An Insight Into The Insolvency And Bankruptcy Code (Amendment) Ordinance, 2020

Pallav Rathi writes an insight into recently introduced Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020.

INTRODUCTION

In the wake of the COVID-19 pandemic (“the pandemic”), the Indian economy has been severely impacted with restricted cash flows and minimum business operations. The balance sheets of various companies have been negatively affected, leading to shortage of funds not only for running the business operations, but also for payment of debts. However, it must be kept in mind that this shortage of funds is not a sign of failure of the companies, but it is a sign of temporary distress caused by the pandemic.

Keeping in mind the current slowdown in the economy, various measures have been taken to mitigate the financial distress caused for the companies and businesses. the Insolvency and Bankruptcy Board of India (“the IBBI”) inserted Regulation 40C in the IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 which provides for exclusion of time period of lockdown imposed by the Central Government in the wake of pandemic, for the purposes of the time-line for any activity in relation to a corporate insolvency resolution process (“CIRP”) under the Insolvency and Bankruptcy Code, 2016 (“Code”). ¹ Further, Regulation 47A was inserted in the IBBI (Liquidation Process) Regulations, 2016 which provides for exclusion of time period of lockdown imposed by the Central Government in the wake of pandemic, for the purposes of computation of the timeline for any activity in relation to any liquidation process under the Code. ² The Reserve Bank of India (“the RBI”) also permitted the banks to grant a 3-month moratorium on payment of all instalments falling due between March 1, 2020 and May 31, 2020 in respect of all term loans. ³

Most importantly, The President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (“the Ordinance”) on 5^th June, 2020. With the Ordinance in effect, the filing of applications for initiation of the CIRP of corporate debtors under the Code has been suspended for categorised defaults for a certain period of time, so that corporate debtors who are facing financial distress on account of the pandemic may be protected from being pushed into CIRP under the Code, thus giving them some time to regain sustainability of their businesses.

The Code was enacted to provide a mechanism for time-bound resolution of the companies and businesses experiencing financial distress, so that the value of the assets of such companies can be maximized and the flow of the credit can be maintained in the economy. It has been designed with a holistic view to balance the interests of all the stakeholders such as creditors including financial institutions and banks, employees, other secured and unsecured creditors of the corporate debtor and the corporate debtor himself. Moreover, there may not be many prospective resolution applicants who would be interested in infusing capital for the revival of the corporate debtor and accordingly, would provide for resolution plans for such corporate debtor. Resultantly, the corporate debtors, though financially viable, will be liquidated prematurely with low rate of return on sale of the assets, thereby negatively affecting the interests of the creditors, and the objectives of the Code would fail. Hence, the Ordinance has been promulgated to promote the objectives of the Code, i.e. to facilitate maximization of value of the assets, balancing of interests of all the stakeholders including creditors, and resolution of the distress caused for the corporate debtors by the on-going pandemic in the economy.

ANALYSIS OF THE PROVISIONS OF THE ORDINANCE

The application to initiate CIRP can be filed before the National Company Law Tribunal (“NCLT”) under sections 7, 9 and 10 of the Code. A financial creditor can initiate CIRP against a corporate debtor by filing application under section 7 of the Code. Similarly, an operational creditor can initiate CIRP by filing application under section 9 of the Code. Lastly, a corporate debtor can initiate CIRP against itself by filing application under section 10 of the Code.

The Ordinance envisages insertion of section 10A in the Code, which essentially provides that no application can be filed to initiate the CIRP of a corporate debtor for a default caused on or after 25^th March, 2020 for a period of six months or such further period, not exceeding one year from such date, as may be notified. ⁴ The proviso to section 10A further clarifies that no application can ‘ever’ be filed to initiate CIRP of a corporate debtor under the Code for such defaults as stated in the Ordinance. ⁵ In other words, applications under sections 7, 9 and 10 of the Code have been suspended for such defaults for the period as specified in the Ordinance.

For abundant clarity, the Ordinance specifically provides an explanation that section 10A shall not apply to any defaults committed prior to 25^th March, 2020. In effect, sections 7, 9 and 10 of the Code have not been fully suspended, and applications to initiate CIRP can still be filed under the Code for defaults committed prior to 25^th March, 2020.

