COVID-19 and Its Effect on the Insolvency and Bankruptcy Code


Authors: Tejas Chhura, NLSIU

Inderjot Kaur, FIMT

Soumya Ranjan Das, KIIT

Kavya Shukla, JGU


Editor: Tejas Chhura, NLSIU



Introduction

Introduced in 2016, the Insolvency and Bankruptcy Code has unified the previously scattered laws regarding bankruptcy and insolvency. However, the unexpected COVID-19 virus has caused the whole country grind to a halt, and with supply chains crumbling, lockdowns happening all over the globe and cases only worsening in major countries like the United States of America, the biggest test of the law is yet to come. The Central Government realising this has made several changes to the Code in an attempt to mitigate the potential problems. However, good intentions only go so far, and it becomes necessary to analyse the Amendment to see if it really helps suppliers or is a double-edged sword and unintentionally causes more problem for them.

Increasing Threshold for Invoking Insolvency

A key change that was made by the Central government was the increasing of the threshold for invoking insolvency to 1 crore in lieu of the 1 lakh it was previously at.[1] This was done to protect MSMEs (Micro, small and medium enterprises) from having insolvency invoked against them by their creditors.


Prima facie, this seems to be a noble gesture; however, unfortunately, in the pretext of protecting one group, it has exposed another. While this change may help protect some businesses from being buried, it fails to consider the countless number of MSMEs that serve as operational creditors. However, unlike their larger counterparts, these MSMEs tend to have lower claim amounts. This was not an issue when the threshold was 1 lakh only, but with this new threshold of 1 crore, it has left them with no choice but to pursue civil remedies in lieu of those under the IBC.

Supply of Essential Goods

Section 14(2) reads as follows:

The supply of essential goods or services to the corporate debtor shall not be suspended or interrupted or terminated during the moratorium period. This provision gives relief to the corporate debtor since he also has a constitutional right to do the business and life of liberty.”[2]

In the era of the pandemic, when one is already low on cash flow and finances, imagine having to supply goods and services for a year or so without any payment being made to them. This imagination has now become a fearful reality for ‘essential’ goods or service suppliers due to the ‘essential’ supply provision under Section 14(2) of the Insolvency and Bankruptcy Code (IBC).

Although, Regulation 32 of the Insolvency Resolution for Corporate Persons[3] limits this ‘essential’ supply to mean only electricity, water, telecommunications and information technology, it can still be problematic for some. In recent times, the overbroad approach to ‘essential’ supply is both counter-productive and downright unfair as it would even include within ‘essential’ suppliers’ small businesses that operate based on regular payments as well as MSMEs. The impact on such suppliers is even more drastic in times of the pandemic, as it is difficult for them to function without a regular cash flow.

However, the Central Government was also aware of this and in order to ensure an uninterrupted flow of essential goods and services, took several steps. Most recently the Small Industries Development Bank of India (SIDBI) has launched assistance facilities for MSME’s that provide essential goods and services. They have lowered interest rates to a mere 5% and are offering loans upto 50 lakh rupees over 5 years without any form of collateral. Alongside this, several government owned banks, such as the Bank of Baroda, Indian Overseas Bank and UCO Bank, have launched their own COVID-19 credit lines which have effectively allowed MSME’s to stay afloat and maintain the supply of essential goods.[4] The Bank of Baroda in particular has played a crucial role by not only providing its own COVID Emergency Credit line, but also providing loans to MSME’s with a moratorium period of 6 months to 24 months. During an unprecedented time like this, providing such relief was an appropriate response that has played out beautifully and kept countless MSME’s in business.

Debt Caused Due To COVID-19 Being Excluded From The Ambit Of Default

Another notable move made by the Central Government was the exclusion of COVID relating debt from the definition of default.[5] The government, in an attempt to shield companies from having insolvency proceedings invoked against themselves, announced that all COVID-19 relating debt shall not be considered to be a default. However, this was a critical oversight as a mere exclusion does not protect a company from having insolvency invoked against them. Creditors can still initiate the insolvency process against a defaulting entity, and while although it can later be tossed out by a judge for the debt being caused to COVID-19 lockdown, the defaulting body will still have to defend the same in court and thus will have to undergo unnecessary expenditure. In addition to this, it will also increase the burden on the judges, which will already be under tremendous pressure due to the existing backlog of cases due to the lockdown.

