How to Look at the Suspension of Insolvency and Bankruptcy Code Due to the COVID-19 Pandemic?

On May 17th 2020, the Finance Minister announced a slew of measures and a framework of initiatives designed to provide a bulwark against the mayhem and uncertainty unleashed by the coronavirus pandemic and the ensuing nationwide lockdown upon an approximately $3trn economy.

The announcement was imminent pursuant to the promise of support and solidarity towards all business activities showcased by the Prime Minister the night before.

One of the most defining measures was the decision of the Union Government to impose a one-year suspension on fresh initiation of insolvency proceedings under the Insolvency and Bankruptcy Code (IBC). A clarification was issued thereafter, indicating that the definition of ‘default’ under Section 3(12) of IBC will be excluded to mean any such default arising directly out of the situations caused by the COVID-19 pandemic.

Furthermore, Micro, Small and Medium Enterprises (MSMEs), emerging as the most vulnerable sector hit by the pandemic, will be exempted from the current framework and will be regulated via an amendment made to the IBC under Section 240A.

Given the fact that the measure is substantial so as to equip ailing businesses and entities standing on the precipice of insolvency, it is important to understand the full-range of consequences that are poised to be borne out of it.

The first and foremost is concern with regard to the visible uncertainty around the announcement. The text of the Insolvency and Bankruptcy (Amendment) Ordinance, 2020 is reductive at best. While it does suspend initiation of insolvency proceedings for a company after March 25th for a period of six months and extendable to one year, the proviso to Section 2 is highly ambiguous. The proviso necessarily extinguishes the statutory initiation of insolvency proceedings for all the companies post the given date, permanently. This is a gross impediment of legislative power because a blanket suspension against judicial processes, even in the event of an exigency, is detrimental to the access to justice. If the Government makes no difference between insolvency arising out of the causes of the pandemic and insolvency arising otherwise, then the relief is open to widespread abuse. The better thing to do would be to assign a future date of resolution for all proceedings that may have arisen in during the pandemic.

The pandemic hit various operations at varying points of time. This begs the question as to whether the ordinance is expected to aid in the rescue of those operations the most, which had been ailing for a while but the looming force majeure conditions tipped them over the edge of insolvency. While one can understand the inconvenience of the tribunals to make a case-by-case determination of causality behind insolvency, the inclusion of a few remedial factors by the Government to ease scrutiny is highly recommended. Factors such as status of NPAs, leverage with lenders, stock prices and shareholders’ confidence in management are key criteria that must be accountable in deciding whether it was indeed the pandemic that aggravated their economic despair.

The process of initiation is regulated under Articles 7 (financial creditors), 9 (operational creditors) and 10 (the debtor itself) of the IBC. Without any further enunciation on the modus operandi of this measure, it is uncertain whether all three classes of initiators are collectively barred from doing so. This could be counterproductive for the debtors who wish to engage in the resolution process suo motu because they are convinced that the pandemic has extinguished all possibilities of maintaining their status on a ‘going concern’ basis. To be precise, the longer they linger on the arena of insolvency, the more is the decline in their market position and asset values, neither of which is welcomed under the ‘value-maximisation’ premise heralded by IBC. Thus, depriving them of their rights under Section 10 would be a flawed exercise.

Conversely, if the creditors are deprived of their rights to initiation of proceedings as under Sections 7 and 9, it would defeat the watershed legislative reform struck by the IBC since it brought a paradigm shift in bankruptcy laws from ‘debtor-controlled’ to ‘creditor-controlled’ regulation.

The decision to exempt MSMEs from the application of IBC is by far the most immaculate aspect of the measures being discussed.

Small and medium-scale businesses comprise almost a third of India’s GDP output and it is only fitting that they are made available to the bulk of the favours granted by the Government. Moreover, the increase in threshold to ₹1cr ($134,000) for triggering insolvency proceedings is a welcome measure for MSME’s post-lockdown recovery.

While the temporary suspension appears to be a remedial measure, there are heaps of uncertainties around their structure and implementation. Although it may sound as a far-reaching and effectual framework in the interests of solidifying investor commitment and protecting the financial health of companies that are worst-hit by the pandemic, one must also account for the projected losses that will be meted out to banks and creditors in these turbulent times.

One could make the argument that India is not the only country to opt for such measures. USA, UK and Australia have announced similar measures to contain the financial crises borne out of the urgency of the pandemic. However, it is impractical to make a comparison vis-a-vis these countries where the structure of bankruptcy and recovery courts as well as the robust financial mechanisms aside, the pendency of an average case is way lesser than in India.

To top it off, records show that there have been less than a handful of cases out of thousands applied since 2016 wherein the court has realistically stuck to the 330-day period timeline that was set to wrap up resolution proceedings under the IBC. Therefore, for us to statutorily put off insolvency and bankruptcy proceedings is akin to taking the engine out of a tarrying train of justice.

The Government has been proactive in instituting stimulus packages for the poor and shoring up capabilities to fend off the menace of the pandemic since day zero. However, in terms of retrofitting the impaired business infrastructure, a lot more could be done.

Suspension is simply a coping mechanism to etch out temporary relief to delinquent and insolvent firms. It cannot last forever and neither can our institutional fatigue.

The Government must contemplate other measures such as debt restructuring or debt solidification (based on the state of every individual company’s finances), which are tried and tested mechanisms shown to have yielded success in the West. They could also contemplate enforcing the ‘pre-packaged’ insolvency and bankruptcy deals, which can go a long way in reducing the traffic in judicial corridors. Much like Arbitration clauses, these pre-packs are a set of previously agreed-upon insolvency/bankruptcy processes to be adopted in cases of default. Where the financial landscape in the country is dotted with non-performing assets (NPAs) and bad loans, the IBC is viewed as the sole mitigating framework in the resolution of these instruments.

Therefore, a measure such as suspending the framework, however immediate and temporary the goal may be to do so, is ,suffice to say, taking a considerable chance on the credit-cycle of the economy.

(Originally published July 9th 2020 in transfin.in)