Sara Jain[i]
(This post is in association with the author’s personal blog Insolvency Simplified, where it was previously published)
On September 24, 2020, the Government released a notification through which the application of Section 10A was extended for a further period of three months commencing from September 25, 2020. Section 10A was introduced through the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (‘Amendment Ordinance’). The Insolvency and Bankruptcy Code (Second Amendment) Act, 2020 (‘Amendment Act’) repealed the Amendment Ordinance and verbatim incorporated its provisions into the Code.
This article presents an analysis of the effect of the amendment and its further extension. It is divided into three parts. Part I provides an introduction of the Amendment Ordinance and Act, highlighting their objectives. Part II highlights the issues that have arisen by virtue of the enactment of Section 10A of the IBC. Part III emphasises upon the problems associated with Section 66(3) and focuses on how it is a deviation from the primary purpose of the Amendment Ordinance. Lastly, Part IV provides a conclusion of the paper and argues against the suspension of CIRP proceedings.
Introduction
a. The Objectives of the Ordinance
On June 5, 2020, the President of India promulgated the Amendment Ordinance. Although the Amendment Act does not contain precise objectives like its predecessor, given that the provisions are the same, it is useful to understand the intended role of the ordinance. The ordinance was released with the following objectives:
(i) To prevent corporate persons suffering from distress because of the exceptional circumstances created by the Covid-19 pandemic from being dragged into the corporate insolvency resolution process (‘CIRP’);
(ii) To exclude defaults arising out of such unprecedented circumstances from the ambit of the Insolvency and Bankruptcy Code, 2016 (‘IBC’ or ‘Code’).
As described in the recitals of the Amendment Ordinance, it is necessary to suspend CIRP because the spread of the Coronavirus and the subsequent national lockdown has enhanced uncertainty and stress for businesses and has even disrupted their activities. Further, in these times, it would be difficult to find suitable resolution applicants to discharge the debt obligations of the corporate debtor.
b. Content of the Amendment Act
The changes brought in by the Amendment Ordinance/Act are as follows:
(i) Insertion of Section 10A: The newly inserted Section 10A provides for the suspension of initiation of CIRP. It states that no application can be filed under Sections 7, 9, and 10 of the Code. In other words, there is a prohibition on initiating CIRP against a corporate debtor by a financial creditor (Section 7), an operational creditor (Section 9), and the corporate debtor itself (Section 10). This suspension is applicable only for defaults arising on or after March 25, 2020 for a period of six months, extendable upto one year (‘suspension period’). Through the September 24 notification, this period has been extended upto December 25, 2020 now. Further, no application can ever be filed for the said default taking place during the continuation of suspension period.
(ii) Insertion of Section 66(3): This subsection states that a resolution professional cannot file any application under Section 66(2) for any default against which CIRP initiation has been suspended by the aforementioned Section 10A. Under Section 66(2) of the Code, a resolution professional is entitled to file an application with the NCLT to order a director or partner of a corporate debtor for making a contribution to the latter’s assets. This application can only be filed if two conditions are satisfied: in case such director or partner of the corporate debtor firstly, knew or ought to have known that it was not reasonable possible to commence CIRP of their corporate debtor and secondly, they did not exercise proper due diligence to minimise the potential losses of the corporate debtor.
Section 10A: Evident Issues and Drawbacks
As mentioned earlier, by virtue of Section 10A, initiation of CIRP against corporate debtors under the Code has been suspended for the suspension period. An analysis of the said provision indicates that it suffers from the following apparent drawbacks.
a. Suspension of applications under Section 10
According to the Amendment Ordinance, its object was to prevent corporate persons “from being pushed into insolvency proceedings” under the IBC. The suspension of applications for initiating voluntary CIRP therefore, does not appear to be directly in consonance with the primary purpose of the ordinance. On the contrary, such prohibition of a corporate debtor in distress might serve detrimental to its interests. With the closure of the alternative of CIRP, the corporate debtor is left with the option of proceeding under Section 230 of the Companies Act, 2013 (‘Companies Act’)- wherein there is no moratorium and the threshold of approval is majority of persons representing 75% of value as opposed to 66% in the Code. Thus, corporate persons should have been accorded with a choice, considering they know what their best interests are, better than anyone else.
b. Exclusion of Personal Guarantors
The Amendment Act provides for suspension of CIRP but is silent on the aspect of insolvency resolution of personal guarantors of these corporate debtors. The Chairman of the Insolvency and Bankruptcy Board of India (‘IBBI’) has however clarified that insolvency proceedings against personal guarantors of corporate debtors are permissible. However, no reasonable explanation has been provided for their exclusion. The pandemic has been collectively stressful for them as well and leaving them without any recourse does not seem justified.