Under section 66(2) of the Code, if a director or a partner of a corporate debtor, as the case may be, knew that or ought to have known before the insolvency commencement date that the commencement of CIRP of such corporate debtor cannot be avoided by any reasonable means, and such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor, then the resolution professional may file an application before the NCLT for making the directors or partners of such corporate debtor liable to make such contribution to the assets of the corporate debtor as the NCLT may deem fit. ⁶ In this context, the second part of the Ordinance now inserts sub-section (3) in section 66 of the Code, which provides that no application shall be filed by a resolution professional under section 66(2) of the Code in respect of defaults against which initiation of CIRP has been suspended as per the newly introduced section 10A. ⁷ This suggests that a resolution professional cannot initiate an application for fraudulent trading or wrongful trading against directors of companies in respect of defaults against which initiation of CIRP is suspended as per section 10A.

It is pertinent to highlight that section 66(2) of the Code deals with the time gap that lies between the point at which the stakeholders know that CIRP would commence against a corporate debtor, and the point at which CIRP actually commences.

Moreover, unlike section 66(1) of the Code which provides for liability for actions taken to defraud creditors of the corporate debtor or for any fraudulent purpose, section 66(2) does not deal with any kind of fraud. Hence, the intent behind insertion of section 66(3) in the Code is to provide immunity to the directors of the corporate debtor for their actions taken during the pandemic which might prove detrimental to the interests of the creditors, but otherwise taken to avert the financial risks to which the corporate debtors are exposed during the pandemic.

THE UNANSWERED CONUNDRUMS

An effort has been made to mitigate the financial problems of the companies and businesses by promulgation of the Ordinance. However, the Ordinance suffers from some inherent defects and leaves some glaring ambiguities, which need to be addressed.

1. Ambiguity in determination of suspension period:

Section 10A provides for suspension of filing of applications to initiate the CIRP of a corporate debtor for a default caused on or after 25^th March, 2020 for a period of six months or such further period, not exceeding one year from such date, as may be notified. ⁸ However, it is unclear whether the suspension period of six months, or such further period not exceeding one year, shall start from the date of promulgation of the Ordinance, or from 25^th March, 2020, or from such date as may be notified under section 10A in the future.

2. Perpetual nature of suspension of filing of applications for categorised defaults:

The Ordinance stipulates that no application can ever be filed to initiate CIRP of a corporate debtor under the Code for such defaults as categorised under section 10A. ⁹ This means that the bar on filing of applications to initiate CIRP for such defaults as categorised under section 10A is perpetual in nature. However, the preamble of the Ordinance refers to the impact of the pandemic on businesses, financial markets and the economy, thereby stipulating that it is necessary to put bar on filing of applications to initiate CIRP to prevent corporate persons who are facing financial distress on account of the pandemic from being pushed into insolvency proceedings for some time, till the distress continues. Therefore, a perpetual bar on filing of applications to initiate CIRP for such defaults may prove detrimental to the interests of the creditors, as the distress shall not continue forever.

The intent of the Ordinance is to protect the corporate persons for the time during which the financial distress continues on account of the pandemic. Once the pandemic is over and the corporate debtors come out of financial distress, it is irrational to put a perpetual blanket ban on filing of applications to initiate CIRP for such defaults as specified in section 10A.

3. Impractical nature of section 10A:

No criteria have been provided under section 10A for determining whether default by a corporate debtor has been caused on account of the pandemic. The Ordinance provides only for a cut-off date, i.e. 25^th March, 2020, on or after which if defaults are caused by the corporate debtors, CIRP cannot be initiated against them. Hence, it may harm the financial interests of such corporate debtors who made defaults before 25^th March, 2020, but such defaults were caused due to financial distress caused by the pandemic itself. It defeats the purpose of the Ordinance, which is to mitigate the financial distress caused on account of the pandemic.

Moreover, absence of parameters to assess whether default has been caused on account of the pandemic may encourage the corporate debtors to cause wilful defaults after 25^th March, 2020 as the creditors cannot initiate CIRP even for such wilful defaults caused by the corporate debtors. Section 10A provides for blanket suspension for initiation of CIRP for all the defaults caused after 25^th march, 2020 without taking into account the fact that some corporate debtors may take undue advantage of such immunity provided to them.

