Suspension of Insolvency Regime Amidst Covid-19: An Analysis of Uncertainties and Efficacious Alternative Remedies for Creditors- Advocate Sajal Awasthi

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Sajal Awasthi,
Advocate, Partner Victorem Legal

Suspension of Insolvency Regime Amidst Covid-19: An Analysis of Uncertainties and Efficacious Alternative Remedies for Creditors

The Insolvency and Bankruptcy Code of 2015 (hereinafter referred to as ‘IB Code’) was enacted and brought into force to safeguard the interest of all the stakeholders in the process of providing credit/debt to various establishments. However, the interest of the creditors has taken a setback during this COVID-19 pandemic, primarily due to uncertainties arising out of suspension of new insolvency proceedings and simultaneous increase in the default threshold u/s. 4 of the IB Code from Rs. One lakh to Rs. One Crore w.e.f. 24.03.2020. The President of India, with objective to relieve the corporate debtors of the financial stress owing to limited business during subsistence of Covid-19, promulgated ordinance dated 05.07.2020, whereby, the government has suspended initiation of insolvency proceedings with respect to any default arising on or after 25th day of March, 2020 for a period of six months. Therefore, leaving both the financial and operational creditors without any effective and substantial remedy to recover their debits. However, I will enumerate herein certain alternative legal remedies, though conventional, but are available with ever creditor for recovering their debts in cases of defaults.

The said Ordinance has been superseded and replaced by the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020 (hereinafter referred to as ‘the Act of 2020’) notified on 23.09.2020. It would be justified to state that such complete suspension of insolvency proceedings for six months, which now further stands extended for additional three months, has raised various issues and uncertainties for the stakeholders involved in the framework contemplated by the IB Code. That the Act of 2020 has suspended and curtailed the operation of Section 7, 9 and 10 of the Code for all the defaults occurring on or after 25th March 2020 for a period of 6 (+3 months now i.e. 9 months) to protect the defaulting corporate entities during the Covid-19 pandemic. However, the issue arises due to proviso to the newly added Section 10A which completely and indefinitely bars initiation of insolvency proceedings for any defaults occurring during the aforesaid suspension period. Thus, this has adversely impacted the financial interest of the creditors as they are left with no remedy under the IB Code.

Effect and Uncertainties Owing to Insertion of Section 10A

The primary legislative intent behind the Second Amendment Act of 2020 is to prevent the viable firms from the distress of insolvency amidst the extraordinary pandemic. However, the primary concern for every creditor is that whether a complete bar for the defaults arising on or after 25.03.2020 is a viable alternative, especially in cases of liability owing to wilful defaults by corporate debtors. The Parliament has failed to comprehend and make a reasonable classification between the defaults induced due to covid-19 and the defaults that have arisen due to distress in firms before the onset of pandemic in India. Further, lack of proper safeguards has put the interest of creditors at risk and simultaneously, is acting as a boon for wilful corporate defaulters.

The IB Code enables both the Corporate creditors and Corporate debtors to initiate insolvency proceedings under the Code. Nevertheless, the prohibition effectuated by the Act of 2020 has failed to clarify its reach over the initiation of insolvency proceedings by the corporate debtors, who are in better position to assess the financial position of the firm and to assess whether invocation of the insolvency framework is reasonable or not. Therefore, such unclear blanket suspension will act in detriment to the financial interest of all the stakeholders in a company. Moreover, an in-depth analysis of the Amending Act also reveals an uncertainty with respect to initiation of insolvency proceedings in cases where there exists personal guarantor of a debt. The Insolvency and Bankruptcy (Application to Adjudicating Authority for Insolvency Resolution Process for Personal Guarantors to Corporate Debtors) Rules, 2019 enables the corporate creditors to initiate CIRP against the individual which provides guarantee for a debt of a corporate debtor, if the latter fails to pay off its liability. The Amendment Act of 2020 prohibits initiation of new insolvency proceedings against the corporate debtors but, still does not specify position of law as against the personal guarantors.

Furthermore, another point of concern for a creditor is the combined effect of increased threshold along with the prohibition to initiate insolvency proceedings for defaults arising in the specified period. The legislation fails to specify the stage which shall be considered for the application of modified position of law i.e. at the time of default or, at the time demand notice or, filing of petition or, passing of admission order by the adjudicating authority. There exists a wide disparity amongst the interpretation being adopted by various NCLTs in the country. It can be stated that in absence of any reasonable limitation as in which class of defaults should be covered within the ambit of the suspension, the misuse of the provisions of law is very apparent on the face of it. It is anticipated that the suspension of Section 7, 9 and 10 of the IB Code along with complete bar for defaults arising during the suspension period would not only prove futile for the interest of the creditors but also the corporate entity as well. The legislative objective behind enactment of the Amending Act of 2020 does not seem to have nexus with the letter of the law as postulated in the Act. The Parliament has blatantly erred in not classifying and differentiating the defaults arising on account of Covid-19 pandemic from those which occurred due to other factors like persistent non-performance by the corporate debtors prior to 25.03.2020.

It can be safely inferred that the creditors, both financial creditors and the operational creditors, are bereft of an efficacious remedy, which was made available to them through the IB Code. However, the legal regime of India provides them with certain alternative remedies for recovering the debt in cases of defaults, especially in present time when the operation of IB Code is suspended.

