‘Likely blanket suspension of fresh cases under IBC may kill any chances of viable restructuring of assets’

Published: June 7, 2020 1:38 PM

While other jurisdictions have also adopted the accommodative stance, they have been varying and have drawn a redline for defaults that may have occurred as a direct result of Covid-19.

There seems to be no rationale of the government to suspend provisions of Section 10 of the IBC Code that allows for a corporate debtor to suo moto/voluntary file for insolvency.
  • By Saurav Kumar and Gaurav Dani

As part of the stimulus package announcement, the Finance Minister has recently announced in connection with the Insolvency laws in India, that there would be a suspension of fresh cases under Insolvency and Bankruptcy Code, 2016 (Code) for six months and up to 1 year. The ordinance to this effect was passed on June 5, 2020, which notifies Section 10 A of the Code, suspending the enabling provisions under Section 7,9 and 10 of the Code that allows for the initiation of a fresh application by a financial creditor, operational creditor or the corporate debtor, respectively. We understand that the main reason for such an important policy decision is emanating largely from the disruption in supply chain arising due to Covid-19 and resultant lockdown. This has caused a suspension of their business activities leading to negligible receivables while the cost continues. The government has duly recognised these uncertain times and has taken an accommodative stand to provide some breathing space to the business. The relief is said to be particularly beneficial for micro, small and medium enterprises (MSME). We would like to discuss these measures under a few broad points.

Voluntary Insolvency 

Firstly, there seems to be no rationale of the government to suspend provisions of Section 10 of the Code that allows for a corporate debtor to suo moto/voluntary file for insolvency. The suspension would literally be forcing such corporate debtor to continue for another year before it can file for insolvency. It may be a safe assumption to suggest that by this time the assets would have deteriorated even further and any chances for a viable restructuring would have been lost.

Only Covid-19-related Defaults

Secondly, the ordinance appeared to be straight forward providing a blanket suspension of fresh cases under the Code for defaults after March 25, 2020. While other jurisdictions have also adopted the accommodative stance, they have been varying and have drawn a redline for defaults that may have occurred as a direct result of Covid-19. For example, in Germany on March 25, 2020, the German Parliament passed a bill “to mitigate the consequences of the Covid-19 pandemic in civil, bankruptcy and criminal procedure law” (COVID19 Bill). As part of the Covid19 Bill, there is a suspension of, inter-alia, creditors’ right to file for insolvency until September 30, 2020. This deadline can be shifted by the Federal Ministry of Justice until March 31, 2021, by decree. 

However for suspension of the filing obligation, two conditions have to be satisfied, First, the reason for insolvency must be based on the effects of the Covid-19 pandemic (and not on other reasons). Second, there are prospects for a restructuring of the company due to pending procedures for granting public aid to the company and/or pending negotiations with (potential) creditors of the company about additional financing or reorganization of debt. There is also a legal presumption that the above conditions are fulfilled if the company was not insolvent as of December 31, 2019.

Singapore as another example passed the Covid-19 (Temporary Measure) Act, 2020 (Singapore Act). Amongst other things, the Singapore Act provides for a moratorium on claims and/ or enforcement actions provided certain requirements, inter-alia, are met. First, it must relate to a scheduled contract. Second, the contract and the obligation must fall within the Covid-19 time period as provided in the Singapore Act. Third, the inability to perform the contract is to a material extent cause by Covid-19; and fourth, the defaulting party must serve a notice of relief on the other parties. Upon serving notice the other parties to the contract cannot take, inter-alia, file for insolvency proceedings during the prescribed period, unless the assessor makes a determination that the case is not one to which the relief should apply. 

The United Kingdom has recently introduced the Corporate Insolvency and Governance Bill (UK Bill) which provides a host of measures to allow the companies to survive through the Covid-19. The UK Bill provides, inter-alia, first, a new moratorium provision where a company can apply for a 20 business days moratorium period through a court process that may be further extended by another 20 business days. Such 40 business days moratorium would not require creditors approval. Second, a temporary provision to restrict statutory demands and winding up petitions issued against companies where the debt is unpaid for reasons relating to Covid-19. 

India does not seem to be following any of the above approaches but prefers to provide a simpler and cleaner provision of suspension, which may need to be relooked in light of the measures followed in other jurisdictions, otherwise, we could quite easily go back on all the progress we have made so far in the Insolvency process under the Code.

Pre-packs and White Knights

Thirdly, for a resolution to be successful a white knight is needed to step in and salvage the corporate debtor. The government may be of the opinion that there may not be enough resolution applicants in the market at this point, leading to a large number of liquidations, which may not benefit the economy. The Code was established with an objective of maximization of value and not the maximization of ‘price’. The value improves if a business is continued and its assets are used more efficiently, which is possible with a change in management, restructuring of the organization, and so on. 

One may argue that there could still be adequate availability of white knights provided restructuring plans are accepted on the basis of value maximization for the stakeholders without significant outgo upfront. A counter to this would be that such an approach is possible under the prudential framework of RBI or under a restructuring route under the Companies Act, 2013, however, lenders may find it more difficult to find a reasonable outcome going with the suspension of the provisions of Code 

Corporate Governance

Lastly, Section 66 (2) of the IBC provides that if the directors allow a corporate debtor to trade where they knew or ought to have known that the company had no reasonable prospect of returning to solvent trading, they can be held personally liable. Such an assessment by a director during the Covid-19 period could become extremely challenging. The suspension of the provision of Section 66(2) is quite relevant from a governance perspective. 

To conclude, the main objective of any bankruptcy law is to reset the clock of a debtor overburdened by the debt and at the same time, preserve the going concern’s value by reorganizing rather than liquidating. Accordingly, the government may consider a more rationale stance around suspension which should be only in relation to the Covid-19 related defaults and the duration may be more reasonable so as to not over-protect. Also, Section 10 should, in particular, be excluded from the suspension.

Saurav Kumar and Gaurav Dani are Partners at IndusLaw. Views expressed are the authors’ own.

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