Article Category: Restructuring & Insolvency

Coronavirus outbreak – IBC suspension.

Suspension of the IBC for a period of 6 months shall further disable the creditors from initiating insolvency resolution proceedings against the corporate debtors, thereby further blocking the mechanism to resolve the debt and recover the credit

In order to prevent community transmission of COVID-19, the government has extended the pan India lockdown. India’s Lockdown 2.0 commenced on April 15, 2020 and shall continue until May 3, 2020. The total count takes it to 40 days since the first phase of the lockdown.

The lockdown has brought India Inc to a standstill, although considering the need to bring the economy back into motion, certain activities in the essential goods and services sector have been allowed, subject to conditions, with effect from April 20, 2020.

The Insolvency Bankruptcy IBC, 2016 (IBC) was enacted in order to provide a solution to creditors, resolve the insolvency of corporate debtors and very importantly, provide a time-bound mechanism to the creditors for debt resolution. Amid COVID-19 outbreak, the government has taken several necessary yet difficult measures such as lockdown, which may render resolution of debts by corporate debtors, strenuous.

Will the IBC be suspended?

As a protectionist move for corporate debtors under the IBC, on March 24, 2020, the Union Finance Minister Nirmala Sitharaman, for the first time, had announced the intention of suspending Sections 7, 9 and 10 of the IBC, in case the difficulties faced by the corporates continue beyond April 30, 2020, amidst the lockdown.

Now that the lockdown has been extended, the government is mulling on promulgation of an ordinance for suspension of the said sections of the IBC. The suspension shall not allow financial and operational creditors as well as corporate debtors themselves from initiating insolvency proceedings.

This is primarily aimed at protecting the medium and small enterprises, which are hit the hardest due to the COVID-19 pandemic, because of disruption of supply chains and disabilities caused by lockdown in carrying out the businesses and generating revenue.

However, a blanket ban on initiation of insolvency proceedings may have been uncalled for as it is likely to have adverse repercussions for certain sections e.g. the creditors. But, the situation may well be unavoidable since the initiation of insolvency proceedings during these times are likely to severely clog the courts and therefore, the government may well press the suspension button, albeit for a temporary period.

We have already seen various measures under the IBC being taken since the last few months including the threshold of minimum default under the IBC being increased ten times from Rs. 1 lakh to Rs. 1 crore thereby swiping off a large number of operational creditors from filing applications for recovery and leaving them toothless under the IBC.

The Force Majeure difficulty

Force majeure is basically a clause which provides an ability to contracting parties to not perform their obligations without being held responsible for it, due to the happening of extraordinary events that were not in their control. Importantly, force majeure is generally not seen in loan agreements. However, business contracts that contain such clauses are likely to see parties invoking it, thereby rendering the performance of contract for the time period, impossible, which means that a corporate debtor, owing to zero or substantially lowered revenues during the lockdown is likely to default on its pay-outs to financial creditors as well as operational creditors. Worse, force majeure clauses in certain contracts may well be drafted in a manner which may not allow an interpretation to be taken such that a pandemic of this nature does not get covered.

If the IBC is suspended, without a doubt, creditors, especially the operational creditors shall be hit hard. Operational creditors, unlike financial creditors are engaged in the supply chain of the corporate debtor and if they are not paid due to invocation of force majeure, this shall further impact their ability to repay their creditors, thereby showcasing a devastating ripple effect on the economy.

RBI’s COVID-19 Regulatory Package

The Reserve Bank of India has allowed financial creditors, i.e., all banks and financial institutions (including NBFCs) to grant a moratorium of 3 months on payment of all term loan installments (including agricultural, retail and crop loans) and interest on working capital loans (such as overdraft facilities), which are due between March 1, 2020, and May 31, 2020.

This not being mandatory in nature, poised a difficult question for borrowers and lenders alike, until India’s largest public sector bank, State Bank of India, opened this line of moratorium and others followed suit. Such moratorium has already made it easy for the debtors to repay their loans and interest after the end of the moratorium.

