Ankesh Kumar and Shefali Chawla

This is the 16th part of our COVID-19 Series

Introduction

As the world continues to battle this pandemic contagion, a slew of measures is being taken by nations across the globe to prevent an equally alarming economic crisis. On March 24 ,2020 the Government of India (hereinafter “GOI”) imposed a nationwide lockdown. On the same day as the imposition of the lockdown, the GOI vide its notification declared that threshold of the amount of default for initiation of insolvency proceedings under the Insolvency and Bankruptcy Code, 2016 (hereinafter “IBC”) shall be increased from INR 1 lakh (USD 1,310) to INR 1 crore (USD 131,000), a staggering hundredfold increase compared to Australia’s and Singapore’s tenfold increase to USD 20,000 and USD 100,000 respectively.

Furthermore, the Finance Minister had expressed her intention to suspend sections 7, 9 and 10 of IBC for 6 months if the lockdown continued beyond April 30, 2020 which may be extended for another 6 months if needed. While the rise in threshold is being seen primarily as an endeavour to preserve and rescue MSMEs from the brutality of an impending economic crisis, the latter expression for a blanket suspension of any new filing under IBC may prove to exacerbate than cure the disease.

The need for revamped restructuring models

Dr. M.S. Sahoo in an interview clarified that the suspension of the foregoing sections shall not affect other provisions and the Insolvency Law framework would shift back to pre-IBC era with there being several other recourses for recovery as well as resolution like the DRT, Section 230 of the Companies Act and civil law.

Debt restructuring in India has been exposed to thin light and is still in a nascent stage with the only models available through sec. 230, sections 30 and 12A in IBC (hereinafter, “resolution plan” and “12A” respectively) and more recently, RBI’s Prudential Framework on Resolution of Stressed Assets (hereinafter, “June 7 Circular”). However, these models have flaws of their own which may not be best suited to pull firms out of an unprecedented crisis.

While sec. 230 has provisions for pre-default restructuring at the behest of the creditor, member or liquidator, it is still uncertain whether it attracts section 29A of IBC (hereinafter, “sec. 29A”). The NCLAT in Jindal Steel and Power Limited v. Arun Kumar Jagatramka & Gujarat NRE Coke Limited had observed, “while a scheme under section 230 is maintainable for companies in liquidation under the Code, the same is not maintainable at the instance of a person ineligible under section 29A of the Code.” In Y. Shivram Prasad v. S. Dhanapal & Ors. it observed that, “As the liquidation so taken up under the ‘I&B Code’, the arrangement of scheme should be in consonance with the statement and object of the ‘I&B Code’”. It is pertinent to note at this point that earlier this year, IBBI vide its notification had imported the disqualifications in sec. 29A to the liquidation process as well.

Similarly, while the June 7 Circular is binding on all creditors entering into the inter-creditor agreement, it was enacted at a time which did not foresee suspension of insolvency filing by other classes of creditors. Therefore, not being a proceeding in rem, it does not take into account equitable treatment of all stakeholders. By this standard, it would meet the same fate as its previous versions and may be challenged for violating one of the basic tenets of IBC. The need for a moratorium or calm period was underlined in the BLRC report as: “While it is optimal for both parties to negotiate to maximise value, the difference in their objectives lead them to take individual action to protect their investments. The Code provides legal recourse to both the debtor and the creditor for a calm period where these negotiations can take place in an orderly, non-conflicted manner, managed by a neutral third party professional.” In the absence of a moratorium, it doesn’t prevent other stakeholders from pursuing litigation in other fora.

The Financial conundrum

Economic and legal institutions across the globe have been suggesting packages to get the economy in a pre-COVID scenario in the shortest time frame possible. RBI on its part mandated banks to impose moratoria on several payments coupled with ambitious liquidity infusions to banks as well as special schemes for Mutual Funds following the Franklin Templeton debt fund closures. Nonetheless, banks remain wary of lending out loans with large pre-COVID NPAs on their balance sheet which is only expected to grow amid the crisis. A suspension of fresh filings may exacerbate the foregoing predicament thereby inducing a liquidity crunch. Conversely, clean debt restructurings may help creditors realise some of their loans not only infusing liquidity but also boosting credit-morale. Some bankers have recommended that instead of doing a total stop clock on resolutions, this could be a good time to attract foreign investors to take over companies because liquidity is easy and cheap overseas.

