Post suspension analysis of stressed insolvencies
By Mr. Miheer Jain, Third-Year B.B.A L.L.B(Hons.) School of Law, NMIMS Mumbai
Introduction to IBC
The Insolvency and Bankruptcy Code (“IBC”) was introduced in the year 2016 in order to provide for a time-bound process for resolution of insolvency. It is considered as one of the biggest economic reforms along with GST. The number of non-performing assets was rapidly increasing and there was an increased delay in debt resolution. The average time for insolvency proceedings in India was 4.3 years which was much higher than other developed countries – 1 year in the United Kingdom and 1.5 years of the USA. As per the Insolvency and Bankruptcy Board of India (“IBBI”), there was an increase of 123% in the number of cases under the IBC. Hence, it can be seen that the introduction of the code was a great success with the number of fresh applications increasing rapidly. This allowed banks to recover bad loans faster and generated more liquidity while also helping companies to stay afloat. It provided for a method to ensure that even the scarce resources of the economy are utilized in the best way possible. In a testament to its success, the number of CIRPs that have commenced under IBC between the year 2016 and September 2020 stand at 4008. There have been 473 CIRPs that have been closed or review or settled. The number of withdrawals stands at 291, with an order for liquidation been made in 1025 of them.
Suspension of IBC during Covid-19
In the wake of the pandemic of Covid-19, there was an increased stress on companies, especially small and medium enterprises. The impact of the lockdown was felt by almost all industries with the NIFTY 50 Index falling below 8100 for the first time since 2017. If the code was allowed to operate a it would have led to the institution of a huge number of default cases. This would have created additional pressure on businesses who were already struggling with the pandemic. Moreover, the National Company Law Tribunal (“NCLT”) and National Company Appellate Law Tribunal (“NCLAT”) were functioning remotely with reduced personnel. They lacked the capacity to deal with the potentially huge volume of cases. Hence, it would have led to a loss on all fronts. Hence, the government decided to suspend fresh proceedings under the IBC by the government for a period of 6 months beginning from March 25, 2020. The threshold of default to initiate the insolvency proceedings under the IBC was Rs 1 Lakh. In light of the pandemic, this too was increased to Rs 1 Crore.
This was done through promulgating an ordinance to add Section 10 A to the IBC. It provided that an application for the initiation of the Corporate Insolvency Resolution Process (“CIRP”) cannot be filed if a default arises on or after March 25, 2020. This provision was initially brought for a period of six months. The government extended it twice for period of three months each and it will now end on March 24, 2021.
Impact of the move
This move helped businesses escape default and NCLT and NCLAT to function with reduced capacity. On the flipside, it increased the number of stressed insolvencies. This led to lenders facing extreme difficulty in order to get value out of their assets. Since the assets could not be re-classified, the balance sheets of the banks were negatively affected as the number of Non-performing assets (“NPAs”) started to increase. A report by the ICRA (a rating agency) provided that the suspension will lead to their being much lower realizations for the Financial Year 2021. They suspect a reduction of up to 40% in the realizations compared to the Financial Year 2020. Hence, the revocation of suspension of Section 7, 9 and 10 of the IBC at the earliest is necessary. The revocation will be complete on 24th March, 2021.
Key problems and potential solutions
However, a new problem will plague the NCLT and NCLAT. The amount of companies that would seek to file for insolvency proceedings has increased drastically due to the pandemic. Moreover, physical hearings have not resumed yet. With the resurgence in the number of cases of Covid-19 across the country, it does not seem that it will happen anytime soon. The reduction in efficiency of the Company Tribunals is evidenced by the fact that as per the Insolvency and Bankruptcy Board of India (“IBBI”) quarterly report from July 2020 to September 2020, “the time taken on average to resolve an insolvency proceeding increase to 433 days. It is over 160% the statutory mandate which is a mere 270 days.” Hence, the problems faced by the tribunals are aplenty. Restoring the staff of the NCLT and NCLAT to the pre-covid numbers and providing them training to function effectively would allow them to deal with the boom in cases that will occur after 24 March. The government already has plans in place to hold review meetings once the suspension of IBC is over. It is expected that these meetings would help address the potential issues and discuss innovative solutions.
Considering that it will not completely solve the problem at hand, it will be a good idea to look for alternative methods that can be used to resolve insolvency proceedings in order to reduce the burden on the Company Law Tribunals. One of the potential solutions for the same is to introduce a framework to allow for pre-packaged resolutions in India. It is one of the fastest methods for resolution of stressed assets. It is cost-effective as “some tasks of an insolvency proceeding are completed before the formal process begins, and some elements of formal process are avoided, pre-pack saves both on costs and time”. It has already been implemented with success in western jurisdictions. The IBBI chief Mr. Sahoo too has publicly spoken in favor of pre-packs agreements and explained their benefits. It is only a matter of time before they are implemented and used to resolve insolvency proceedings.
This will reduce the role of the NCLT to a supervisory body while companies and creditors would work together in order to negotiate an acceptable restructuring package. In order to allow for the implementation of these resolutions it would be essential to suspend the Section 29-A of the IBC. This section restricts the participation of the promoters in the resolution process. This could adversely affect the pre-pack resolutions. Its revocation would provide a major boost and flexibility to companies who seek an alternative method to resolve their insolvency. It would expedite the process while still remaining under the watchful eyes of NCLT. The continuity of business would be maintained and the obligations of the company would be restated to an acceptable level. The government has already made an effort to introduce pre-pack in the Indian IBC ecosystem. It is a special framework made for MSMEs that will allow them an expedited and more convenient resolution. However, it is seemingly not rushed to implement this scheme unlike GST or Demonetization and has asked or suggestions from the public regarding the same.
In addition to this, the government has also allowed for a creation of a Bad Bank in order to provide a resolution to stressed debts worth Rs 2.25 Crore that plague the banking sector currently. It will involve the construction of an Asset Reconstruction Company (“ARC”) and Asset Management Company (“AMC”). It will help in assisting the banks who are under a mountain of bad loans due to stressed assets to reduce their overall losses. It could also result in more profits as more resources will be concentrated on their core business which is lending. The impact of the bad bank on the IBC will also be positive. It will help enhance its use. There will be a special focus in resolving stress. This would also allow for creation of a greater business acumen that would allow for differentiation between economic and financial stress. This would aid in the formulation of the right strategy for its resolution. The use of IBC would be done in a more effective way by the ‘Bad Bank’. It might even serve as a lesson to allow for even better outcomes from IBC.
The government has also provided stimulus package to help MSMEs avoid insolvency proceedings and get their business back on track. In the present scenario, despite a resurgence of Covid, the businesses are growing and striving to achieve pre-covid levels. The large cap companies have benefited most from this revival with the Indian stock indexes going strong and consistently hitting fresh highs. However, it is essential to ensure that small and medium cap companies stay afloat and relevant as the business environment in India is co-dependent and a decline of either sector would not augur well for the other. Hence, it is imperative that the government brings out reforms to effectively implement the IBC once again, while also taking other affirmative steps to ensure that there is a conducive business environment and reduction of stressed assets. This will go a long way in ensuring India’s economic recovery after the pandemic and helping it grow its economy further. It will also lead to more foreign investment which will further boost up the economy.
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