c. Permanent suspension for defaults arising during suspension period
The proviso to Section 10A states that no application can “ever be filed” for the initiation of CIRP for defaults arising during the suspension period. There has been an ambiguity regarding the interpretation of this phrase. The more common and literal interpretation suggests that for all defaults arising during the suspension period, CIRP can never be initiated till eternity. On the other hand, there is an interpretation that as the phrase appears in the proviso, it cannot broaden the scope of its enacting section. The argument is that when the enacting section discusses only about the suspension period, a proviso cannot extend its scope to mean forever. The issue with this interpretation is that it does not seem to explain the purpose of inserting the proviso. Therefore, for the purposes of this article, we presume that the former literal interpretation shall be considered. Nevertheless, this interpretation suffers from serious consequences. Firstly, deviating from the purpose of the Amendment Ordinance, it does not require the establishment of any link between the Covid-19 pandemic and the default. Secondly, it promotes an environment where debtors would intentionally default as there are no consequences against the same under the Code. This would inevitably result in the retracing of ‘debtor’s paradise’ for a plethora of defaults- a situation which had made the enactment of the Code necessary. Thirdly, it has significantly reduced the bargaining power of creditors as against their corporate debtors.
d. Adverse consequences for operational creditors
As the time frame of the Amendment Act is almost in consonance with the moratorium put in place by the RBI, it does not majorly impact the financial creditors. The brunt is faced by the operational creditors, which includes employees and other vulnerable groups. Unlike financial creditors, all of them cannot take action under SARFAESI Act, 2002 or the Companies Act. It would further promote a cycle of defaults- if the operational creditors do not receive their payment on time, they would be unable to pay their creditors and so on.
e. The ineffectiveness of the suspension
In India, the IBC is not the only legislation through which debt recovery takes place. Some alternatives to it are the SARFAESI Act, 2002, scheme under Section 230, Commercial Courts Act, 2015, stressed assets framework under RBI etc. Therefore, the suspension of IBC would not mean that corporate persons can continue their businesses without debt recovery litigation. In effect, the result of the suspension is not a relief for either debtors or creditors. Debtors would be dragged to courts for long-drawn proceedings with no moratorium, while creditors would not be able to exercise the rights they have in the IBC regime.
Reduced responsibility of directors and partners: Section 66(3)
The title of Section 66 suggests that it deals with ‘fraudulent or wrongful practices’. Owing to this, there is a common notion that through the Amendment Act, a resolution professional would be unable to proceed against any corporate debtor or its officers in default if they indulge in fraudulent or wrongful practice. However, a reading of Section 66(3) read with Section 66(2) finds this finding erroneous. Section 66(2), as mentioned earlier deals with a situation where a director or partner of a corporate debtor does not act with due-diligence to prevent losses for creditors of the corporate debtor despite knowing that the said corporate debtor might be admitted to CIRP. Therefore, for any defaults arising during the suspension period, an application under Section 66(2) for requesting the NCLT to order such directors or partners to contribute to the corporate debtor’s assets on these grounds has been prohibited.
Arguments favoring this provision suggest that the same is necessary in these unprecedented circumstances as expecting persons to act ‘reasonably’ or in the ‘ordinary course of business’ would be unreasonable. However, this contention does not seem tenable because directors or partners cannot be permitted to act arbitrarily. In fact, with the liberty being provided owing to the suspension of CIRP, there is a need to enhance due-diligence on directors and partners.
During the suspension of the CIRP by virtue of Section 10A, steps such as enforcing a Code of Corporate Governance or providing indemnity to nominee directors should be taken. If the insolvency law of any country is extremely biased in favour of the debtor, it adversely affects the entire framework and severely impacts the availability of credit in the economy. For the economy to recover, it is extremely necessary to maintain a balance of the rights of both the debtors and the creditors.
Conclusion
The Amendment Ordinance and subsequently the Amendment Act were released with the purpose of providing relief to corporate persons from being pushed into insolvency at a time when the country is struggling with the Covid-19 pandemic. However, a closer look at the newly inserted provisions indicates that the amendment is quite far from achieving its desired objectives.
Section 10A creates an environment where corporate debtors are encouraged to commit defaults intentionally without regard to the rights of their creditors. Apart from the ambiguity that persists regarding its interpretation, there are also major loopholes in the form of exclusion of personal guarantors and prohibition of voluntary initiation of CIRP. As aforementioned, these provisions cannot arise from any of the purposes listed in the Amendment Ordinance itself.
On the other hand, Section 66(3) does not even fall remotely within the scope of the object of the Amendment Ordinance. The rationale for giving a liberty to such an extent has not been explained and neither has been implemented by any other country of the world.
Though the Code has been amended to ameliorate the situation of corporate persons because of the coronavirus, it does not establish any connection between the defaults and the pandemic. The impact of this suspension would be widespread and might last for years together.
[[i]] Sara Jain is a Graduate of MNLU Mumbai and an incoming associate at Shardul Amarchand Mangaldas & Co. Her interest lies in Insolvency laws in furtherance of which she runs her own blog – Insolvency Simplified. This article was previously published on her blog here: https://www.insolvencysimplified.com/post/an-analysis-of-the-insolvency-and-bankruptcy-code-second-amendment-act-2020