10 June 2020
Introduction
On June 5, 2020, the President of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2020 (“Ordinance”), in furtherance to the economic measures announced by the Ministry of Finance[1] to support Indian businesses impacted by the outbreak of the Covid-19 pandemic.
The Ordinance has introduced the following amendments to the Insolvency and Bankruptcy Code, 2016 (“IBC”) (effective immediately):
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Section 10A has been inserted in the IBC, restricting filing of any application for initiation of the corporate insolvency resolution process (“CIRP”) of a corporate debtor (being a company or a limited liability partnership) for any default[2] arising after March 25, 2020, for a period of six months or such further period, not exceeding one year from March 25, 2020, as may be notified in this behalf (such period being “Specified Period”).[3]
Further, a proviso has been inserted in section 10A to specify that no application shall ever be filed for initiation of CIRP of a corporate debtor for the said default occurring during the Specified Period i.e. CIRP can never be initiated on the basis of a default during the Specified Period, even if the default is continuing after having occurred during the Specified Period.
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A non-obstante clause has been inserted in to section 66 (Fraudulent trading or wrongful trading) of the IBC to give protection to the directors of a corporate debtor. Accordingly, no application can be filed by a resolution professional under sub-section 66(2), in respect of such defaults against which initiation of CIRP is suspended under Section 10A of the IBC.[4]
In our previous blog (available here), we had dealt with the judicial and legislative measures introduced in India in light of the Covid-19 pandemic. In this piece, we have analysed the implications of the amendments introduced pursuant to the Ordinance. It may be noted that the special insolvency resolution regime in respect of micro, small and medium size enterprises (MSME) as mentioned in the announcement of the Ministry of Finance is still awaited.[5]
Prohibition on IBC proceedings for defaults during specified period
Section 10A prohibits filing of an application for initiation of insolvency proceedings for any default arising after March 25, 2020, till the end of the Specified Period without an inquiry into the cause of default, which prohibition continues in perpetuity. While the preamble of the Ordinance stipulates that the Ordinance has been introduced in light of business disruptions caused on account of Covid-19 and the consequent inability to find adequate number of resolution applicants to rescue corporate debtors, no rationale has been provided for this permanent prohibition. This approach, however, does take away the possibility of extended disputes on the cause of default.
Looking at international measures in light of Covid-19, a permanent prohibition seems unprecedented. Countries such as Singapore, Germany and United Kingdom have proposed or carried out changes to the insolvency regimes to address the impact of the pandemic in the form of restrictions to insolvency proceedings, however, a complete and permanent prohibition appears to have no parallel.
Exception to wrongful trading
As specified above, the Ordinance protects a director or partner of the corporate debtor from proceedings being initiated against them for wrongful trading, relating to a default during the Specified Period. However, this does not mean that a board should continue running business of the company and incurring debts if it has no prospect of recovery of the business. There is also a risk that reckless behavior of directors prior to March 25, 2020, which led to a default during the Specified Period, may go unpunished, unless dealt with under Companies Act, 2013 (“Companies Act”), as a breach of directors’ duties.
Relaxations from wrongful trading have also been granted in many other jurisdictions such as Australia[6] where the Coronavirus Economic Response Package Omnibus Act 2020 was introduced as a safe harbour provision, so that directors can no longer be held liable for incurring debts while insolvent in relation to any debt incurred by the company in the initial six month period as being insolvent trading, commencing on March 25, 2020. This measure has also been announced in New Zealand and the United Kingdom.
Analysis
Against this background, the following may be noted:
Firstly, the introduction of the Ordinance would bring the out-of-court restructuring regime under the Prudential Framework for Resolution of Stressed Assets dated June 7, 2019[7], into focus. With applicability only to RBI-regulated creditors and the primary tool of implementation being contractual arrangements, the courts will also have a role to play in its success as well as implementation of restructuring, arrived under the said framework, especially if the debtor is not playing ball after signing up to the restructuring package. Equally, stakeholders would have to look at schemes of arrangements and foreign restructuring tools[8] to give effect to a debt restructuring, depending on the debt profile of the company. The provisions relating to schemes of arrangement do not provide a moratorium against creditor actions.
