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The COVID-19 pandemic has brought the world economy to a standstill. It has impacted firms’ profits by disrupting the supply chains and reducing the consumer demand for their products and services. To mitigate the economic fallout caused due to the pandemic, various countries have carried out extraordinary and unprecedented reforms in their respective insolvency laws ranging from suspension of directors’ duty to file for insolvency to suspension of the right of creditors to file for insolvency. The primary objective of these reforms is to ensure that financially viable firms are not prematurely dragged into insolvency and that they have breathing space to conduct their businesses in a streamlined manner. Guided by these objectives, India introduced its highly anticipated Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (the ‘Ordinance’) on June 5, 2020.
The Ordinance brings about two changes in the Insolvency and Bankruptcy Code, 2016 (the ‘IBC’):
(i) Inserts section 10A which suspends filing of an application under sections 7, 9 and 10 of the IBC for initiating corporate insolvency resolution process (‘CIRP’) for any default arising on or after March 25, 2020 for a period of 6 months (extendable up to one year); and
(ii) Inserts section 66(3) which bars the resolution professional from making any application against the director or partner of a corporate debtor under section 66(2) of the IBC in respect of any default against which the initiation of CIRP has been suspended under section 10A of the IBC.
Section 10A: Suspension of insolvency proceedings
Section 10A provides for a blanket suspension (without any inquiry into the cause of default) of the initiation of CIRP for any default arising on or after March 25, 2020 for a period of six months or a further period not exceeding 1 year. On a plain reading of section 10A of the IBC, it becomes apparent that the suspension of initiation of insolvency proceedings is temporary in nature i.e. from March 25, 2020 to September 24, 2020 (subject to extension of up to 1 year) (‘Suspension Period’). To put it simply, section 10A of the IBC suspends the right of a creditor to initiate insolvency proceedings during the Suspension Period and, after the expiration of the Suspension Period creditors could proceed for any default occurred during the Suspension Period. This interpretation resonates with the objective sought to be achieved by the ordinance i.e. to suspend initiation of insolvency proceedings for some time to prevent companies from being pushed into insolvency on account of reasons beyond their control. However, the language of the proviso to section 10A of the IBC raises doubts about the right of a creditor to proceed against the debtor after the expiration of the Suspension Period for a default committed during the Suspension Period. According to the proviso to section 10A, no application shall ever be filed for initiating CIRP for default occurring during the Suspension Period. Thus, the proviso to section 10A, read literally, perpetually prohibits the initiation of insolvency proceedings against corporate debtor for defaults committed by it during the Suspension Period. Lastly, explanation has been added to section 10A of the IBC to clarify that provisions regarding suspension of insolvency proceedings will not apply to default committed before March 25, 2020.
The rule laid down under section 10A of the IBC seems too broad. Section 10A has imposed a blanket ban on the initiation of insolvency proceedings without distinguishing between cases where default has occurred on account of disruption in business due to the COVID-19 pandemic and those where the company was already insolvent but the creditors chose not to proceed against the said company before March 25, 2020. These latter firms, in my opinion, should not benefit from the suspension of the initiation of insolvency proceedings by creditors for a specified period.
The amendment to the IBC, by way of insertion of section 10A, raises a number of questions. Firstly, none among the developed economies like the United States, the United Kingdom, and Singapore have suspended paramount freedom of a corporate debtor to seek initiation of CIRP to restructure its debt while they may have restrictions on the right of a creditor to initiate insolvency proceedings. The Ordinance manifestly takes away the autonomy of a corporate debtor under section 10 of the IBC to restructure its debt and start with a clean slate. It appears that legislators have overlooked the fact that the IBC is not only a tool for recovery but also a tool for restructuring the debt of a corporate debtor. Post-lockdown, the economically distressed companies would experience debt overhang as the burden to pay off lockdown induced debts would be so large that a chunk of the company’s earnings would go to clear existing debts. Further, future income of the company will remain tenuous, and a lion’s share of financial aid given by the government, in the form of loan, will be utilized to clear debts incurred during the lockdown period. Thus, the company will not be able to mobilize funds towards new projects thereby making the chances of defaulting higher. With the freedom to initiate insolvency proceedings suspended, the spiral of sub-optimal utilization of resources would continue, and companies would continue to roil in absence of an alternative mechanism to restructure debt.
