Suspension of IBC

Author: Megha Gupta

Introduction

 Insolvency and Bankruptcy Code, 2016 (referred as IBC) which is considered as the biggest insolvency reform, is a central Act enacted for reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner for maximization of the value of assets of such persons.

IBC was enacted and came into force 28th  May 2016, however, some of the sections were made effective on various dates to implement in a systematic manner. Some of the parts have not even been notified till date i.e. 01/01/2019 e.g. bankruptcy process for partnership firms and individuals.

Insolvency & Bankruptcy (IBC) HISTORY

The era before IBC were having various scattered laws relating to insolvency and bankruptcy which caused inadequate and ineffective results with undue delays. For example

  • SARFAESI – (Securitization and reconstruction of financial assets and enforcement of security interest) Act for security enforcement,
  • RDDBFI (Recovery of debt due to banks and financial institutions) for debt recovery by banks and financial institutions,
  • Companies Act for liquidation and winding up of the company,
  • Presidency Towns Insolvency Act and Provincial Insolvency Act for sick-ness and insolvency of partnership firm, HUF & individual

Ineffective implementation, conflict in one of these laws and the time-consuming procedure in the aforementioned laws, made the Bankruptcy Law Reform Committee to draft and introduce Insolvency and Bankruptcy Law bill.

IBC OBJECTIVES

  • To simplify and expedite the Insolvency and Bankruptcy Proceedings in India.
  • Consolidate and amend all existing insolvency laws in India.
  • To protect the interest of creditors including stakeholders in a company.
  • To revive the company in a time-bound manner.
  • To promote entrepreneurship
  • To get the necessary relief to the creditors who have been waiting for the payments since a long time
  • To curb down the fraudulent corporate persons who have been defaulting in making due payments.
  • To work out a new and timely recovery procedure to be adopted by the banks, financial institutions or individuals.
  • To set up an Insolvency and Bankruptcy Board of India.
  • Maximization of value of assets of corporate persons.

KEY FEATURES OF IBC

  • One set of laws for insolvency and bankruptcy
  • Timely bound process for payment to creditors and insolvency process.
  • It is the most prevalent law dealing with Insolvency and Resolution proceedings in India.
  • It has an overriding effect on other laws.
  • Gives equal representation to all the creditors for effective resolution of the stressed assets.
  • Appointment of Insolvency Resolution Professional to take care of the business of financially distressed companies.
  • Provide relief to all the creditors (Financial or Operational) who are owed some amount from the corporate persons.
  • Empower the creditors to make key decisions during the insolvency proceedings.
  • Includes homebuyers under the definition of financial creditors.
  • Financial as well as operational creditors cab, initiate Corporate Insolvency Resolution Proceedings against corporate persons.
  • Invitation to submit resolution plans to take over the distressed companies.

In the light of above features, we can clearly make out how this new legislation will act as superior law in effective industrial development. IBC will help in removing the defaulting and fraudulent businessmen from the market.

On 5 June 2020, in the wake of the COVID-19 pandemic and the subsequent lockdown and with an aim of shielding businesses from being pushed into insolvency proceedings, the much-awaited ordinance suspending initiation of corporate insolvency resolution process (CIRP) was promulgated. The Insolvency and Bankruptcy Code (Amendment) Ordinance 2020 (Ordinance) inserted Section 10A to the Insolvency and Bankruptcy Code 2016 (Code) that prohibits financial creditors, operational creditors and corporate debtors (CD) from initiating a CIRP for a default arising on or after 25 March 2020 (specified date). The said suspension is to remain in effect for 6 months, till a further notified period, but not exceeding a year (suspension period). The Ordinance also inserts sub-section (3) to Section 66 of the Code, technically creating an exception to wrongful trading.

Although the Ordinance is a welcome move, providing some breathing space to corporations (companies and limited liability partnerships) and is effectively in pursuance of a policy recommendation given by the World Bank in its recent blog, there are certain shortcomings that outweigh the benefits that the Ordinance intends to deliver. First, the Ordinance blanketly suspends initiation of CIRP for any defaults within the suspension period. Second, it takes away the option of a CD to voluntarily initiate CIRP. Third, it suffers from indelible drafting flaws that create ambiguities. Lastly, it protects directors/partners from wrongful trading. This article discusses all the aforementioned points in seriatim and concludes by highlighting the need to reorient the Ordinance.

Blanket suspension

‘Any default’ in the suspension period is assumed as a default on account of the COVID-19 pandemic and the lockdown

The Finance Minister, in her recent announcements, indicated exclusion of the debt related to COVID-19 from the definition of ‘default’. In its preamble, the Ordinance recognizes exclusion of defaults arising on account of the COVID-19 pandemic situation. However, the meaning of the word ‘default’ has not been mentioned in the Ordinance, and in the absence of an amended definition, the definition under Section 3(12) would be applied to interpret default. Against this backdrop, Section 2 of the Ordinance assumes any default that occurred on or after the specified date is necessarily a default that arose due to COVID-19 pandemic and the lockdown, without any carve-outs to determine if COVID-19 had a substantial financial effect on a corporation that culminated into a default.