Secondly, where no restructuring is feasible for companies defaulting during the Specified Period, the lenders would have to rely on applicable recovery and enforcement tools such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and Recovery of Debts Due to Banks and Financial Institutions Act, 1993, in addition to civil courts and arbitration, where applicable. The backlog of cases and feeble functioning of debt recovery tribunals (“DRTs”) is well documented. In fact, one of the Indian private banks has recently approached the Supreme Court, seeking strengthening of the DRT system.[9]
Thirdly, the Ordinance places no prohibition on insolvency/ bankruptcy proceedings of personal guarantors under the IBC. This regime has come into effect very recently and is rather untested.
Fourthly, while the ability of companies to file themselves into insolvency under IBC has been prohibited, if a need is felt that the company should be liquidated, the (now almost forgotten) winding up procedure under the Companies Act and voluntary liquidation under IBC continues to be available (creditors cannot file for winding up under the Companies Act and voluntary liquidation is not available for companies in default).
Fifthly, there may be a moral hazard risk of a debtor, covered by this exclusion, undertaking undervalued or preferential transactions and dissipating assets of the company to the detriment of creditors. Creditors will need to monitor the debtors more closely to avoid such a situation (the J Crew case in the US has some learnings in this regard). Even if the company goes into insolvency for a default post the Specified Period, the look-back period to challenge the transaction may be over. While Companies Act remedies may provide a fall back, the standard of proof is usually higher for such cases to succeed.
Conclusion
The Ordinance seeks to provide an efficient breathing space to Indian businesses hit by the pandemic. While there is a small chance of debtors abusing the suspension for defaults during the Specified Period for reasons other than the pandemic, given the extent of damage otherwise to the economy, such a chance is miniscule.
*The Authors thank Ms. Surbhi Pareek, Senior Associate for her assistance on this blog.
For further information, please contact:
Cyril Shroff, Managing Partner, Cyril Amarchand Mangaldas
cyril.shroff@cyrilshroff.com
[1] Available at: https://pib.gov.in/PressReleasePage.aspx?PRID=1624661> <Last visited on June 6, 2020>
[2] “default” under the IBC means, “non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be.”
[3] Section 2 of the Ordinance
[4] Section 3 of the Ordinance.
[5] supra note 1. In the meanwhile, vide notification dated June 01, 2020, the Indian Government has modified the criteria for classifying businesses as MSME as follows: (i) investment in plant and machinery of Rs. 1 Crore (from earlier limit of Rs. 25 Lakhs for manufacturing and Rs. 10 Lakhs for services) and turnover of Rs. 5 Crores for micro enterprises; (ii) investment in plant and machinery of upto Rs. 10 Crore (from earlier limit of Rs. 25 Lakhs to Rs. 5 Crores for manufacturing and Rs. 10 Lakhs to Rs. 2 Crores for services) and turnover of Rs. 50 Crores for small enterprises; and (iii) investment in plant and machinery of upto Rs. 50 Crore (from earlier limit of Rs. 5 Crores to 10 Crores for manufacturing and Rs. 2 Crores to Rs. 5 Crores for services) and turnover of upto Rs. 250 Crores for medium enterprises.
[6] INSOL International and the World Bank’s Global Guide: an interactive map of measures adopted to support distressed businesses through the COVID-19 crisis
[7] Reserve Bank of India (“RBI”) circular dated June 7, 2019 bearing reference number RBI/2018-19/203 DBR.No.BP.BC.45/21.04.048/2018-19.
[8] With one eye on the cross-border insolvency regime and limited avenues for enforcement of foreign judgements in India.
[9] Writ Petition No. 478 of 2020. Please also see: https://www.livemint.com/news/india/sc-agrees-to-hear-kotak-mahindra-bank-s-plea-seeking-resumption-of-drt-proceedings-via-videoconferencing-11591379248851.html> <Last visited on June 6, 2020>