However, this moratorium shall restrict the liquidity of the creditors and pose difficulty in extending credit to potential borrowers. Even if the credit is extended to potential borrowers considering the hiatus in business activities created by the novel coronavirus pandemic, such borrowers shall be in limited or no capacity to repay at this juncture, which shall only further dry up the liquidity of the creditors. If creditors run out of liquidity, since the Indian banking sector is already exposed to several NPAs, businesses shall be hampered, as a substantial majority run on credit.

How will a suspension be brought about?

The central government may exercise its powers under Section 242 and other provisions of the IBC to issue a notification suspending Sections 7, 9 and 10 of the IBC, in order to prevent the companies at large from being forced into insolvency proceedings. Section 242 empowers the central government to make such provisions not inconsistent with the provisions of the IBC in order to remove any difficulty.

Will a temporary suspension be useful?

Suspension of the IBC for a period of 6 months shall further disable the creditors from initiating insolvency resolution proceedings against the corporate debtors, thereby further blocking the mechanism to resolve the debt and recover the credit.

In light of the aforementioned measures already taken by the government to ensure the corporate debtors to sail through this period of financial stress, suspension of IBC maybe a little too much of an overprotection of the corporate debtors.

Certainly, this suspension will put the creditors in dire financial crisis, as despite the end of the second phase of the lockdown, they will have to remain remediless for at least a period of 6 months, only after which they may seek redressal under the IBC, which shall further take a period of 330 days to recover the loan from the corporate debtors.

This is a long period to throw a lot of creditors, especially the operational creditors out of business. Also, during this extended time, the quality of the asset is most likely going to further decrease.It is imperative to question whether the period of 6 months would be enough for the corporate debtors in regaining the same financial position, as was before the first phase of the lockdown so that repayment towards the loans can be made?

Especially since no economy in the world knows the end date for the current pandemic. Despite that, optimistic economists predict the economic recovery to take at least a span of 9-12 months.

During the IBC’s temporary suspension, corporate debtors may not be reinstated into the pink of their financial conditions, so as to repay their loans. The feeble repayment capacity of the borrowers is evident from various circulars released by RBI upon requests of various stakeholders amid COVID-19.

For instance, the RBI released a circular upon requests of exporters, seeking relaxation in the timeline for realisation and repatriation of funds to India from 9 months to 15 months.

Hence, unless the proceeds are realised, payment of borrowings made by the exporters is only a dream for creditors not coming true anytime soon, even after the period of 6 months for suspension of the IBC is over. This implies that the period of six months may not be enough for the borrowers to regain their repayment capacity, hence the suspension of the IBC may not render envisaged outcomes.

How necessary is suspension of IBC?

However, the suspension of IBC appears to be the last resort before the government to prevent the initiation of mass insolvency proceedings against the companies that may have defaulted during the COVID-19 pandemic impacted period.

Mass insolvency proceedings may cause retardation of economic growth, as vital activities to keep the businesses going are carried out during the insolvency proceedings. Additionally, the already overburdened National Company Law Tribunals (NCLT) shall become further burdened.

Strangely, this time, the debate on whether or not a suspension will be imposed may lie on different pedestals which may not have been why the IBC was brought about in the first place. Unfortunately for the government, India Inc’s engines are corporates themselves and the burden of keeping this engine running may push the government to once again require the banks and financial institutions to shoulder this responsibility. In turn, the government may infuse funding into these banks for sustenance.

 

Sailent features of the amendment to the IBC Code

Author by Faranaaz G Karbhari

Introduction:

On March 13, 2020, the Insolvency and Bankruptcy Code (Amendment) Bill, 2020, which  was passed by both the houses of the Parliament, received the President’s assent to become a law in the form of the Insolvency and Bankruptcy Code (Amendment) Act, 2020 (“Amendment Act”). The Amendment Act aims to streamline the Corporate Insolvency Resolution Process (“CIRP”) and provide protection to new owners of a loan defaulter company against prosecution for misdeeds of previous owners. By way of the Act, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2019 was also repealed.