Furthermore, the power to determine whether default by a corporate debtor has been caused on or after 25^th March, 2020 should have been left with the Adjudicating Authority (“the AA”) under the Code, which is NCLT or NCLAT. Accordingly, the AA needs to determine occurrence of default since it is the triggering event for initiation of CIRP against a corporate debtor, ¹⁰ and the same can be determined by the AA only after filing of applications under sections 7, 9 or 10 of the Code ¹¹. However, section 10A impractically puts bar on filing of applications itself, thereby creating an anomalous situation for the AA.

4. Ambiguity in retrospective application of the Ordinance:

It is pertinent to note that the date of promulgation of the Ordinance is 5^th June, 2020. The Ordinance is silent on the treatment of applications that have been filed between 25^th March, 2020 and 5^th June, 2020 – whether the application of the Ordinance is retrospective or prospective. This poses challenges to the rationale of the Ordinance, as the Ordinance puts bar on filing of applications itself.

5. Ambiguity in determination of amount of default:

The minimum amount of default to be caused for filing applications to initiate CIRP of corporate debtors under the Code before 24^th March, 2020 was ₹ 1 lakh, ¹² which was raised to ₹ 1 crore through a notification dated 24^th March, 2020 (“the Notification”). ¹³ The increased threshold of minimum amount of default under the Notification shall operate prospectively, i.e., it shall not apply to the applications filed under sections 7, 9 or 10 of the Code before 24^th March, 2020. ¹⁴ It is envisaged that default may have been caused by the corporate debtors partly before 25^th March, 2020 and partly after that. However, the Ordinance does not make it clear whether such amount of default, which has been caused in part after 25^th March 2020, shall be included or excluded for calculating minimum amount of default under section 4 of the Code for the purpose of initiation of CIRP for the default caused in part before 25^th March, 2020.

It is further envisaged that default might be caused by the corporate debtors partly during the suspension period provided under section 10A, and partly after the expiry of such suspension period. This again gives rise to an ambiguity regarding filing of applications for initiation of CIRP for defaults caused after expiry of suspension period provided under section 10A, as the Ordinance does not provide for any provision for inclusion or exclusion of such amount of default which has been caused in part before expiry of suspension period provided under section 10A, for calculating minimum amount of default under section 4 of the Code for the purpose of initiation of CIRP for the default caused in part after expiry of suspension period provided under section 10A.

6. Irrationality of sub-section (3) of section 66 of the Code:

As mentioned previously, the Ordinance proposes to insert section 66(3) to the Code, which provides immunity to the directors and the partners of the corporate debtor from making contribution to the assets of the corporate debtor in respect of defaults against which initiation of CIRP has been suspended as per section 10A introduced by the Ordinance, even if the directors and partners of such corporate debt or do not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor. This may change the dynamics of the credit market in the economy, as providing such immunity may discourage the creditors from providing loans to the companies and businesses during the pandemic. The Ordinance does not provide for any rationale for giving complete immunity under section 66(3) of the Code in respect of such defaults against which initiation of CIRP has been suspended as per section 10A.

Further, section 66(3) of the Code bars filing of application by a resolution professional under section 66(2) of the Code in respect of such defaults against which initiation of CIRP has been suspended as per section 10A. ¹⁵ However, application under section 66(2) of the Code can be filed during an on-going CIRP. ¹⁶ Therefore, this makes insertion of section 66(3) in the Code redundant, as the Ordinance already bars initiation of CIRP for defaults categorised under section 10A.

7. Insensitivity towards Micro, Small & Medium Enterprises:

Although, the Ministry of Corporate Affairs (“MCA”) issued the Notification ¹⁷ dated 24^th March, 2020 to prevent MSMEs from going into insolvency proceedings under the Code by raising the threshold of minimum amount of default for initiation of CIRP from ₹ 1 lakh to ₹ 1 crore. However, the Ordinance does not provide for any provisions to address the problems of Micro, Small & Medium Enterprises(“MSMEs”). In effect, the Notification and the Ordinance may have combined negative effect on financial status of the MSMEs.

