No Panacea for Stressed Assets

The Insolvency and Bankruptcy (Amendment) Bill, 2020 was passed by both Houses of Parliament last week. The Bill, which replaced the Insolvency and Bankruptcy (Amendment) Ordinance 2020, received the President’s assent on September 23. Its underlying objective, as was pitched, was to protect stressed companies from the corporate insolvency proceedings arising out of defaults committed with effect from March 25 for a period of six months — now nine months pursuant to the MCA notification dated September 24.

While it may be reasonable to laud the endeavour of the government for having come to the rescue of India Inc, the devil, as always, is in the details, and it must be said that the amendment reflects inconsistencies, which should either be revisited or corrected through judicial intervention. If not, it may end up distressing rather than de-stressing our ailing MSMEs and may also provide fertile territory for wilful defaults by estranged promoters.

From the text of the ordinance, it was clear that the objective behind its promulgation was the inadequacy of resolution applicants to rescue or bid for a stressed company undergoing the corporate insolvency resolution (CIR) proceedings. The newly inserted Section 10A fails to meet that objective. Section 10A only bars fresh initiation of CIR Proceedings for defaults arising within nine months (or 1 year, if extended) from March 25. What about the cases instituted just prior to the outbreak of COVID-19? In many such cases, the prospective resolution applicants would neither have filed an expression of interest (EOI) nor would they have submitted a resolution plan. The reluctance of a resolution applicant to invest in a going concern, when business sentiment is low, is more likely to be market driven than be affected by the date of default by such an entity. This defeats the principal objective behind the country’s insolvency jurisprudence, that is, maximising asset value and pushing companies, who may have committed a default just prior to the lockdown, towards liquidation.

Default, as defined under Section 3(12) of the IBC, means non-payment of a debt when the whole or any part of the instalment of the amount becomes due and payable. The application of the term “default” in relation to the amendment is sure to disadvantage the operational creditors, a lot of which are MSMEs.

For instance, if a financial creditor gives a secured loan to a company, then the default would arise on the date the company’s account is declared as a non performing asset — unlikely in view of the moratorium announcements during the pandemic. However, for unsecured loans, usually given by operational creditors, it can be argued that non-payment of instalments prior to the operation of the amendment, that is, March 25 and continuing thereafter, could constitute a continuing cause of action, thereby depriving the debtor company of the exemption granted by the amendment. Another aspect, which requires clarification, is whether the debts, which accrue during the operation of the amendment can be added to the debts, which will accrue after it ceases to operate. This is important since many business contracts are executory in nature where payment in lieu of goods and services is a recurring obligation.

Section 10A bars the fresh initiation of CIR Proceedings by both, financial and operational creditors (Sections 7 and 9), as well as by the corporate debtor/company itself (Section 10). The inclusion of Section 10 applications within the ambit of Section 10A appears to be unreasonable and constricting. This is likely to hurt companies stuck with debts, wanting a viable exit option using the voluntary mechanism provided under the IBC.

The amendment, ex-facie, doesn’t align itself to the slew of measures announced by the government for the protection of MSMEs. Whilst the debtor MSMEs can take refuge under the revised pecuniary threshold for initiating CIR Proceedings (from Rs 1 lakh to Rs 1 crore), the creditor MSMEs (usually operational creditors) could be left in the lurch as they will be barred from taking recourse under the IBC against defaulting parties. This is likely to encourage wilful non-payment/defaults to MSMEs during this period thereby further hurting the sentiment of the MSME sector in the country.

Having been guaranteed immunity for COVID related defaults - those committed after March 25 - companies and promoters could use the leeway given under the amendment and commit intentional/wilful defaults, despite having the capacity to pay. Further, without the surveillance of the resolution professional, promoters may look to enter into preferential and fraudulent transactions to siphon off assets and divert cash flows.

While recourse under the IBC for COVID related defaults may have been shelved, creditors are not barred from instituting other recovery proceedings such as arbitrations, summary/commercial suits or even under the SARFESI Act. These courts/tribunals have sufficient injunctive powers to order freezing of accounts/status-quo of the activities of a business which does not augur well for the stressed companies who may have defaulted during the COVID period for reasons beyond their control.

Suspending the operation of what was hailed as a landmark commercial reform, without covering all corners, may end up being counter-productive. The economy is going through a bad phase and clarity in regulations governing business in India is the single biggest ray of hope that can guide Indian economy through this phase. If this phase is due to an “act of god”, then hope is all we have.

Written by Arush Khanna