Salient Features:
  • Insolvency commencement date:

The proviso to Section 5(12) of the Insolvency and Bankruptcy Code (“Code”) has been deleted thereby making it clear that the insolvency commencement date would be the date of admission of an application for initiating CIRP by the National Company Law Tribunal (“NCLT”) under Sections 7/ 9 or 10, as the case may be.

Earlier, the proviso to Section 5(12) (which was inserted in the Code with effect from 6th June 2018) states that where the interim resolution professional (“IRP”) is not appointed in the admission order, the insolvency commencement date shall be the date on which such IRP is appointed by the Adjudicating Authority.

  • Prescribing a threshold for initiating Resolution Process:

Section 7 of the Code has been amended to the extent that a threshold for initiating Resolution Process for a certain category of financial creditors has been put in place. The Proviso’s 1 and 2 to this section elucidates that the financial creditors who are allottees under a real estate project; and financial creditors falling in the category of creditors referred to in Section 21(6A) (a) and (b), may initiate CIRP against the corporate debtor before the adjudicating authority by filing a joint application comprising of not less than 100 such allottees under the same real estate project or not less than 10% of the total number of such allottees under the same real estate project, whichever is less.

  • Corporate debtors allowed to initiate CIRP against other Corporate debtors

By way of the Amendment Act, explanation II has been added to Section 11 of the Code which states  that corporate debtor as referred to in clauses (a) to (d) of Section 11 of the Code will now be permitted to initiate CIRP against other corporate debtor’s, which was not allowed earlier.

  • No suspension/ termination of licenses, permits etc. issued by the Government, during moratorium

An explanation to Section 14 of the Code has been inserted in order to clarify that a license, permit, registration, etc. given by the Central Government or any other authority shall not be suspended or terminated on the grounds of insolvency, subject to there being no default in payment of current dues arising for the use or continuation of the license, permit, etc. during the moratorium period.

The changes have been made again for keeping the thrust of going concern and to maximise the value of a corporate debtor.

  • Continuance of supply of goods/ serviced critical to Corporate Debtor

It is common knowledge that as per Section 14(2) of the Code, the supply of essential goods or services to the corporate debtor could not be terminated or interrupted during moratorium. With the new amendment, sub-section (2A) has been inserted which states that where the IRP/ IRP considers the supply of goods/ services critical to protect and preserve the value of the corporate debtor and manage the operations of such corporate debtor as a going concern, then the supply of such goods or services shall not be terminated or interrupted during moratorium, except where the corporate debtor has not paid dues arising from supply during moratorium.

  • Appointment and tenure of IRP

Earlier, the Adjudicating Authority had to appoint an IRP within 14 days from insolvency commencement date. In light of the amended Section 16(1), the IRP must be appointed on the date which the insolvency has commenced, itself.

  • Liability for prior offences

A new section namely, Section 32A has been inserted by way of the Act which provides that the corporate debtor will not be liable for an offence committed prior to the commencement of CIRP from the date the resolution plan is approved by the Adjudicating Authority. However, the approved resolution plan must result in change in the management or control of the corporate debtor as prescribed in Section 32A. The said Section further discharges the corporate debtor from any prosecution that has been instituted against it during the CIRP on the approval of the resolution plan, however, the officer who is default in case of a company and a designated partner in case of an LLP shall continue to be liable for any such offence committed by the corporate debtor. In respect to such scenario, this Section also safeguards the property of the corporate debtor from actions such as attachment, seizure, retention or confiscation of such property.

Conclusion

In the years since the act came into force and with the changing times and scenario there has been a need felt to give priority in repayment to last mile funding  to corporate debtors to prevent insolvency i.e in case the company goes into corporate insolvency resolution process or liquidation. The amendment was necessary in order to prevent potential abuse of the Code by certain classes of financial creditors. The amendment also provides immunity against prosecution of the corporate debtor, action against the property of the corporate debtor and the successful resolution applicant subject to fulfilment of certain conditions. The amended act was needed in order to fill the critical gaps in the corporate insolvency framework. The act seeks to remove bottlenecks and streamline the corporate insolvency resolution process.