The MSMEs provide credit to the companies in form of operational debt or financial debt as the case may be, and default can be caused by the companies in payment of debt owed to the MSMEs. However, during the suspension period stipulated under the Ordinance, MSMEs cannot initiate CIRP against such corporate debtors, who cause defaults in payment of debts after 25^th March, 2020. Also, after 24^th March, 2020, MSMEs cannot initiate CIRP for defaults caused before 24^th March, if the amount of default is less than ₹ 1 crore. This indicates that after 25^th March, 2020, MSMEs can initiate CIRP for defaults caused in payment of debt owed to them, only if two conditions are met: Firstly, the amount of default should be greater than or equal to ₹ 1 crore, and secondly, the default should have been caused before 25^th March. Hence, by restricting the MSMEs from initiating CIRP for defaults caused in payment of debts owed to them, the Ordinance coupled with the Notification may harm the financial interests of the MSMEs rather than protecting them.

8. Problems of on-going CIRPs left unaddressed:

There is hardly any doubt in the fact that all companies are experiencing financial distress on account of the pandemic. Therefore, it is essential to consider the plights of on-going CIRPs. The resolution applicants may be facing difficulties in implementation of the resolution plans in on-going CIRPs, due to the financial distress caused on account of the pandemic. However, the Ordinance does not address the financial problems faced by them in the implementation of the resolution plans in on-going CIRPs during the pandemic.

In cases where the CIRPs were initiated before the pandemic, the resolution plan for the corporate debtors may not have been proposed, as the companies may not bid for the corporate debtors on account of financial distress caused by the pandemic. In such a situation, the corporate debtors would be unnecessarily pushed into liquidation under the Code, if no resolution plan is received by the AA under section 30(6) of the Code before the expiry of the maximum period permitted for completion of the CIRP under section 12 of the Code. ¹⁸

9. No suspension of proceedings against the personal guarantors:

While the Ordinance suspends initiation of CIRP for the defaults as specifically stated under section 10A ¹⁹, the creditors of the corporate debtors can still go behind the personal guarantors of the corporate debtors to recover the money associated with defaults caused by the corporate debtors, as the Ordinance does not suspend the initiation of proceedings against the personal guarantors of the corporate debtors. This may frustrate the objective of the Code, i.e. balancing of interests of all the stakeholders. The Ordinance fails to accommodate the interests of the personal guarantors, thereby risking their financial status for the defaults caused by the corporate debtors.

SUGGESTIONS AND THE WAY AHEAD

Keeping in mind the ambiguities and defects as highlighted above, the following measures can be taken to ensure the smooth implementation of the Ordinance:

1. A notification can be introduced by the authorities, clarifying the starting date of the suspension period stipulated under section 10A introduced by the Ordinance.

2. Instead of a perpetual immunity, the corporate debtors could have been given a temporary protection from being dragged into insolvency proceedings for the defaults caused on account of the pandemic.

3. Instead of providing a cut-off date for categorising the defaults under section 10A introduced by the Ordinance, the default caused on account of the pandemic could simply be excluded from the definition of default provided under clause (12) of section 3 of the Code, by adding a proviso to the definition. Further, instead of suspending the filing of applications for initiation of CIRP for the defaults categorised under section 10A, the NCLT could have been empowered, after filing of applications, to determine whether a default has been caused by a corporate debtor due to distress caused by the pandemic.

4. A clarification can be provided by the IBBI mentioning that all such applications which have been filed before 5^th June, 2020, for initiation of CIRP for defaults caused after 25^th March, 2020, shall stand suspended.

5. If the defaults in payment of debts have been partly caused during the suspension period provided under section 10A, and partly before or after that, then such amount of default which has been caused during such suspension period shall be allowed to be included for the purpose of calculating minimum amount of default under section 4 of the Code for the purpose of initiation of CIRP for the default caused in part before or after the suspension period. Otherwise, if such amount of default which has been caused during such suspension period is not allowed to be included for such calculation, it would encourage the corporate debtors to commit continuing defaults in payment of their debts till the threshold of minimum amount of default is met under section 4 of the Code.

