The outbreak of Covid-19 has inevitably caused economic activities to slow down causing disruption in demand and supply chain due to which many companies are facing severe financial crunch. Among these, Start-ups and Micro, Small and Medium Enterprises are the worst impacted. To protect such companies from being forced into insolvency proceedings, the Government of India vide notification dated March 24, 2020 amended section 4 of the Insolvency and Bankruptcy Code, 2016 (hereinafter the ‘Code’) by which it raised the minimum amount of default to Rs. 1 crore.
Even though, the Government has planned revival of the economy in a phased manner, the shutdown of economic activities for the last 3 months and the continued slowdown has pressurized the Government to provide further reliefs to defaulting companies, amongst others. Thus, through an Ordinance dated June 5, 2020, it suspended sections 7, 9 and 10 of the Code by introducing sections 10A to the Code. Section 10A of the Code provides for the following as reliefs to borrowers:
- Initiation of Corporate Insolvency Resolution Process (hereinafter CIRP) by financial creditors, operational creditors and the company itself is barred for defaults arising on or after March 25, 2020.
- Section 10A is applicable for a period of 6 months w.e.f March 25, 2020 and extendable upto 1 year.
- The proviso to section 10A further absolutely bars initiation of CIRP against a corporate debtor for a default arising for a period of 6 months w.e.f March 25, 2020 and 1 year, if and when notified.
- The explanation clarifies that it is not applicable to defaults that have occurred before March 25, 2020.
The Government of India vide Ordinance dated June 5, 2020 has further prohibited resolution professional to file applications in respect of defaults against which CIRP is suspended under section 10A of the Code by introducing section 66(3) to the Code.
The rationale behind the suspension of the CIRP altogether is to mitigate the impact of the outbreak of Covid-19 on borrowers and provide breathing space for defaulting companies to survive the financial turmoil while also adhering to the Government directives for maintaining their workforce and making full payments of wages. Notwithstanding the fact that these defaulting companies are operating at a time when they generating insignificant to zero revenue. The survival and operation of these companies have been further challenged by continued disruption and obstruction in transportation of goods, commutation of workforce, reduction in workforce due to social distancing norms, ill functioning of logistics, etc.
The suspension of initiation of CIRP while provides borrowers/defaulters time to recoup their losses and gradually realize the value of their assets and re-stabilize themselves, the lack of protection to the creditors has reversed the insolvency game that is envisaged under the Code. The essence of the Code was to provide control to the creditors to be able to drag defaulters into insolvency proceedings for admitted liabilities. This not only reduced the time, effort and cost of recovery of admitted liability and stabilized cash flow, it also provided incentives to the debtors to clear their dues on time for the fear of being dragged into bankruptcy proceedings.
However, the Ordinance has taken away the control from the creditors to recover admitted liabilities from companies that are capable of paying their dues completely for a period of 6 months w.e.f March 25, 2020 which may be extended upto 1 year. This has rendered the creditors remediless under the Code. Without an incentive or a deterrence for borrowers to willfully clear their dues may result in a domino effect of debts and insolvency. The creditors who have been surviving on the repayments of their dues are more likely to default of their own debts.
Furthermore, a complete bar on initiation of CIRF for defaults occurring from March 25, 2020 for a period of 6 months, extendable up to 1 year, will also cause lenders to be more critical due to lack of remedies for recovery in the event of default. Thus, the blanket suspension of CIRP without providing any measure for the continuous circulation of finances and liquidity may contribute towards a further slowdown in the economy. The major impact of reversing the essence of the Code will be noticeable in future on debt restructuring of the companies and in the number of cases that will be filed for insolvency.
A complete suspension of initiation of CIRP for 6 months has not only taken away the threat looming over borrowers who are capable to clearing their dues of being dragged into insolvency proceedings but has brought with it issues such as:
- Attempts to defeat the rights of the creditors
- Scope for Directors and Promoters to indulge in fraudulent, undervalued and preferential transactions.
- Siphoning of funds and assets to reduce the realization value of the assets
Thus, Ordinance dated June 5, 2020 urgently also calls for a revisit to sections 43, 44 and 66 of the Code and the need for its further strengthening to avoid the section from being mis-utilized by the debtors.
The Ordinance dated June 5, 2020 has also suspended initiation of CIRP by defaulting company by which it could have otherwise restructured its assets to pay of its debts. The suspension of section 10 of the Code in the current scenario has forced the defaulting companies, willing to self-initiate CIRP that have realized that operation would be unviable for its survival, into a limbo.
The introduction of section 10A to the Code has also rendered section 14 of the Code, which provides asset protection to the corporate debtor by prohibiting a creditor from initiating or continuing a suit or a recovery action by a third party. This moratorium period under section 14 of the Code can only be triggered while a resolution scheme is ongoing and with the suspension of CIRP, there is no other provision providing for such security to the debtors. As such section 66(3) of the Code bars resolution professional to file any application in respect of defaults specified under section 10A of the Code.
The creditors now have no option but to avail remedies available under the laws such as Companies Act, 2013 and Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002. Notwithstanding the fact that the earlier remedies available for recovery of debts due to the creditors were far more complex, time consuming and cost inefficient, a creditor may still choose to opt for a harsher course of recovery of its due than to face bankruptcy.
To conclude, even though the creditors may not be able to initiate CIRP against the debtors, they will still be able to initiate bankruptcy proceedings against the promoters who have provided personable guarantees to the borrowings under Part III of the Code. However, adapting any other remedy will not be as efficient as the remedies available to the creditors under sections 7, 9 and 10 of the Code, which provided certainty of process, time and outcome for recovery of admitted liability.
The authors are Simranjeet Singh, (Partner) and Rudrakshi Deo (Associate) at Athena Legal
Disclaimer: This update is intended for your general information only. The information and opinions contained in this document are derived from public sources which we believe to be reliable and accurate but which, without further investigation, cannot be warranted as to their accuracy, completeness or correctness. It is not intended to be nor should be regarded as legal advice and no one should act on such information without appropriate professional advice. Athena Legal accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material.