Lessons can be drawn from the American automobile giants, General Motors and Chrysler in how they dealt with the 2008 crisis. Both neared death during the 2008 financial crisis, but were taken into Chapter 11, where each received financial support from the federal government. Each was sold off to a buyer within weeks. The speedy bankruptcies, financed by the federal government, allowed both companies to renegotiate or shed legacy liabilities that had been a drag on innovation for decades. GOI can therefore create specially monitored funds or bonds as a source of direct liquidity infusion into firms or for interim financing. As an alternative, Prof. Marti Subrahmanyam suggests infusion of pseudo equity into body corporates wherein the government would buy equity in selected firms based on their performance in previous years aiming primarily at MSMEs. This pseudo equity should be eligible to bought back by firms at a predetermined descending rate per annum so that the governmental treasury is benefitted by any profit these firms make.

One of the measures may include grant of extended timelines for debt repayment to help them recover in initial years with simultaneous conditions for laying off a portion of their disposable income.

Conclusion and Way Forward

It may be accepted that one of the reasons behind suspending fresh filings of any colour is to partly declutter already overburdened NCLTs and partly to prevent aggravation of this situation by a huge influx of COVID induced insolvencies. We began by drawing an analogy of this crisis to pandemic which, if not cured in time, would subsume everyone. GOI’s approach is perhaps analogous to evading a disaster than sending a rescue team to pull out the ones stranded in it. A possible solution to this situation can be to identify the most time consuming procedures involved in CIRPs and coming around a solution for the same or the enhancement of e-court infrastructure of NCLTs.

In Swiss Ribbon Pvt Ltd s vs Union of India (hereinafter, “Swiss Ribbons”) the apex court had noted that one of the primary motives behind introducing sec. 29A was to prevent malfeasant promoters from taking back the reins of the corporate debtor. The situation in hand vehemently demands a shift in this presumption. Mr. Joseph Stiglitz had opined that in resolving insolvencies arising out of major macroeconomic disturbances, there should be a strong presumption in favour of the continuation of the same management and restructuring of liabilities with the creditors. At best, a valuer or an auditor may be given the task of determining whether a pre-existing zombie enterprise looking to exploit the situation or the insolvency of the firm is a COVID induced stress, but provisions of section 29A disqualifying an unfortunate promoter from saving his firm ought to be suspended temporarily. This may be coupled with a temporary suspension section 66 as well, which holds a director liable for withholding information with respect to a default.

The need for a calm period in an effective insolvency legislation has been stressed in almost every jurisdiction across the globe. The suspension of the foregoing sections may induce moratorium free resolutions or schemes which may possibly not be binding on all stakeholders. This would create more problems than solve them as it has been highlighted above.

Section 12 A was introduced to the IBC as a representative and non- exclusionary debt settlement mechanism to allow for withdrawal of a CIRP application subject to approval of 90% of the Committee of Creditors. It is suggested that the threshold be temporarily reduced to encourage entities presently undergoing CIRPs that may have suffered as a consequence of Resolution Applicants pulling out of the process or not being able to attract any applicant at all.

SEBI and IRDAI may come up regulations of their own to facilitate a debt restructuring with mutual funds and insurance companies. The June 7 Circular may be tweaked to comply with fundamental IBC principles incorporating the interest of all stakeholders. The foregoing world bank report suggests that to fully come out of this crisis personal bankruptcies have to be heeded as well. This may be crucial considering a possibility of a steep escalation in unemployment. Despite having robust provisions for resolution of personal bankruptcies, the IBC has only been notified so far for corporate insolvency. In relation to personal bankruptcy, the IBC provisions have only been operationalised for individuals who have given guarantees for loans taken by corporations, and not for other individuals, sole proprietorships and partnership firms. Keeping this in mind, it may be a good time to notify provisions relating to personal bankruptcy.

To this end, we observe that the economic crisis likely to ensue from the COVID-19 pandemic demands the operation, albeit with alterations, and not the suspension of the IBC or in the alternative a significant refurbishment of the non-IBC restructuring mechanisms. We believe that regaining creditor confidence and a systemic infusion of liquidity need urgent redressal to revamp the Indian debt landscape and economy at large- for which purpose innovative solutions form the need of the hour.

The authors are IVth year students of National Law Institute University, Bhopal

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