INSOLVENCY LAW – COVID LINKED OPERATIONAL REFORMS

[Dr. Sanjiv Agarwal]

Reforms proposed in Insolvency Law

One of the crucial reforms were announced on 17 May, 2017 in relation to Insolvency law, i.e., Insolvency and Bankruptcy Code, 2016 (in short, IBC). These reforms may not yield immediate benefits but are aimed to boost demand in mediums to long term, make business environ stronger and resilient and boost business sentiment across the board.

According to one report (Source: Business Standard dated 21.05.2020), the present status of IBC cases in India is as follows :

No. of cases / year	2017	2018	2019	2020	Total
Admitted	546	963	1,878	387	3,774
Appealed / Settled	67	91	131	23	312
Withdrawn	0	66	79	12	157
Approved	9	72	113	27	221
Liquidated	32	278	483	121	914

The reforms announced in Insolvency law are both, timely as well as well envisioned. In fact, in the given situation, they are strategic. The major reforms in insolvency and bankruptcy are towards easing the trigger for IBC to get attracted, i.e.,

• Threshold for initiating IBC proceedings raised from ₹ 1 lakh to ₹ 1 crore
• Fresh proceedings under IBC to remain suspended for a period of one year (earlier it was announced to be suspended for six months in March, 2020)
• The threshold trigger to exclude Covid related debts
• Specific framework for micro, small and medium enterprises (MSMEs)

Suspension of IBC proceedings

For the present, Government’s intention is to temporarily suspend IBC proceedings by way of fresh filing and also excluding Covid related debts from the scope of default with an objective of avoiding any company attracting otherwise avoidable IBC route of debt management. Any such temporary suspension is only to mitigate the risk of insolvency during the current crises.

Suspending the fresh proceedings for a year under IBC may help the defaulting companies but is likely to distort the recovery mechanism as well as market driven financial discipline. It may be noted that what is proposed to be suspended is only the fresh initiation under IBC Code upto a period of one year. Further, relaxations may depend upon the situation which unfolds over a period but atleast one year’s suspension will be there. Recently only, application of section 7, 9 and 10 of IBC were suspended for a period of six months  in March, 2020.

Since there may be no new IBC filings in next one year, financial creditors as well as operational creditors may not welcome this move. This includes the entire banking system.

Temporary suspension for a year also indicates this thought and is also a deterrent for errant and willful borrowers. These are trying times and as such temporary suspension is desirable for more than one reason. The arguments in its favour out weigh the arguments against it.

The suspension should not be applicable to section 10 of IBC cases for corporate insolvency resolution plans. By doing so, it would be allowing the corporate debtor to accept a slow death and deprive them from a possible resolution in a timely manner.

Though there have been delays in implementation of IBC in terms of deadlines be it at creditors level, on account of resolution professional  or legal framework, (NCLT and NCLAT), IBC has been at effective tool to address defaulters. Infact, even this decision will have adverse impact on share market behavior too.

Suspension of IBC for one year as well as enhancing the threshold to rupees one crore simultaneously also does not make any sense as if suspension is effected, there was no need to enhance the limit to rupees one crore. Further, suspension should also apply to voluntary insolvency initiated by corporate debtors in which case, unviable units will be forced to incur losses and continue. This needs clarification.

The suspension of insolvency proceedings is most likely applicable to defaults occurring after the lockdown was imposed, i.e., 25^th March, 2020. Thus post-lockdown, no new filings shall be accepted for one year and would permit future filings which exclude post- Covid defaults. Pre and post -Covid defaults will be accepted once suspension period is over. IBC is a credit reform which may not be reversed, though temporary suspension is considered desirable.

The only relief in terms of work load would be to NCLT and NCLAT which are presently flooded with IBC cases. Further, insolvency professionals and associated service providers would also face the heat of such suspension for a period of one year which will leave them dry and cry from business perspective.

It is learnt that in other countries, such a suspension has not been resorted to.

IBC for MSMEs

On insolvency resolution framework for MSMEs, Government has announced that a special MSME specific scheme for MSMEs shall be framed u/s 240A of the IBC  Code, 2016 which applies to MSMEs. Accordingly, provisions of section 29A (c and h) does not apply to resolution applicant in relation to corporate insolvency resolution process of any MSME. It empowers the Central Government to direct, in public interest, that any of the provisions of IBC shall not apply to MSMEs or apply with modification as may be notified.

In case of MSMEs, the otherwise promising but financially weak sector in India, the actual situation is likely to be grim in future in terms of liquidity and ability to pay back as the proposed scheme of collateral free loans will allow easy flow of money to MSMEs without any appraisal in terms of requirement and repayment. The damage may be more in case of NPAs as definition of MSMEs has also been made liberal and inclusion of service sector into MSME ambit. Banks already have substantial exposure to MSMEs ranging to 10 to 35 percent of total advances (e.g., Axis Bank 11%, State Bank of India 14%, IndusInd Bank 33% and so on).

Government has enhanced the limit to Rs. one crore but it may not result in delay of payment to MSMEs. A lower limit only works in favour of MSMEs as even a sum as low as Rs. one lakh is enough to trigger IBC.

MSMEs require a more comprehensive package by amending section 240A of IBC itself rather than just what has been announced.

Increase in threshold limit

Presently, the minimum threshold for invoking proceedings under  IBC is Rupees one lakh only which is considered too small an amount to initiate IBC proceedings. As a breather to industry, it has been announced to steeply increase this threshold limit to rupees one crore. This will serve twin objectives- provide the much needed relief to companies and also reduce the burden of work load for the time being on the NCLT and NCLAT.

This limit does not service the desired purpose as of now in view of the fact that IBC itself has been suspended. For MSMEs, there will be a separate set of sops and there being uncertainly prevailing all around amidst Covid pandemic.

Covid debts excluded

Exclusion of debts taken on account of present Covid-2019 crises from the definition of default by companies is a measure to be welcomed. While it has nothing to do with the past defaults, if such a default originates due to the abnormal Covid pandemic which is beyond anybody’s control, such debt will not qualify for IBC. This is justified on the ground of equity also and seems to be a proactive effort in right direction. It would address the genuine defaults in repayment of fresh debts during the current post Corona period in order to survive and sustain businesses.

Effectively, all debts taken during Covid-2019 period in normal course of business shall not be considered for triggering the proceedings under IBC. Thus, if there is a default in 2021-22 or later for debt obligations during current period, they may not qualify as default for the purpose of IBC.

The root cause of Covid related debt default may not necessarily surface now or in next one year. The default in repayment of Covid related debt may happen after three years or more which would mean that debtors would play with this relaxation to suit their needs and if at all there would be defaults, they would be made to fall in this basket first to get relief in IBC proceedings .

Epilogue

It is expected that the stimulus announced by Central Government in relation to IBC will become effective by way of promulgation of an Ordinance and Notifications. IBC also requires a comprehensive review of Code since its implementation from the view point of all stakeholders, not just corporate and financial creditors. IBC should become integral part of Indian financial and corporate framework.