COVID-2019 IMPACT ON INSOLVENCY CASES AND RECENT CHANGES

Dr. Sanjiv Agarwal, INN/Rajasthan, @Infodeaofficial

Covid-2019 or Corona virus has impacted almost entire world including India. It has changed the way of life and has impacted businesses deeply and adversely so much so that even many resourceful and strong economies are facing its dreaded impact.

The economies have been hit by and large in all sectors including corporate performance, banking, liquidity crisis, debt management and commercial defaults.

In order to attempt bringing economy back to normal (or near normal) Central Government has announced a stimulus package worth Rs. 20 lakh crore which has since been detailed by the Finance Minster in five tranches, last one being on 17 May, 2019.

These include various measures to ease out business compliances, steps for ease of doing business, fiscal measures including relaxations, liberal compliance environment, steps to boost demand and enhance liquidity in system by way of economic and fiscal reforms. 

According to one report (Source: Business Standard dated 21.05.2020), status of IBC cases in India is as follows :

No. of cases / year	2017	2018	2019	2020	Total
Admitted	546	963	1,878	387	3,774
Appealed / Settled	67	91	131	23	312
Withdrawn	0	66	79	12	157
Approved	9	72	113	27	221
Liquidated	32	278	483	121	914

 

Reforms proposed in Insolvency Law

One of the crucial reforms were announced on 17 May, 2017 in relation to Insolvency law, i.e., Insolvency and Bankruptcy Code, 2016 (in short, IBC).

These reforms may not yield immediate benefits but are aimed to boost demand in mediums to long term, make business environ stronger and resilient and boost business sentiment across the board.

The reforms announced in Insolvency law are both, timely as well as well envisioned. In fact, in the given situation, they are strategic. The major reforms in insolvency and bankruptcy are towards easing the trigger for IBC to get attracted, i.e.,

• Threshold for initiating IBC proceedings raised from Rs. 1 lakh to Rs. 1 crore
• Fresh proceedings under IBC to remain suspended for a period of one year (earlier it was announced to be suspended for six months in March, 2020)
• The threshold trigger to exclude Covid related debts
• Specific framework for micro, small and medium enterprises (MSMEs)

There have been various other measures taken or announced which indirectly aim at easing out corporate’s concern include measures by way of liquidity support, granting of pending refunds, funds to non-banking finance companies (NBFCs), moratorium allowed to banks leading to enhanced liquidity to borrowers, steps taken to boost demand and domestic production as well as consumption etc.

Collateral free loans, participation by way of equity for small businesses, partial guarantee for NBFCs etc are some of the other measures which would help in doing business and prevent liquidity crisis and eventually bankruptcy.

However, there should be no fears under IBC law now as its operation has been deferred by a year resulting in no filings under the IBC for next one year. There is a special insolvency framework for micro, small and medium enterprises (MSMEs) in the offing. 

 

IBC proceedings to be Suspended for one year

For the present, Government’s intention is to temporarily suspend IBC proceedings by way of fresh filing and also excluding Covid related debts from the scope of default with an objective of avoiding any company attracting otherwise avoidable IBC route of debt management.

Any such temporary suspension is only to mitigate the risk of insolvency during the current crises. 

Suspending the fresh proceedings for a year under IBC may help the defaulting companies but is likely to distort the recovery mechanism as well as market driven financial discipline.

It may be noted that what is proposed to be suspended is only the fresh initiation under IBC Code upto a period of one year.

Further, relaxations may depend upon the situation which unfolds over a period but atleast one year’s suspension will be there. Recently only, application of section 7, 9 and 10 of IBC were suspended for a period of six months  in March, 2020.

The Government fears that in view of Covid-2019, there could be increased number of cases under IBC due to defaults emanating from Covid created situation and as such has proposed embargo on any new filings under IBC.

Ideally, instead of suspending the operation of IBC itself, Government should try to provide a platform to redress the debtor-creditor issues. Suspension may not be the desirable answer as the problems will continue till resolution is found.

Further, suspension alone does not help as there are other legal recourse available to lender such as under SARFAESI Act, 2002, Debt Recovery Tribunal etc. There is no specific mention of stay of recovery procedures under other laws.

Why suspension ? In Covid crises, companies ought to come out of fear of insolvency proceedings and rather focus on getting the business back on track. Suspension however, would have adverse impact on promoter / company initiated proceedings u/s 10 of IBC.

On the other hand, from lender’s view point, banks may be compelled to resort to old recovery modes under SARFAESI. This is like an untended fall out of suspension of IBC proceedings for one year.

Public sector banks may adopt a slow approach to do so keeping government’s intention in mind. Further, private lenders and operational creditors will also have to look at other alternatives in terms of contractual obligations (e.g., civil suits, suits for specific performance, restructuring of transaction, arbitration and mediation etc).

Government’s other argument is that in the present crises, there is no one to help companies ripe for IBC filings. Moreover, by suspension, distress buy-outs can be avoided.

Finding buyers and investor too would be difficult in such times. It appears that one year embargo will apply to fresh filings only as the applications already filed can not be said to be hit by defaults due to Covid.

Since there may be no new IBC filings in next one year, financial creditors as well as operational creditors may not welcome this move. This includes the entire banking system.

This step may tend to make defaulting corporate debtors more delinquent pushing the IBC proceedings (otherwise very much needed) by a year by which time recovery may get impacted and valuations impaired.

Banks will be worried as their recoveries will be hit, non-performing asset (NPA) levels will mount and balance sheets impaired in view of higher provisioning.

