Ease of Doing Business: Implications on IBC

While business & individuals are struggling with the growing uncertainties amid COVID-19, there is hardly any area of law which is not affected by this global pandemic. Recently the Finance Minister announced Government reforms to promote ease of doing business for Corporate entities.[1] In light of the same certain changes are proposed in IBC which since its inception have been a talk of the town.  Some of the key announcements for ease of doing business include:

  1. A Special Resolution framework to be notified under S.240 A.
  2. Minimum threshold to initiate fresh insolvency proceedings raised to Rs. 1 Crore (from Rs. 1 Lakh) for the purpose of mainly insulating MSMEs.
  3. Suspension of fresh insolvency proceedings further extended up to 1 year which was earlier 6 months
  4. Amending the insolvency law to exclude debt relating to Covid-19 from the definition of “default” under the code.

Though a detailed ordinance highlighting these changes is awaited, blanket suspension of this framework is likely to result in more harm than good. It will break the chain of progress made under the resolution framework so far.

The increased threshold to institute insolvency proceedings is driven to protect the interest of MSMEs is accompanied by the suspension of fresh proceedings. Soon after this announcement, there were market speculations that there will be an embargo on fresh insolvency proceedings under Section 10 IBC as well. This section allows a corporate debtor to opt for voluntary insolvency if its financial & operational viability is no longer secure.  The ordinance should rather take into consideration the fact that it is well within the right of a corporate entity to close down its business as the right to carry on with such a business, this section cannot be carved out. If the ordinance does not exclude S. 10 from its ambit it will force unviable businesses to continue which in turn will have negative consequences for all the stakeholders concerned. The much-awaited ordinance should specify timeline with the proper demarcation of proceedings where IRP is appointed or old proceedings where IRP is not appointed. In that case, it will cover not only fresh proceedings but also some old ones.

A complete ban on proceedings by financial creditors ought to be dealt with caution as there is an economic disruption for a considerable time & the stress have already been mounting. In the wake of the same, ‘zombie companies’ have been prevailing for quite a while now which does not have any connection with the virus. Earlier a proceeding under IBC was an effective mechanism fearing which the defaulters either agreed for restructuring or one-time settlement. Though excluding fresh defaults is a welcome move but a complete ban on recoveries will result in new NPAs post the crisis & will compromise capital adequacy. It is expected that the ordinance addresses the problem of lower valuation for future resolutions and lesser interest from bidders amid the growing uncertainty across sectors which could result in higher haircuts for the successful conclusion of resolution.

There is huge uncertainty about the position of Operational Creditors as they are already considered as ‘second class’ creditors by the Code. Now with the lockdown in place, these small creditors would have sought to recover their debts from the debtors or would have demanded protection in the ongoing transactions, so that if there come a situation of emergency, owing to the harsh times their debt does not remain unanswered. Just the way COVID- 19 has had its most impact on the MSME sector, small creditors will also be impacted as their debt comes later in line as per the waterfall mechanism. It is therefore important that the ordinance not only focuses on the safeguard of the micro and small enterprises but also of the operational creditors, so that their transactions can be maintained with the corporate debtor with as little disruptions as possible.

Despite the imposition of a blanket ban on fresh IBC proceedings, a significant restructuring is bound to happen to the balance sheets of the debtor and the sale of certain assets might get hit by certain provisions relating to preferential or undervalued transactions[2]. It, therefore, remains pertinent to identify whether the transactions that were entered into during the lockdown period are to be considered as ones entered into during the ordinary course of business. It is important that the ordinance which is likely to impose a blanket ban should consider this aspect, as to how these transactions will be treated, and how it facilitates corporate debtor to reorganize his affairs to get back on his feet.

Furthermore, there exists a duty upon the directors of a company that, when the company is near insolvent, and the directors have knowledge of the same, they are to conduct necessary due diligence and attempt to minimize the loss to the creditors during that period. Here arises a major question as to when can it be said that the directors had such knowledge, as the aspect of avoidance of CIRP does not exist anymore. It, therefore, remains important to note that how will NCLT approach such issues.

Conclusion

There is no doubt that the challenges posed by the COVID pandemic are huge and unprecedented. All across the world in various jurisdictions, countries have made attempts to amend various aspects of commercial laws including Contract Law, insolvency law, securities law, as they look forward to restarting their economies. The solution does not lie in brushing IBC aside, but rather in encouraging its application and development. In this time of economic distress, it cannot be disputed that the absolute liability regime is to be suspended for a particular time as the business are going to face a cash flow problem for some time. However, the ordinance that is sought to bring about these changes should be considerate of the needs of all the corporate players. Ensuring a steady credit supply remains a prerequisite for India’s continued economic growth, but not at the expense of the ones that are maintaining this flow.

The Code has undergone several amendments and has emerged as an effective tool for resolution mechanism. Therefore, what the country needs is some relief for companies whose businesses have been hit by COVID-19 and not a dismantling of the hard-fought gains from the Insolvency & Bankruptcy Code over the last three years.

[1] https://pib.gov.in/PressReleasePage.aspx?PRID=1624661

[2] Section 43 & 45 of IBC


ABOUT THE AUTHORS

Himanshu Awasthi

Himanshu

Himanshu Awasthi is a fourth-year B.A.LLB. (Hons.) student at The National University of Advanced Legal Studies, Kochi. His areas of interest are Technology Law and Corporate Laws.

Parul Sharma

Parul

Parul Sharma is a fourth-year B.A.LLB. (Hons.) student at The National University of Advanced Legal Studies, Kochi. Her subjects of interest are Technology Law and Law relating to Insolvency & Bankruptcy.

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