Lenders face a choice between debtor, guarantor

Authored by Partner Ramya Hariharan along with Associate Asmita Rakhecha

Guarantee as a form of collateral security is popular in financing deals as the liability of a guarantor and the principal debtor are coextensive. Thus, the creditor has a remedy against both the principal debtor and the surety without having to exhaust the remedy against one of the parties before proceeding against the other. Despite this well-established principle, the question of whether simultaneous proceedings can be initiated against the principal debtor and guarantor was the subject of debates under the Insolvency and Bankruptcy Code, 2016 (code).

The National Company Law Appellate Tribunal (NCLAT), in the Vishnu Kumar Agarwal v Piramal Enterprises Ltd case, did not allow simultaneous proceedings against corporate guarantors for the same debt. Piramal Enterprises, a financial creditor, had instituted a corporate insolvency resolution process (CIRP) against the two corporate guarantors – Sunrise Naturopathy and Resorts and Sun system Institute of Information Technology for a debt owed to it by All India Society for Advance Education and Research. It had not initiated a CIRP against the borrower. The NCLAT was faced with two questions – whether a CIRP can be initiated against corporate guarantors without initiating one against the principal borrower, and whether a CIRP can be initiated against two corporate guarantors simultaneously.

The NCLAT answered the first question in the affirmative. However, with regards to the second question, the NCLAT held that though there is no bar in the code for filing applications simultaneously, once one of the applications is admitted, the financial creditor cannot proceed against the others. The rationale was that the code does not have the provision for filing a joint application against multiple corporate debtors unless they are combined in a joint venture company. The NCLAT held that for the same set of debts, a claim cannot be filed by the same financial creditor in two separate CIRPs. This means the lender is barred from pursuing parallel proceedings and it cannot participate in the CIRP of both the borrower and the guarantor even if such proceedings or one of them have been initiated by any other creditor or by the debtor itself.

The NCLAT dismissed the CIRP against the first guarantor as a CIRP against the second guarantor had already been admitted. The NCLAT held that the once a CIRP is admitted against the second guarantor, the first guarantor can say that the debt in question is not due as it is not payable in law, because it has been shown that the debt is payable by the second guarantor. This reasoning goes against the law relating to guarantees, where the guarantors may be jointly or severally liable for the debt. The admission of claim against one cannot constitute extinction of the right against the other.

The NCLAT had, in the ICICI Bank v Vista Steel Private Limited case, allowed a CIRP against the respondent guarantor despite a CIRP being admitted against the borrower and a resolution plan approved for the borrower. Thus, it appears that the NCLAT has been taking contrary positions on the question of simultaneous proceedings against guarantors and borrowers.

The Insolvency Law Committee (ILC), in a report, observed that having a remedy against both the surety and the debtor without the obligation to exhaust the remedy against one before proceeding against the other, is of utmost importance for the creditor and is the hallmark of a guarantee contract. The availability of such a remedy is in most cases the basis on which the loan may have been offered. The ILC’s observation was also relied upon by the Supreme Court in the State Bank of India v V Ramakrishnan & Ors case, albeit in the context of section 14 of the code, while arriving at the decision that a moratorium on a corporate debtor should not constitute a bar to the institution of proceedings against the personal guarantor.

The decision in the Piramal case, therefore, appears to be contrary to the cardinal principles of guarantees. Pursuant to this decision, the lenders seeking remedies under the code will now have to make a choice between the debtor and the guarantor. Further, the decisions where tribunals have allowed simultaneous proceedings are now open to challenge.

Simultaneous insolvency proceedings against the borrower and guarantor may result in complications especially where the CIRP of one of the parties is concluded while the other is still pending. To address these concerns, a framework for the consolidation of proceedings is needed. Denying the lender, the right to pursue simultaneous remedies may not be the answer.

Source: India Business Law Journal