of insolvency proceeding for up to one year.In furtherance of these economic measures, the President of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2020, which came to force on 5 June 2020.
The ordinance inserted Section 10A to the Insolvency and Bankruptcy Code, 2016 (IBC) which restricts creditors from filing an application to initiate corporate insolvency resolution process (CIRP) under Sections 7, 9 and 10 of the Act for any default committed by corporate debtors after 25 March 2020 till the expiry of six months or further, as may be notified in this behalf, however, not exceeding one year. The right to initiate CIRP against debts occurring in this period has been permanently restricted.
A non-obstante provision has been inserted to Section 66 (Fraudulent or Wrongful Trading), which bars the Resolution professionals from filing an application under Section 66(2) against the directors of the corporate debtor, for any default occurring during the exempted period.
The rationale behind introducing the aforementioned changes was to prevent businesses affected by pandemic from being pushed into insolvency. Additionally, since most of the corporate persons were in stress due to the economic slowdown, it would be difficult to find an adequate number of resolution professionals to rescue the defaulter.
Even though several countries have made various changes in their insolvency regime to address the impact of the economic slowdown caused due to COVID-19, no other country has put a complete and permanent prohibition on proceeding against defaults on debts happening during this period. Hence, the changes made by the ordinance are unprecedented and may cause harm.
The following essay is divided into three parts, the first part of the essay critically analyzes the ordinance and highlights the various issues that may arise due to it. The second part of the essay focuses on the various alternatives that would be available to the creditors during the suspension of proceedings under IBC. The third part of the essay suggests certain mechanisms that can be introduced by the government to strengthen the debt-resolution regime.
1. Restricts Corporate Debtor’s Autonomy
Section 10 gave autonomy to the corporate debtors to restructure their debt and revive their businesses. However, by the suspension of Section 10, IBC, the ordinance has prohibited initiation of voluntary insolvency by a corporate applicant. This prohibition may lead to an increase in the deterioration of the assets available with the defaulting businesses, which would further decrease their chances of revival and may force them into liquidation. Thus, the suspension of Section 10 does not align with the intention of the ordinance as it jeopardizes the best interest of the corporate debtors.
2. The Dilemma of the Personal Guarantors
The personal guarantors of the debt are given no protection under the Ordinance; hence creditors may proceed against them under part III of IBC.
3. Does not Link the Defaults with the Pandemic
The preamble of the Ordinance states that the objective of the amendment is to protect the businesses from being pushed into insolvency at the time of economic uncertainty caused due to the COVID-19 pandemic. However, Section 10A does not link the defaults to the pandemic, thus, the parties defaulting would not have to prove that the default was caused to the pandemic. This would however preclude defaults that took place before March 25 2020 but were caused due to the impact of the pandemic on the economy.
4. The Possibility of Intentional Default
The creditors are permanently exempted from taking a recourse under IBC for any defaults that may occur during the suspension period, this has increased the chances of debtors intentionally defaulting against their creditors.
Through the inclusion of Section 66(3) to IBC, the directors or partners of the corporate debtors would be protected from any consequences that they would’ve had to face for deliberate acts of transgression. This might lead to the managers dissipating the assets of the company or taking on a preferential or undervalued transaction which may be detrimental to the creditors.
It must be taken into consideration that, the economic instability caused due to the pandemic cannot be taken as a blanket defense for unlawful/illegal conduct. It would thus become necessary for the creditors to closely monitor the activities of the debtor, as even if the business goes into insolvency the look back period for challenging such fraudulent transactions might be over. Though the Companies Act may provide an alternative in cases where the look back period has ended, the standard of proof for such matters to succeed is very high.
5. Continuing Defaults
Section 10-A permanently prohibits the corporate debtors from initiating CIRP for any default committed within the suspension period. The provision however fails to address the treatment of continuing defaults which may continue even after the suspension period.
ALTERNATIVES AVAILABLE TO THE CREDITORS
The laws related to reorganization and insolvency resolution of corporate persons were consolidated and amended to create the IBC. The framework provided under the Code led to expeditious resolution of financial debts, hence it became the preferred manner for the creditors to recover or restructure debts. However, due to the Ordinance, the creditors would have to rely on other enforcement tools to recover their debts, some of which are discussed below:
i. Companies Act, 2013
The creditors may seek redressal through the Scheme of Arrangement prescribed under Section 230 of the Companies Act to restructure debts. This provision can be utilized by a wide array of debtors since the Act does not differentiate between operational and financial creditors like the IBC. Also, the debtor is put in control under the scheme provided in the Act. This would be advantageous in the present times of economic uncertainty as it would prevent the creditors from exploiting the vulnerable position of the debtors.
