The Present and Future of Insolvency under the COVID-19 Pandemic

Shriraj Khambete & Akshata Timmapur

Not many people could have foretold the widespread disruption that COVID-19 has caused the world. Reports had been coming in since January, 2020 of a potentially lethal spread of a disease but the general outlook had always been of it being something for other countries to deal with. Now however, since the full implications of the spread are clear, India has taken affirmative action in terms of dealing with the situation in the insolvency sector, the foremost change being an increase in the minimum threshold prescribed under the Insolvency and Bankruptcy Code, 2016, (“IBC”) for initiation of Corporate Insolvency Resolution Process (“CIRP”) against a defaulting company

The increase in the threshold to initiate CIRP under IBC was brought about through a notification being S.O. 1205(E). dated 24.03.2020 passed by the Ministry of Corporate Affairs. This notification was brought about by the Central Government by the power granted to it under Section 4 of the IBC. It is settled law that unless specified to the contrary, any amendment to a statute shall be prospective in nature. The increase in the threshold will presumably be with immediate effect meaning thereby that all petitions filed before the 24.03.2020 will be unaffected while any petitions filed after the passing of the amendment shall have to adhere to the requirement of having the amount of default over Rs. 1 Crore. It has to be noted though that initially the threshold was proposed to be Rs. 50 lakh in general and Rs.5 lakh for MSMEs. There is a strong possibility that such an increase in the threshold will be the most detrimental to operational creditors since in most cases, operational creditors may not have an amount in excess of Rs. 1 crore due and defaulted from a company. This is because operational creditors by virtue of their business of providing goods or services, work on a much shorter cycle of finances unlike financial creditors. Operational creditors expect payment of their dues in a given short period so that their services are not impeded. Financial creditors on the other hand deal with the time value of money over a much longer period of time and with far larger amounts. However, with the way the notification is worded there remains some ambiguity of the manner in which the petitions will be dealt with in the future

It is only the adjudicating authorities themselves that can clarify what will be the outcome in certain cases. For example, no clarity has been given with regard to cases which are pending admission. Such cases would have been filed before the amendment but are pending adjudication and it would be unfair to dismiss such matters out of the blue. Similarly, whether the amendment will apply to Operational Creditors who have already issued demand notices under Section 8 of the Code, also remains unanswered. One possibility is that for pending cases, the creditors may be directed to adhere to the new requirement within a specific timeframe, similar to how homebuyers were given a month’s time to conform to the criteria of minimum number of applicants. Another interesting aspect is that the initial Press Releases by the Govt. mentioned that the increase in the threshold was to protect MSMEs from becoming corporate debtors under the Code in the background of the COVID-19 pandemic. However, the notification does not mention that the same is w.r.t. to MSMEs only. It had also been initially indicated that the increased threshold will be for a limited time, but no clarification has come in this regard yet and it appears that the increased threshold is here to stay

At present, the IBC remains a financial creditor oriented legislature in as much as financial creditors have the benefit of not having to fulfil the threshold limit criteria individually. What this means is that as long as the proposed corporate debtor company has defaulted in making payment of over Rs.1 crore, but specifically towards financial creditors, any financial creditors can initiate CIRP proceedings against such a company.

This is rather contrary to the objective of the Code to balance interests of all shareholders, stakeholders and creditors. As discussed earlier, unsecured operational creditors who have a much shorter periodic cycle for getting its dues cleared will quite likely never cross the required threshold of Rs.1 crore. While it is true that a number of times operational creditors have filed proceedings under the Code for recovery rather than resolution, it was a system that worked, where other legislations for actual recovery of dues, failed. A possibility is that creditors may start inflating their claims so as to qualify under the requirement.

As a parallel to the increased threshold for initiating CIRP against companies, no similar amendment has come for the provisions of the Code relating to personal guarantors of corporate debtors. At present, the minimum amount of default required to initiate proceedings under Section 95 of the Code, is Rs. 1000. This is in sharp contrast to the requirement of Rs.1 crore in default, to initiate proceedings against companies. Therefore, a very possible outcome of the notification dated 24.03.2020 could be that it would simply lead creditors to move against personal guarantors at the outset.

In the background of the present pandemic, nearly all industry sectors will be hit hard. It will not be surprising at all if the number of companies against whom CIRP will be initiated in the future rises substantially, only because of the present lockdown. However, a ray of hope for such businesses is that the Govt. has decided to suspend initiation of new cases under Section 7, 9 and 10 of the IBC for a period of at least 6 months and extendible up to 1 year and this decision was approved by the Union Cabinet a few days ago. While the exact notification or Ordinance has not been notified, it is expected to be effective from the date of its publication.

Such suspension of fresh insolvency proceedings will certainly grant a significant relief to companies which have been affected adversely by the pandemic and isolation situation but such suspension for a specific period will only be a stop gap arrangement. It is the domino effect which the present crisis springs that will have the greatest crippling effect on the market at large. It is true that suspension of IBC proceedings will allow some companies to recover in that interregnum but those which depend on a continuous cycle of work or are unable to recover enough in the period of 1 year will end up under the CIRP.

The full implication of the suspension the aforementioned section is not yet clear only because the amendment has not yet been notified. How this notification is worded will really give complete clarity as to the effect on companies already under IBC. It is likely that a particular date will be set post which initiation of insolvency against companies will be suspended for a given time period.

Another effect caused due to the present COVID19 situation is that financial institutions, through the respective Committees of Creditors, are inclined to suspend even the pending cases under CIRP. With the market slowing down, the very objective of the IBC of maximising enterprise value through debt resolution or reconstruction may not be fulfilled.This idea certainly has credit in as much as any Resolution Applicant will rethink its entire Resolution Plan with regard to a corporate debtor. In fact, it might come to a scenario where the Resolution Applicant decides to completely withdraw their Resolution Plan and face a penalty of forfeiture of their earnest money deposit rather than be saddled with a debt riddled company amidst the present crisis.

It is quite likely that the IBC framework will undergo change to specifically address the concerns of the industries. It has already passed the necessary notifications to protect ongoing cases from the consequences of failure to complete the CIRP process in a time bound manner. Even the bar of limitation that applies to a cause of action has been appropriately extended by the Hon’ble Supreme Court vide an Order dated 23.03.2020, passed in a Suo Motu Writ Petition (Civil) No.3 of 2020.

It is quite likely that the IBC framework will undergo change to specifically address the concerns of the industries. It has already passed the necessary notifications to protect ongoing cases from the consequences of failure to complete the CIRP process in a time bound manner. Even the bar of limitation that applies to a cause of action has been appropriately extended by the Hon’ble Supreme Court vide an Order dated 23.03.2020, passed in a Suo Motu Writ Petition (Civil) No.3 of 2020.

However, along with these measures a robust system at the National Company Law Tribunals (“NCLTs”) is required to ensure that the IBC is not misused by unscrupulous stakeholders. A system will have to be envisaged where the adjudicating authority delves into the question of whether a given corporate debtor has actually been affected by the crisis or is taking advantage of the situation to avoid CIRP. To make this an efficient process, the system could be made a summary proceeding so as to not take up the time of the courts. But it can be taken for granted that at least for the near future, the present situation will be a standard defence for corporate debtors.