Brief Overview of Alternative Legal Remedies

I. Civil Suit for Recovery under the Code of Civil Procedure, 1908

An effective alternative remedy, though traditional, available with the corporate creditors is filing civil suit for recovery of their debt amount owed by the concerned corporate debtors. The financial/operational creditors have the option to approach the civil court, having appropriate jurisdiction, under Order IV of the Code of Civil Procedure, 1908 for recovering their debts on the occasion of defaults by the corporate debtors. This remedy can be termed as the most traditional remedy available with every lender/creditor, though has some of its own drawbacks. It is relevant to note here that filing and pursing suit for recovery is tedious and time-consuming process, owing to huge backlog of cases pending with the traditional court infrastructure of the country.

Further, the financial/operational creditors have another efficacious remedy in form of Summary Suit under Order XXXVII of the Code of Civil Procedure, 1908. In cases, where the creditors have clear/undisputable case of default and consequent, express inability of the corporate debtors in paying off its liability owed to the creditor, then such concerned creditor have the legal remedy to approach the civil court for summary procedure under the afore provision of law. The Order XXXVII Rule 1(Sub-rule 2) clearly provides that procedure of summary suit is applicable in the following cases: –

“(a)suits…

(b) suits in which the plaintiff seeks only to recover a debt or liquidated demand in money payable by the defendant, with or without interest, arising, –

(i) on a written contract, or

(ii) on an enactment, where the sum sought to be recovered is a fixed sum of money or in the nature of a debt other than a penalty; or

(iii) on a guarantee, where the claim against the principal is in respect of a debt or liquidated demand only”

 

Unlike traditional suit for recovery, the Summary suit is much faster and viable option for the creditors to recover their lawful debt amount as against the corporate debtors. The Order XXXVII Rule 2 (Sub-rule 3) entitles the plaintiff to a decree in cases wherein the defendant i.e. corporate debtors, fails to enter appearance on receipt of summons.

II. Commercial Suit under the Commercial Courts Act, 2015

The legislative intent to boost the financial growth in the nation was clear with enactment and passage of Commercial Courts Act, 2015 with primary goal to facilitate litigation with ease in commercial disputes. The alternative remedy of filing commercial suit under the said Act is one of the most cherished and widely accepted legal procedure, when compared with the traditional remedy of filing civil suit for recovery. The financial/operational creditors have the legal right to institute proceedings under the Commercial Courts Act, 2015 against the corporate debtors. It is herein enumerated that Section 2 (1) (c) of the Act defines the term ‘commercial dispute’, wherein, the financial creditors are covered within the ambit of Section 2 (1) (c) (i), as follows:

“(i) ordinary transactions of merchants, bankers, financiers and traders such as those relating to mercantile documents, including enforcement and interpretation of such documents”

That the exclusive definition of ‘commercial disputes’ also includes the case of operational creditors, especially in Section 2 (1) (c) (xviii). The Commercial Courts Act, 2015 postulates stricter timelines for initiation of proceedings and its completion. The financial/operational creditors have the option to expedite the procedure under the said Act by invoking the provisions of Summary Judgment under Order 13A of the Code of Civil Procedure, 1908. Moreover, the creditor also has the remedy to file Summary Commercial Suit under Order XXXVII of the Code of Civil Procedure, 1908 read with Commercial Courts Act, 2015.

However, the initiation of proceedings under the Commercial Courts Act, 2015 suffers from a key drawback, which is not linked to efficiency of the remedy but entirely linked with the economic viability of this legal remedy. In order to institute a commercial suit, the plaintiff i.e. creditor in our case, is required to pay ad valorem court fees, as enumerated under the Court Fees Act, which is approximately 1% of the value of the suit. The said amount is obviously on the higher side for a financial/operational creditor, when compared to that in remedy available under the IB Code. Thus, such a financial barrier might act as deterrent for many corporate creditors to avail this legal remedy.

Additionally, the mandatory requirement of Pre-Institution Mediation under Section 12A of the Act, for commercial disputes not having any urgency, might act as an encumbrance for the creditors in their way to recover the debt from debtors.

III. Remedy under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI)

The SARFAESI Act would be the most viable alternative legal remedy for financial secured creditors like banking sector and NBFCs as it allows the secured creditors to sell of the mortgaged properties of the defaulter to recover the rightful dues owed to such creditors. However, this remedy is not available for operational or unsecured creditors. Further, this alternative remedy can be availed by approaching the Debt Recovery Tribunal (DRT) having appropriate jurisdiction over the subject-matter.

Conclusion

The Government’s intention to protect the corporate debtors from financial distress, owing to Covid-19 pandemic, does not have nexus with the changes brought into effect in the legal regime. The legislative step to completely bar the initiation of insolvency proceedings for the defaults arising during the suspension period of nine months, has shifted us back to pre-IBC era, wherein, the corporate creditors are left with no other option but to seek recovery of their rightful dues either through the tedious procedure/mechanism of Civil or Commercial suit or under the SARFAESI Act. Further, complete and unruly imposition of suspension, without any reasonable classification, of the CIRP and on the resolution professional, would eventually lead of diversion of assets by the wilful defaulting corporate entities.

 

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