The IBC (Amendment) Ordinance, 2020: A Well Stuffed Cushion Against The Economic Blow

Shreya Dagar and Rishabh Kumar

IBC 2020

With a nation-wide lockdown in force, corporate concerns are facing the brunt of the economic fallout caused by the Covid-19 crisis, in terms of cash crunch and stagnant business activities. In wake of the economic distress, the President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 on 05.06.2020, to extend a helping hand to corporate debtors. The move comes as a huge relief for corporate borrowers who may have ended in premature corporate death if the ordinance hadn’t come to their rescue in time. However, a series of debate followed the pronouncement, questioning the necessity of such an ordinance.

What does the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 entail?

By virtue of Section 10A, inserted by the ordinance, the operation of Sections 7, 9 & 10 of the Insolvency and Bankruptcy Code, 2016 [“the code”] has been suspended, i.e. barring the initiation of any corporate insolvency resolution process [“CIRP”], with respect to defaults arising on or after 25.03.2020 for a period of six months, which may be extended up to a maximum of one year from such date as may be notified. Further, a new clause, i.e. Section 66(3) has been added to the code, barring filing of applications under Section 66(2) of the code.

The Ordinance: A called-for development?

The Ordinance has been criticized on various grounds. The suspension of Section 10 of the code is specifically attacked as it prevents corporate debtors from filing an application for insolvency on their will.

In order to appreciate the reasoning underlying such a move, it is imperative to understand how a corporate insolvency resolution process works. An application under section 7, 9 and 10 triggers the resolution process thereby initiating the CIRP of the corporate debtor. The control of management and affairs of such a corporate debtor is transferred to a resolution professional who invites claims from the creditors and thus, a committee of creditors is constituted. Applications are invited from the resolution applicants to take over the corporate debtor. In case no resolution plan is approved/finalized within a period of 180 days (extendable by another 90 days), liquidation proceedings are commenced with respect to such a corporate debtor.

Therefore, it is explicit from the above that a third party in the form of a resolution applicant is required to inject funds to keep the company in operation. This is based on the presumption that there are financially sound persons or entities in the market willing to invest money, acquire or purchase the corporate debtor to keep it as a going concern. However, realistically speaking, almost all companies are facing a huge financial crunch. This is evident from the fact that major companies are downsizing their workforces, recalling the job offers made to graduates or resorting to salary cuts. In light of the present pandemic, it is not feasible to expect potential resolution applicants who would be willing to support the company.

Promotes the objectives of the code

As per the preamble of the IBC, one of its objectives is the maximization of value of the assets of a corporate debtor. According to the Insolvency and Bankruptcy Board of India’s quarterly newsletter for the months October to December, 2019, the sums realized by the creditors under the insolvency process is much lower as compared to their admitted claims. For example, the amounts realized in the CIRP of Ambey Iron Private Limited were merely 11.3 crores while the admitted claims of the financial creditors were Rs 218.55 crore and the liquidation value of the company was Rs 5.63 crore. Even if a resolution applicant does come forward, the value of the sums realized by the creditors would be even lower considering the unfavourable financial climate. This will be further disadvantageous to the creditors. Therefore, the suspension of the insolvency process for the said period is in fact, conducive to the better realization of the creditor’s claims.

It has been argued that Section 10A, added by virtue of the ordinance, restricts the debtor’s freedom to self-initiate the insolvency process. However, the mere suspension of Sections 7 and 9, while keeping Section 10 operative, will defeat the entire objective of this ordinance. The main objective of the ordinance is to prevent the businesses facing financial distress from getting pushed into insolvency proceedings for reasons beyond their control.

Section 10 ensures the transfer of the corporate debtor from inefficient management and control to a more efficient one. Due to the unprecedented circumstances, most of the companies are financially unhealthy or are potential financially sick companies dealing with the situation through layoffs and salary cuts. The demand is an all-time low. Therefore, even the most efficient management of affairs may end up on the verge of insolvency. In such a situation, section 10 may not provide the most plausible solution. In the light of macro-economic distress, it is a dubious assumption that a potential resolution applicant will ensure better management of the company.

