Is this pandemic taking us back to the pre- IBC era?
While India moves towards Lockdown 3.0, the World Bank suggests that the coronavirus outbreak has severely disrupted the Indian economy. Due to this pandemic, companies, both small and large, are taking a hit. Keeping this in mind, the Government has tried to introduce some measures so as to lessen the burden on these companies and give them a chance of revival. In March, a special task force was constituted, led by the Union Finance Minister Smt. Nirmala Sitharaman, in order to remove economic difficulties and to look into the economic distress due to these unprecedented circumstances.
The Insolvency and Bankruptcy Code (hereinafter referred as ‘Code’) was introduced in the year 2016, and since then, it has brought a paradigm shift in the manner of handling insolvency cases in India. This one-umbrella legislation consolidated all laws relating to insolvency and bankruptcy and brought a shift from the concept of ‘Debtor in possession’ to ‘Creditor in control’.
It is but obvious that the situation in hand will see a rise in the number of insolvency applications and the burden on NCLT is further going to increase. In order to keep this in control, the task force has made some changes in the routine way of dealing with insolvency matters. This started on 24th March, 2020 when Smt. Nirmala Sitharaman announced the increased threshold limit under Section 4 of the Code. Henceforth, the minimum amount of default under the Code is now one crore rupees.
Further, there have been reports((There is no official notification for the introduction of Section 10A by the government yet. However, on 24th April 2020, Smt. Neermala Seetharam, the day minimum threshold under Section 4 was increased, announced that the government is considering suspending Sections 7, 9 and 10 of the code if the situation does not improve. Further, this has been in all major news websites. The links to the same are as follows:
While some would argue that it is a step in the right direction, there are a number of problems that this provision carries with itself.
Introduction to Section 10A
The Central Government, by exercising its power under Section 242 of the Code is introducing a new section i.e. Section 10A to deal with the situation in hand. This section would suspend the applicability of sections 7, 9 and 10 of the Code for a period ranging from six months to one year. This means that, during the applicability of this section, no Corporate Insolvency Resolution Process (hereinafter referred as ‘CIRP’) would be initiated by the financial creditors or the operational creditors or the corporate debtor itself.
Rationale behind introducing this Section
As India moves towards the third phase of lockdown, there is a definite slowdown in the economy. The SBI Ecowrap report suggests that this would result in an economic loss of Rs. 12.1 trillion or six per cent of the nominal Gross Value Added (GVA), taking the nominal GVA growth for entire year to be around 4.2%. This will have a sweeping impact on companies of all sizes, the medium and small enterprises are likely to suffer the most.
In order to provide these firms a breather, Section 10A is being introduced. This provision would provide firms, who are under financial distress, a period raging from six months to one year to recover. This means that, no creditor would be able to drag these firms into insolvency if they fail to honor their financial commitments.
Additionally, the number of insolvency related applications would have put NCLT under enormous pressure and this step would not only reduce the quantum of cases before the tribunal, but will also increase its efficiency and thus, would lead to speedy disposal of matters.
While some would argue that this is a much needed relief during the crisis, it comes with a significant number of challenges that could throw it under the bus.
Challenges that lie ahead
Although this provision is like a knight in shining armor for Corporate Debtors, it is most likely to create a series of problems for other stakeholders.
To start with, this provision could pose serious challenges to both financial and operational creditors. After the applicability of the said provision, the creditors would either have to wait for a period of more than six months to initiate CIRP and for a further period of 330 days to recover their dues. Or, go through the tiresome and elongated court procedures to recover their money.
This would be more problematic for Operational Creditors who are more often than not, directly related to the business operations of Corporate Debtors. This restriction on initiating CIRP might put some of these creditors in huge financial distress throwing most of them out of business. This provision would further impact the ability of Operational Creditors to repay their creditors, thus creating a domino effect. It would not be a shocker if the number of insolvency applications, post this restriction period touches the sky, further increasing the burden on NCLT.
Furthermore, during this period, the Corporate Debtor and not the Creditor would be in control of the assets of the business, in which case, they might end up defrauding the creditor by alienating those assets. Moreover, the value of the assets will depreciate to some extent and the creditors will not be able to realize its proper value. All in all, this will have a direct impact on the value of debt due to the creditors.
Additionally, there is no guarantee that a period of six months or one year would be enough for these companies to regain their financial strength as there lies a huge uncertainty to when this will all end.
The Insolvency and Bankruptcy Code, 2016 was an overhaul of the decades old traditional debt recovery regime. In addition to this subsisting pandemic, the introduction of Section 10A could bring back the problems that existed in the pre IBC era. This provision could challenge the very rationale of IBC and could take us back to the ‘Debtor in control’ regime.
While the Corporate Debtors will breathe a sigh of relief, the aftermath of this provision could take a serious halt on other stakeholders involved in the process, as already discussed. Accordingly, there is a need to address the forthcoming consequences of this provision or else, the very foundation of the current legislation would be lost while tackling one out of the many obstacles that the stakeholders are facing.
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