6. The Ordinance provides complete immunity to the directors and the partners of the corporate debtor from making contribution to the assets of the corporate debtor in respect of defaults against which initiation of CIRP has been suspended as per section 10A, even if the directors and partners of such corporate debt or do not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor. Instead, the power could have been left with the NCLT to determine the liabilities of the directors and partners of the corporate debtors on case-to-case basis.

7. Provisions could have been included in the Ordinance to address the problems of the MSMEs, as the MSMEs are the one who have been majorly hit by the pandemic. There is an immediate need to address the financial problems of MSMEs. Additionally, MSMEs could have been permitted to initiate the CIRP for the defaults stated in section 10A, as MSMEs also provide debt to the companies and businesses in the economy. Otherwise, if MSMEs are not made an exception to the creditors who cannot initiate CIRP for such defaults, then the funds of MSMEs may be blocked, thereby giving a major blow to the financial strength of the MSMEs.

8. It is imperative to defer the implementation of already-approved resolution plans in on-going CIRPs, as the resolution applicants may also be facing financial distress on account of the pandemic. Deferring the implementation of already-approved resolution plans may ensure that they are being implemented in a viable manner, when the resolution applicants are financially strong again. Further, in case there is no successful resolution applicant for the corporate debtors against whom CIRP was initiated before 25^th March, 2020, then steps should be taken to suspend the CIRP of such corporate debtors, so as to prevent them from going into liquidation.

9. There is a need to suspend the insolvency and bankruptcy proceedings against the personal guarantors of the corporate debtors, in the same manner in which it has been suspended in respect of the corporate debtors. This will allow the personal guarantors of the corporate debtors to mitigate their financial distress, which they may be facing on account of the pandemic, thereby enabling them to provide a better financial security to the creditors in the future. Moreover, it will also ensure balancing of financial interests of the personal guarantors in line with the interests of other stakeholders.

CONCLUSION

The picture would have been much better if the Ordinance was promulgated taking into consideration the defects and ambiguities as highlighted above. However, the Ordinance still manages to keep up the spirit of the corporate debtors and the companies facing financial distress on account of the pandemic. The Ordinance has been promulgated keeping in mind the nitty-gritty of the Code. It is imperative to acknowledge the fact that the Code is designed to deal with the distress of companies or an industry, and not designed to deal with the distress caused across the whole economy or an economic disaster. Therefore, the Ordinance cannot facilitate the revival of the economy as a whole. It will also be interesting to see how the NCLT and other authorities such as the IBBI respond to the ambiguities and difficulties which may arise in future with the Ordinance in effect. Accordingly, the NCLT would have a much important role to play in facilitating the smooth implementation of the Ordinance, as it is the AA under the Code.

Despite all the shortcomings in the Ordinance, it is vital to understand that overall objective of the Code is to rescue the companies which are financially viable. In the case of Swiss Ribbons Pvt. Ltd. v. Union of India ²⁰, Hon’ble Supreme Court assessed the Preamble of the Code and discerned that maximisation of value of the assets of the corporate debtors is very important objective of the Code, so that the corporate debtors can be brought back into the economic mainstream and are able to repay their debts. This in turn enhances the viability of credit in the hands of banks and financial institutions. ²¹

To mitigate the financial distress caused in the economy due to the pandemic, there were essentially two options available under the Code. First, the initiation of CIRP could not have been suspended for any defaults caused in payment of debts.

It is necessary to realise that all the companies are facing financial distress on account of the pandemic. Therefore, there are not enough resolution applicants who can rescue the corporate debtors causing defaults. Thus, the first option could irreversibly push such corporate debtors into liquidation which may be facing temporary distress on account of the pandemic, but are financially viable. Second option is what the Ordinance put in effect, thereby allowing all the corporate debtors, whether financially viable or non-viable, to regain stability and come back into the economic mainstream.

It is possible to liquidate the non-viable companies in future, but it is not possible to undo the liquidation of the financially viable companies, which could have been liquidated, had the Ordinance not promulgated to suspend initiation of CIRP for the defaults mentioned in the Ordinance. Hence, the overall impact of the Ordinance is in furtherance of the objective of the Code.