Even if some relief or relaxation is granted by Reserve Bank of India, Corporate and Bank’s financial statements will actually not reflect a true and fair view in real sense.

Thus, on one hand borrowers will have no fear or threat and on the other hand bankers / lenders will be helpless. If the situations worsens, it will create further distortions in the system.

For equity firms, the avenue for investments will also take a back seat for a year and their fund deployment strategy may change or shift from India, in case of foreign players.

The announcement of suspension will also hit those who were waiting since 25^th March to file cases. They will just have no option but to wait.

Temporary suspension for a year also indicates this thought and is also a deterrent for errant and willful borrowers.

These are trying times and as such temporary suspension is desirable for more than one reason. The arguments in its favour out weigh the arguments against it.

The suspension should not be applicable to section 10 of IBC cases for corporate insolvency resolution plans.

By doing so, it would be allowing the corporate debtor to accept a slow death and deprive them from a possible resolution in a timely manner.

Though there have been delays in implementation of IBC in terms of deadlines be it at creditors level, on account of resolution professional  or legal framework, (NCLT and NCLAT), IBC has been at effective tool to address defaulters. Infact, even this decision will have adverse impact on share market behavior too.

Today it is not sure whether the impact of Covid will be for a year or even longer. If it goes beyond, the problem would still persist.

As such, at this juncture, we are not sure to whether this one year holiday will just be one year only  or it may be further extended as none of us know how Corona will behave in future and how countries will be able to deal with it in terms of spread, prevention and cure.

Suspension of IBC for one year as well as enhancing the threshold to rupees one crore simultaneously also does not make any sense as if suspension is effected, there was no need to enhance the limit to rupees one crore.

Further, suspension should also apply to voluntary insolvency initiated by corporate debtors in which case, unviable units will be forced to incur losses and continue. This needs clarification.

The suspension of insolvency proceedings is most likely applicable to defaults occurring after the lockdown was imposed, i.e., 25^th March, 2020.

Thus post-lockdown, no new filings shall be accepted for one year and would permit future filings which exclude post- Covid defaults. Pre and post -Covid defaults will be accepted once suspension period is over.

IBC is a credit reform which may not be reversed, though temporary suspension is considered desirable.

The only relief in terms of work load would be to NCLT and NCLAT which are presently flooded with IBC cases.

Further, insolvency professionals and associated service providers would also face the heat of such suspension for a period of one year which will leave them dry and cry from business perspective.

It is learnt that in other countries, such a suspension has not been resorted to.

 

IBC for MSMEs

On insolvency resolution framework for MSMEs, Government has announced that a special MSME specific scheme for MSMEs shall be framed u/s 240A of the IBC  Code, 2016 which applies to MSMEs.

Accordingly, provisions of section 29A (c and h) does not apply to resolution applicant in relation to corporate insolvency resolution process of any MSME.

It empowers the Central Government to direct, in public interest, that any of the provisions of IBC shall not apply to MSMEs or apply with modification as may be notified.

In case of MSMEs, the otherwise promising but financially weak sector in India, the actual situation is likely to be grim in future in terms of liquidity and ability to pay back as the proposed scheme of collateral free loans will allow easy flow of money to MSMEs without any appraisal in terms of requirement and repayment.

The damage may be more in case of NPAs as definition of MSMEs has also been made liberal and inclusion of service sector into MSME ambit.

Banks already have substantial exposure to MSMEs ranging to 10 to 35 percent of total advances (e.g., Axis Bank 11%, State Bank of India 14%, IndusInd Bank 33% and so on).

Government has enhanced the limit to Rs. one crore but it may not result in delay of payment to MSMEs. A lower limit only works in favour of MSMEs as even a sum as low as Rs. one lakh is enough to trigger IBC.

MSMEs require a more comprehensive package by amending section 240A of IBC itself rather than just what has been announced.

Increase in threshold limit

Presently, the minimum threshold for invoking proceedings under IBC is Rupees one lakh only which is considered too small an amount to initiate IBC proceedings.

As a breather to industry, it has been announced to steeply increase this threshold limit to rupees one crore.

This will serve twin objectives- provide the much needed relief to companies and also reduce the burden of work load for the time being on the NCLT and NCLAT.

This limit does not service the desired purpose as of now in view of the fact that IBC itself has been suspended. For MSMEs, there will be a separate set of sops and there being uncertainly prevailing all around amidst Covid pandemic.

Covid debts excluded

Exclusion of debts taken on account of present Covid-2019 crises from the definition of default by companies is a measure to be welcomed.

While it has nothing to do with the past defaults, if such a default originates due to the abnormal Covid pandemic which is beyond anybody’s control, such debt will not qualify for IBC.

This is justified on the ground of equity also and seems to be a proactive effort in right direction. It would address the genuine defaults in repayment of fresh debts during the current post Corona period in order to survive and sustain businesses.

Effectively, all debts taken during Covid-2019 period in normal course of business shall not be considered for triggering the proceedings under IBC.

Thus, if there is a default in 2021-22 or later for debt obligations during current period, they may not qualify as default for the purpose of IBC.

The root cause of Covid related debt default may not necessarily surface now or in next one year. The default in repayment of Covid related debt may happen after three years or more which would mean that debtors would play with this relaxation to suit their needs and if at all there would be defaults, they would be made to fall in this basket first to get relief in IBC proceedings .

 

Epilogue

It is expected that the stimulus announced by Central Government in relation to IBC will become effective by way of promulgation of an Ordinance and Notifications.

IBC also requires a comprehensive review of Code since its implementation from the view point of all stakeholders, not just corporate and financial creditors. IBC should become integral part of Indian financial and corporate framework.