Suspension of the Corporate Insolvency Resolution Procedure

As mentioned above, the Government of India has made some effective changes in the Insolvency and Bankruptcy Code, 2016 for those people who are impacted by COVID-19 with one of the most prominent being the introduction of Section 10A in the Code, which says,

Notwithstanding anything contained in Sections 7, 9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after March 25, 2020, for a period of six months or such further period, not exceeding one year from such date, as may be notified in this behalf.”[6]

Section 7 of the IBC allowed financial creditors to file a complaint about insolvency against a cooperate debtor. However, keeping in mind the existing lockdown and circumstance, the Central government has suspended this section along with the Corporate Insolvency Resolution Procedure (CIRP) to help avoid all sorts of potential disruptions that could happen should a company have an initiation of the CIRP against them. However, this suspension of the CIRP can prove to be counter-productive as it effectively limits the number of remedies that a lender can attain in the case of a default. In addition to this, as per Section 10 of the Code, defaulting companies are obligated to submit itself to the CIRP. However, if it is suspended, then that rendered the companies who would ordinarily seek recourse through this, remediless.

Section 66(3)

The introduction of sub-section 3 to the existing Section 66 is arguably the most controversial addition made by the Central Government. To properly understand the implications and effect of the inclusion of this new sub-section, we must first take a look at Section 66(2). Section 66(2) provides for a process by which resolution professionals can indirectly ask directors or partners to make contributions to the assets of the Corporate Debtor.[7] However, the newly introduced sub-section 3, effectively bars resolution professionals from doing this.[8] As expected, this inclusion has faced severe criticism on the grounds that it goes against the primary objective of the IBC. The core objective of the IBC is to help revive a Corporate Debtor with Section 66(2) acting as a means to ensure that directors and partners always act diligently. However, the introduction of this new sub section displaces the existing system of checks and balances and hence leaves several institutions vulnerable to directors or partners acting in a manner that can be detrimental to a Corporate Debtor.

Conclusion

As mentioned in the beginning, COVID-19 is proving to be one of the biggest tests that the IBC will have to face. Despite the good intentions of the amendments and the relaxation that has been given, the potential abuse and exploitation of the same can mitigate the same. The relaxations have to cater to everyone and not overlook one or more groups and need to be revisited to ensure the same. It is understandable that these are unprecedented times, but there is a dire need to revisit these relaxations and come up with an alternative method that can help ensure that we do not accidentally move backwards and reverse all the efficient system we have in place.

[1] Pti, “Govt Raises Default Threshold to Rs 1 Cr for Invoking Insolvency Proceedings against Firms” (The Economics Times March 24, 2020) <https://economictimes.indiatimes.com/news/economy/policy/govt-raises-default-threshold-to-rs-1-cr-for-invoking-insolvency-proceedings-against-firms/articleshow/74796076.cms?from=mdr>. [2] Insolvency and Bankruptcy Code 2016, Section 14(2). [3] Insolvency Resolution Process for Corporate Persons Regulations 2016, Regulation 32. [4] ETBFSI, “SIDBI launches loan for MSMEs manufacturing Goods fighting COVID19; Four more Banks extend COVID credit line’ (BFSI The Economic Times, March 26, 2020) <https://bfsi.economictimes.indiatimes.com/news/banking/sidbi-launches-loan-for-msmes-manufacturing-goods-fighting-covid-19-four-more-government-banks-extend-covid-19-credit-line/74832888>. [5] Ruchika Chitravanish “COVID-19: Govt clears plan to suspend IBC for 6 months, ordinance soon” (The Business Standard, June 4, 2020) < https://www.business-standard.com/article/economy-policy/covid-19-govt-clears-plan-to-suspend-ibc-for-6-months-ordinance-soon-120060301307_1.html>. [6] Insolvency and Bankruptcy Code 2016, Section 14(2). [7] Insolvency and Bankruptcy Code 2016, Section 66(2). [8] Insolvency and Bankruptcy Code 2016, Section 66(3).

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