However, a large number of procedural compliances, delayed proceedings and no provisions relating to moratorium or stay of proceeding makes the scheme provided under the Companies Act less effective than IBC.
ii. Prudential Framework for the Resolution of Stressed Assets
RBI’s prudential framework for the resolution of stressed assets focuses on timely resolution of stressed assets. In case of default, the framework provides the creditors 30 days to review a borrower’s account before recognizing it as a non performing asset. However, this framework is only applicable to creditors regulated by the RBI.
iii. In matters where restructuring of the debt is not feasible, the lenders may resort to debt recovery mechanisms such as the SARFAESI Act, 2002 and the Recovery of Debts Due to Banks and Financial Institutions Act, 1993.
However, the legislators must introduce reforms for ensuring the smooth functioning of the Debt Recovery Tribunal, as presently these Tribunals are relatively inefficient and suffer from a huge backlog of cases.
THE WAY FORWARD
Pre- Packaged Insolvency Resolution Plan
While it is possible to restructure debts through the mechanisms provided by other legislations, unlike IBC, these legislations do not offer benefits like moratorium on legal proceedings, efficiency of proceedings and relaxation of certain statutory provisions.
Pre packaged insolvency resolution plan is a mechanism in which the stressed company and its creditors form an agreement regarding the sale of the whole or part of the creditor’s business, before the insolvency professional is appointed as the administrator. These sales need to be approved by the appointed insolvency professional before they are effectuated. Pre packs, thus help in expediting the insolvency process by decreasing the time spent in court proceedings and negotiating with the creditors after the initiation of insolvency proceedings.
The pre-pack regime would provide an adequate alternative in the present times as it would decrease the time taken by the resolution plan and lessen the burden on the NCLT. Additionally, it would also provide the parties a certainty regarding the result of the resolution proceedings as the outcome of the pre packs is binding.
This regime gives the promoters an increased control over the resolution proceedings. Thus, pre packs can be a feasible option for debtors who are unable to carry out their business activities. However, the control of promoters hampers the transparency of the proceedings and increases the possibility of promoters leaving behind certain operational and unsecured creditors and carrying out preferential transactions in favor of the certain bidders. To ensure the effectiveness of pre packs, the creditors must be given the authority to maintain an oversight on the proceeding to ensure that there is no fraudulent conduct or overvaluation of assets.
Another alternative that can be introduced by the government is that of bad banks. These entities buy high risk/ non-performing assets that are held by banks or financial organizations at discounted rates and extract their maximum value. These banks would help the creditors to isolate these non-performing assets from their books and provide a good alternate for banks and financial institutions during the suspension of IBC.
In the case of Swiss Ribbons Pvt. Ltd. and Ors. vs. Union of India (UOI) and Ors., the Supreme Court had observed that IBC has revolutionized the Indian financial system by providing an efficient mechanism for dealing with financial debts. The COVID-19 pandemic has created stress on the Indian economy, to protect Indian businesses from being forced into insolvency the proceedings under Section 7, 8 and 10 of IBC were suspended. However, there is a possibility that the debtors might abuse this suspension which may result in the increase of wilful defaults during the suspension period. Thus, the legislature and the adjudicating authority must impose protective mechanisms to prevent the misuse of the suspension and strengthen the debt resolution regime. Further, they must also provide some clarity regarding continuing debts and the liability of personal guarantors.
 Finance Minister Announces Government Reforms and Enablers across Seven Sectors under Aatma Nirbhar Bharat Abhiyaan, GOVERNMENT OF INDIA, (July 9, 2020, 10:05 PM). https://pib.gov.in/PressReleasePage.aspx?PRID=1624661  Section 2, Insolvency and Bankruptcy (Amendment) Ordinance, 2020.  Id, Section 3.  Siddharth Srivastava & Harshit Khare & Mohit Kishore, Insolvency And Bankruptcy Amendment Ordinance: June 2020, MONDAQ, (July 9, 2020, 10:05 PM) https://www.mondaq.com/india/insolvencybankruptcy/952306/insolvency-and-bankruptcy-amendment-ordinance-june-2020.  Prudential Framework for Resolution of Stressed Assets, RBI, (June 5, 2020, 10:50 PM), https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0  Dheeraj Nair & Anjali Anchayil, Getting a move on: Is it time for pre-packaged insolvency in India?, ECONOMIC TIMES, (June 2, 2020, 10:50 PM), https://economictimes.indiatimes.com/small-biz/legal/getting-a-move-on-is-it-time-for-pre-packaged-insolvency-in-india/articleshow/75771588.cms?from=mdr.  Shreya Choudhary & Arnav Sinha, Suspension of the Insolvency and Bankruptcy Code: The Way Forward, INDIACORPLAW, (June 2, 2020, 10:50 PM), https://indiacorplaw.in/2020/06/suspension-of-the-insolvency-and-bankruptcy-code-the-way-forward.html.  Sunny Verma, What is a Bad Bank, and Why is a Proposal to Set it Up Being Floated, INDIAN EXPRESS, (June 10, 2020, 4:00 PM)https://indianexpress.com/article/explained/explained-what-is-a-bad-bank-why-proposal-to-set-it-up-is-being-floated-6496725/  Swiss Ribbons Pvt. Ltd. and Ors. vs. Union of India (UOI) and Ors., AIR 2019 SC 739.