Coming to a more realistic state of affairs, it would be preposterous to assume that resolution applicants will come forward or that a resolution plan will be finalized. The more probable outcome would be the companies heading towards liquidation. Liquidation is generally, the last resort and attempts should be made to keep the company as a going concern. In the case of Y Shivaram Prasad v S Dhanapal & Ors, the Hon’ble NCLAT mentioned that “efforts must be made to keep the company as a going concern”. Therefore, the continuation of sections 7, 9 and 10 will promote liquidation rather than reorganization of the corporate debtor, defeating the very objective for which the code was brought into life.

A complementary measure to the moratorium announced by the RBI

The ordinance has been criticized by many bankers, saying that there was no need for such a measure when the moratorium announced by the Reserve Bank of India was already in force. Recently, the RBI extended the moratorium period, announced by it vide a circular on 27/03/2020, allowing all lending institutions to grant a moratorium on payment of all the instalments falling due between March 1, 2020, to August 31, 2020, in respect of all term loans. While the move cushions the borrowers from lending institutions raising claims, it has left them unprotected from the blow that may come their way from other creditors. The moratorium announced by the central bank only restrains lending institutions from filing a claim under the code, leaving other creditors in the clear to initiate CIRP against corporate debtors resulting in their premature insolvency.

Moreover, considering the persisting pandemic, it is uncertain as to when the economy will start picking up again. In such a situation, post the moratoria announced by the central bank, there will be an unprecedented pressure on the corporate debtors to make payments. Any default in payment after such date may lead to the initiation of CIRP by various lending institutions. The ordinance fixes this problem as it excludes the defaults arising in the period as notified by the ordinance, providing that a CIRP can never be initiated for such defaults. If the ordinance had not been brought into the picture, a lot of business concerns would be on the verge of insolvency for reasons beyond their control. Therefore, the ordinance is a full proof plan, providing protection to corporate debtors from any blow that may have threatened their existence.

A Better Alternative in Times Of Uncertainty

The Insolvency and Bankruptcy Code, 2016, has been designed in a manner which requires a transfer of control of the corporate debtor on the initiation of the corporate insolvency resolution process, and sale of the debtor to an unrelated party. Considering the state of disorder that the market is reflecting presently, even the applicant acquiring control over the corporate debtor post-CIRP would struggle to keep it as a going concern. In a murky situation like this, a better alternative for companies would be to recourse to Section 230 of the Companies Act, 2013 [hereinafter “the Act”]. Section 230 of the Act, 2013, provides corporate concerns with the power to compromise or make arrangements with their creditors and members. Under the provision, companies may float a scheme of arrangement or compromise, seeking restructuring of the debt obligations towards their creditors which, considering the current situation seems to be a more appropriate option. In fact, recourse to Section 230 is favourable for both corporate debtors and creditors, as it is a debtor-driven solution requiring a consensus with the creditors as well, and brings an ounce of certainty to them in this situation of a pound of uncertainties.

Conclusion

Difficult times call for unprecedented measures. In essence, the ordinance had to have been brought into the picture for safeguarding the interests of all stakeholders in the market. It requires an understanding on part of the creditors that, a little forbearance on their part in the present would save numerous corporate concerns from dying a premature corporate death. However, the creditors may resort to other alternatives, e.g. The SARFAESI Act, 2002, for the realization of their money, it is suggested that they refrain from any knee-jerk reaction. The ordinance provides for intended succour, giving time to companies to recoup from the shambles they are in, and will eventually prove to be in the interest of all.


The authors are students at the National Law University, Jodhpur.

Picture Credits: Bar and Bench


Click on the book images below to make your Amazon purchases. All affiliate commissions earned are donated to Stranded Workers Action Network.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s