Thus, the promulgation of the Ordinance has happened in complete ignorance of the circumstances wherein a company was nearly on the brink of insolvency due to prolonged failures in business that had nothing to do with COVID-19 or the lockdown, but since the date on which the said default occurred was 25 March 2020 or after, no insolvency proceedings could ‘ever’ be initiated. In corollary, defaults which occurred before the specified date, on account of the pandemic have not been insulated, essentially discriminating and depriving those businesses that were hampered on account of the global outbreak of the pandemic.

Perpetual bar on initiation of CIRP for defaults falling in the suspension period

The proviso in the Ordinance uses the word ‘ever’ to stipulate that no CIRP can be initiated for defaults arising in the suspended period, as mentioned in Section 10A. In addition, the preamble to the Ordinance states that defaults arising on account of the unprecedented situation are to be excluded for the purposes of insolvency under the Code. Therefore, the cumulative effect of both these factors leads us to conclude that the Ordinance essentially creates a perpetual prohibition to initiate CIRP for defaults in the suspension period. It is imperative to note that Section 10A specifies a limited period of 6 months extendable to a year, but the proviso enlarges this scope by using ‘ever’. The proviso is, therefore, substantive in nature, granting willful defaulters an opportunity to circumvent the law and garner undue advantage. Furthermore, it creates confusion in cases of continuing defaults.

Ambiguity in cases of continuing defaults that are in parts and phased over a time-frame

A default is said to have occurred when a part or whole of the amount of debt has become due and payable but the same has not been paid by the debtor. Such a default continues until it has been remedied or waived. While the Ordinance is unclear if a waiver has been granted to defaults in suspension period (two reasons, one- proceedings against personal guarantors can be initiated for defaults in the suspension period, suggesting defaults have not been waived per se but only CIRP initiation has been prohibited; two- definition of default has not been amended, granting a waiver), it does not even attempt to clarify if defaults that continue post the suspension period can be remedied. For instance, a CD defaults twice- first, for an installment of INR 75,00,000 in the suspension period (within Section 10A of the Code) which continues even once the suspension period is over, and, for another installment of INR 35,00,000 outside the suspension period (not within Section 10A). The default that occurred later (INR 35,00,000), alone is not sufficient to fulfill the threshold requirements for triggering the Code (i.e. INR 1 crore), but on combining both the defaults, the threshold is met. The question that arises herein is whether Section 10A will be attracted in cases of one-time default only or even to defaults that continue after the suspension period is over. Further, one wonders if the defaults can be combined to meet the threshold and trigger action. An absence of clarity in this regard makes the Ordinance confusing.

Considering another example, if a CD defaults in payment of multiple installments of INR 50,00,000 (two defaults of INR 25,00,000 each over 2 months) before 25 March 2020 and again defaults on other installment payments of INR 50,00,000 (2 defaults of INR 25,00,000 each over 2 months), but the latter default happen in the suspension period and the former defaults continue throughout the suspension period, will such CD be in a position to defend the initiation of CIRP for the former defaults by relying on the Ordinance?

Voluntary initiation of CIRP by the corporate debtor suspended

The Ordinance inter alia suspends voluntary filing of applications under Section 10 of the Code by the CD. This could prove counter-intuitive, primarily in 2 situations – first, for those businesses who genuinely require restructuring of intractable debt caused on account of the pandemic, and second, in other conditions where the debt has snowballed on account of continuous poor performance in previous financial years with pandemic adding the final blow. In both scenarios, the CD will either be forced to continue operations in an unviable state or eventually shut down perpetually by voluntarily liquidating. Furthermore, the CD cannot even avail a statutory moratorium which otherwise could have helped them to get a waiver on interest. Debtor-induced insolvency proceedings can aid to good commercial solutions, but the opportunity for the same has been lost with suspension.

Drafting flaws

Ambiguity in the calculation of the suspension period

A plain reading of Section 10A, with the placement of the words ‘such date’ and ‘as may be notified in this behalf’ right next to each other, may raise confusion regarding commencement of the suspension period. However, a closer, logical and contextual examination reveals that the words ‘such date’ in the section evidently refer to 25 March 2020 and the words ‘as may be notified in this behalf’ actually refer to the Central Government’s power to extend the suspension period beyond 6 months.

Exception to wrongful trading

The Ordinance inserts a non-obstante clause to Section 66 of the Code (fraudulent trading or wrongful trading), granting protection to the directors or partners (as the case may be) of a CD. Therein, a resolution professional is barred from filing an application for wrongful trading under Section 66(2) in respect of defaults under Section 10A. In the absence of specific conditions to avail protection under this section, rash behavior of directors/ partners of a CD prior to the specified date resulting in default in the suspension period may go unpunished.

Conclusion

The Ordinance was promulgated to help corporations steer through an unprecedented crisis beyond their control. However, inherent lacunae such as suspending voluntary initiation of CIRP by the CD, ambiguities on account of poor drafting, lack of clarity in cases of continuing defaults, and blanket suspension that fosters discrimination, scar the very object for which the Ordinance was promulgated. Perhaps, judicial intervention will help answer a few questions and clear some of the confusion. Nonetheless, there exists a need to reorient the Ordinance in a manner that it substantially benefits the ailing corporations and, at the same time, safeguards the legitimate interests of their creditors and other stakeholders.

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