Secondly, the Ordinance has suspended only the insolvency proceedings under the IBC, and the other recovery laws continue to be in operation. With the insolvency proceedings being suspended; a financially distressed company will no longer be able to take benefit of the moratorium provisions under the IBC. The moratorium shields the assets of a corporate debtor and stays the collection efforts of individual creditors. In the absence of moratorium, a corporate debtor would face piecemeal enforcement of claims from creditors which will end up destroying its going concern value. Thus, the same amendment which was brought in to give breathing space to the financially distressed companies would push them closer to bankruptcy.
Thirdly, with regard to the proviso to section 10A of the IBC, it is not clear as to whether it permanently precludes the creditors to proceed against defaults committed during the Suspension Period. The confusion is predicated over the word ‘ever’ found in the proviso. The usage of the word ‘ever’ presumes: (I) Extinguishment of debt occurred during the Suspension Period; and (II) Cessation of the default as a ‘default’ after expiration of the Suspension Period. Thus, on the face of it, the proviso appears to suggest that a corporate debtor may default during the Suspension Period, and escape insolvency forever. If the proviso is interpreted in such manner, a debtor will deliberately use this leeway and accelerate default during the Suspension Period even if it has the capacity to pay its debts so as to bring it within the exception and avoid the consequences permanently. Further, it is unclear that if the default is not cured during the Suspension Period and it continues then whether the creditor will be precluded from initiating CIRP on the ground that default occurred after March 25, 2020. After all, a company that has not cured its default by voluntary payment remains liable upon expiration of the Suspension Period as the debt does not miraculously extinguish. However, the proviso sends across a different signal, which can be potentially abused to mean that there is a perpetual suspension against initiating CIRP for defaults during the Suspension Period.
Suspension of director’s liability for wrongful trading
Section 66(3) of the IBC provides protection to a director or partner of a corporate debtor from proceedings being initiated by resolution professional for wrongful trading under section 66(2) of the IBC, in respect of the default committed by a corporate debtor during the Suspension Period. The rationale behind suspending the liability is presumably to prevent the otherwise financially viable companies from being pushed into insolvency prematurely on account of disruption in businesses due to the COVID-19 pandemic. To put it simply, section 66(3) of the IBC allows directors to incur debts as being necessary to facilitate the continuation of the business, which has been impacted heavily on account of the COVID-19 pandemic, during the six months period during which the suspension operates under section 10A of the IBC. Moreover, the directors will not be saddled with personal liability for such debts incurred during the Suspension Period even if the CIRP is initiated against a company at a later stage. Further, this protection is available only in respect of default occurred during the Suspension Period. Lastly, section 66(3) only bars the application for wrongful trading under section 66(2) and does not in any manner condone fraudulent transactions carried out during the Suspension Period.
Conclusion
The amendment sought to be introduced by the Ordinance is an incomplete solution to tackle the economic stress caused due to the pandemic. The decision of the government to introduce a moratorium on the initiation of insolvency proceedings against the company is based on the idea that post-lockdown, miraculously, the companies would become fully operational and would be able to pay off debts fuelled by the lockdown. Thus, it appears that the government sees the IBC as a problem instead of a solution for the corporate debtors to effectively restructure their debts. Post the Suspension Period, there will be a manifold increase in the bad assets of the creditors, and the suspension of the IBC without providing any exception will only exacerbate the sufferings of the creditors. Therefore, a wise way out is to allow the corporate debtor to seek initiation of CIRP to restructure its debt until the resumption of the admission of cases under the IBC, and that will reduce the likelihood of clogging of bad assets.
[i] Pinak Parikh is an advocate at the High Court of Gujarat. He graduated from Institute of Law, Nirma University, Ahmedabad, with Corporate Honours in 2019. For any discussion related to the article, he can be contacted via email pinakparikh157@gmail.com. This article was reviewed by Deeksha Sahni and Kareena Sobti. Preferred Citation: Pinak Parikh, “Blanket suspension of IBC: A problem or a solution?”, Arbitration & Corporate Law Review, Published on 6th July, 2020. Keywords: Insolvency, IBC, Suspension, COVID.