Impact of Covid-19 on Insolvency Laws in India
In response to the economic initiatives announced by the Ministry of Finance, the President of India promulgated the Insolvency and Bankruptcy (Amendment) Ordinance, 2020 on June 5, 2020 to assist Indian companies that have been affected by the Covid-19 pandemic. The Insolvency and Bankruptcy Code, 2016 (“IBC”) has been amended by the Ordinance in the following ways:-
- The IBC has been amended to include Section 10A, which forbids a corporate debtor (a corporation or a limited liability partnership) from filing an application for the initiation of the corporate insolvency resolution process (“CIRP”) for any default arising after March 25, 2020, for a duration of six months or for such additional period, not to exceed one year from March 25,2020, as may be informed in this behalf (the “Specified Period”).
- To secure the directors of a corporate debtor, a non-obstante clause has been added to Section 66 (Fraudulent or wrongful trading) of the IBC. As a result, no complaint under sub-section 66 (2) may be filed by a resolution practitioner in respect of defaults for which CIRP initiation is suspended under Section 10A of the IBC.
The consequences of the changes made pursuant to the Ordinance have been examined in this article.
IBC proceedings for defaults are prohibited for the specified period
Section 10A makes it illegal to file an application for the commencement of insolvency proceedings for any default occurring after March 25,2020, until the expiration of the Specified Period, without first conducting an investigation into the cause of default, and this prohibition is perpetual. Although the preamble of the Ordinance states that it was enacted in response to economic disturbances caused by Covid-19 and the ensuing failure to find a sufficient number of settlement applicants to save corporate debtors, no reason for this permanent prohibition has been given. This strategy, on the other hand, removes the risk of prolonged conflicts over the cause of default.
In view of Covid-19, a permanent prohibition seems to be unprecedented. Countries such as Singapore, Germany, and the United Kingdom have introduced or implemented reforms to their insolvency regimes to address the pandemic’s effect in the form of limitations on insolvency proceedings, but there appears to be no precedent for a full and permanent prohibitions.
Wrongful trading is an exception
As previously stated, the Ordinance prohibits a corporate debtor’s director or partner from being sued for wrongful trading in connection with a default within the Specified Period. This does not, however, suggest that a board can continue to manage the company’s business and incur debts if the company has no chance of recovering.
There’s also a chance that reckless conduct by directors prior to March 25,2020, which resulted in a default during the Specified Period, will go unpunished unless it’s dealt with as a violation of directors’ duties under the Companies Act, 2013.
In several other countries, such as Australia, exemptions from wrongful trading have been issued, where the Coronavirus Economic Response Package Omnibus Act 2020 was adopted as a safe harbour clause, so that directors can no longer be held responsible for debts incurred when insolvent in relation to any debt incurred by the company in the first six months of insolvent trading, effective on March 25, 2020. New Zealand and the United Kingdom have both announced similar steps.
- To begin with, the Ordinance will bring the out-of-court restructuring regime into compliance with the Prudential Framework for Resolution of Stressed Assets, which was published on June7, 2019. Since it only applies to RBI-regulated creditors and the primary tool of compliance is contractual agreements, the courts will play a role in its success as well as the implementation of consolidations reached under the system, especially if the debtor refuses to comply after signing the restructuring package. Similarly, depending on the debt profile of the business, creditors will have to consider schemes of arrangement and international restructuring tools to put a debt restructuring into practise. There is no restriction on creditor acts under the rules relating to schemes of arrangement.
- If no redemption is possible for companies that default within the Specified Period, lenders must rely on available recovery and enforcement tools, including the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, and the Recovery of Debts Owed to Banks and Financial Institutions Act,1993, as well as civil courts and arbitrators. It is well known that debt recovery tribunals (“DRTs”) have a backlog of cases and operate inefficiently. In reality, one of India’s private banks has recently petitioned the Supreme Court to have the DRT system strengthened.
- The Ordinance makes no provision for personal guarantors to file for insolvency or bankruptcy under the IBC. This regime is relatively new and has not been extensively checked.
- Although companies cannot file for insolvency under the IBC, if it is felt that the company needs to be liquidated, the (now almost forgotten) winding up process under the Companies Act and voluntary liquidation under the IBC remain available (creditors cannot file for winding up under the Companies Act and voluntary liquidation is not available for companies in default
- There is a moral hazard threat that a debtor protected by this exclusion will indulge in undervalued or preferential transactions, mismanaging company assets to the disadvantage of creditors. To prevent this, creditors would need to keep a closer eye on their debtors (the J Crew case in the US has some learnings in this regard). And if the company becomes insolvent after the specified time due to a default, the look-back period for challenging the transaction may be over. Although Companies Act remedies may be available as a substitute, the burden of proof in such situations is typically higher.
The Ordinance aims to allow Indian companies impacted by the pandemic some room to breathe. Although there is a slight risk that debtors will take advantage of the suspension for defaults during the Specified Period for reasons other than the pandemic, considering the scale of the financial damage, this is a remote chance.
Another significant feature of the insolvency ordinance is that it suspends the corporate debtor’s right to initiate voluntary insolvency proceedings under Section 10. This may seem fair at first glance, but upon closer examination, it appears that the distressed corporate debtor’s limitation on voluntary insolvency, in genuine cases, may result in asset attrition and force the corporate debtor into unintended liquidation at a later date, where the selling of such distressed assets will yield little or no realisable value.
The insolvency ordinance also does not offer pending corporate insolvency proceedings any reprieve or ability to resubmit updated plans or revised valuations, which seems reasonable given the current economic situation. While the government’s goal is to shield businesses, promoters, and directors from unjustified liability during these extraordinary times, it must also ensure that the country does not devolve into a “defaulter’s paradise.”
These are uncharted waters that necessitate constant re-evaluation and monitoring. The insolvency ordinance does not completely address all of the issues, but it appears to be a step in the right direction.
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