Analysis Of The Insolvency And Bankruptcy Code (Amendment) Ordinance, 2020

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Introduction

The rapid spread of coronavirus (COVID-19) has dramatic impacts on financial markets all over the world, including India. The Nationwide lockdown since 24 March 2020 has added disruption to the normal business operation and created uncertainty and financial distress for business. Companies were also severely affected leading to a shortage of funds not only for running business operations but also for payment of debts and also causing investors to suffer significant losses in a very short period.

On 5th June 2020, the president promulgated the Insolvency and Bankruptcy Code (Amendment) ordinance, 2020[1]. The Ordinance was part of the Atamnirbhar Bharat relief package[2] to provide relief to the companies who are on the verge of insolvency[3]. The increase of the default threshold from INR 1 lakh to INR 1 crore was one of the first few Covid-19 relief measures announced by the Finance Minister. Thereafter, the announcement by the Government to suspend the initiation of fresh insolvency proceedings. The Ordinance intends to prevent companies from going into insolvency proceedings and safeguarding the corporate debtors who default in the discharge of their obligations. Another rationale for bringing the Ordinance is a paucity of resolutions applicants to rescue the corporate debtors as most of the corporate persons are under financial distress in the wake of COVID-19[4].

With the promulgation of the Ordinance, some questions have been answered and some remain unanswered, which results in ambiguities regarding the provisions of the Ordinance. The papergives a detailed analysis of the unanswered questions of the Ordinance and suggestions that would emerge due to amendment.

The Ordinance of Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020

The Ordinance is promulgated to amend the Insolvency and Bankruptcy Code, 2016. The following changes are proposed in the Ordinance dated 5th June 2020:

Insertion of new Section 10A:The Ordinance states that notwithstanding anything in sections 7[5], 9[6] and 10[7], no application for the initiation of the corporate insolvency resolution process (CIRP) against a corporate debtor for any default arising on or after 25th March 2020 for six months, extendable up to a maximum of one year[8]. In the simplest terms, no application shall “ever” be filed for the initiation of CIRP of a corporate debtor during the said suspension period.

Furthermore, it is mentioned in the explanation of this section that the provisions shall not apply to any default committed before 25th March 2020 under the said sections[9]. There seems no escape for the defaults which are prior to this date and are effectively enforceable under the code.

Insertion of clause (3) of Section 66:The section provides relaxation with respect to wrongful trading. It states no application shall be filed by resolution professional under subsection (2) of section 66[10], in respect of such defaults against which initiation of the corporate insolvency resolution process is suspended as per section 10A[11]. Simply, Section 66 (3) is an exception to obligations imposed under Section 66 (2) of the code.

Unanswered Questions on the Ordinance

The Ordinance has been passed to mitigate the financial problems of the corporate debtors who are experiencing financial distress on the account of the unprecedented situation. However, the Ordinance raised several unanswered questions, which are considered here.

  1. Perpetual bar on the filing of applications:The Ordinance specifies that no application shall “ever” be filed to initiate CIRP against a corporate debtor for a default arises during the said period i.e. for the six months (or extendable up to 1 year) from 25th March 2020[12]. The expression “no application shall ever be filed” puts a blanket bar on filing an application to initiate CIRP for such defaults as categorized under Section 10A which signifies its perpetual nature. However, the objective of the Ordinance is to provide some relief to those corporate debtors who are directly affected due to the COVID-19 pandemic. Nevertheless, what would be the situation if even after the expiry of the said period, the default continues? Therefore, it is unreasonable to put a perpetual bar on the filing of applications to initiate CIRP for such defaults and may prove inimical to the interests of the creditors.
  2. Ambiguity in the determination of the amount of default:The minimum amount of default to be triggered by filing applications for the commencement of CIRP against corporate debtors was ₹ 1 lakh under the code before 24th March 2020, which was raised to ₹ 1 crore from 25th March 2020 as per the promulgated ordinance. It is anticipated that default may cause partly before 25th March 2020, and partly after that. However, the Ordinance remains silent whether such amount of default, which has been caused partly after 25th March 2020, shall be included or excluded for calculating the minimum amount of default under section 4[13] of the code. Similarly, ambiguity regarding the partly amount after the expiry suspension period is considered or not for calculating the minimum amount of default for initiation of CIRP under section 10A.
  3. Unfeasible nature of Section 10A:The absence of yardstick for determining whether a default has been caused on the account of an unprecedented situation may lead to intentional defaults by corporate debtors towards the financial and operational creditors. The instant Ordinance under section 10A provides permanent immunity to corporate debtors without taking into account the fact that it may corporate debtors may take undue advantage of such immunity. Additionally, as per the code, the power to determine whether a default has been caused on or after 25th March should have been left with the Adjudicating Authority (“the AA”) i.e. NCLT or NCLAT[14]. And the same is determined by filing applications under sections 7, 9, or 10 of the IBC code. However, an inappropriate bar on the filing of applications itself defeating the very purpose of the promulgated Ordinance.
  4. The effect of section 66(3) of the code:The Ordinance has also amended section 66 of the code which provides the right to resolution professional to file an application for against any business of corporate debtor which is being carried with the intent to defraud the creditors. The insertion of section 66 (3)[15] provides immunity to the directors and the partners of the corporate debtor from contributing the assets of the corporate debtor in respect of defaults against the initiation of CIRP has been suspended as per section 10A. However, such immunity may discourage the creditors from providing loans to the companies and business during the lockdown, and appears to downgrade the powers of resolution professional. Additionally, the insertion of section 66 (3) in the code is redundant, as an application can be filed under section 66 (2) of the code amid an on-going CIRP[16].
  5. Impact on MSMEs and Operational creditors:The ordinance has an adverse impact on the MSMEs and Operational creditors. It is observed that operational creditors are mostly Micro, Small, Medium Enterprises (MSMEs)[17]. The minimum amount of default increased from INR 1 lakh to INR 1 crore by the Ministry of corporate affairs[18] could be detrimental to MSMEs. As per the Ordinance, MSMEs cannot initiate CIRP against corporate debtors during the suspension period. Also, MSMEs cannot initiate CIRP for the defaults caused before 24th March 2020, if the amount is less than 1 crore. Thus, the amendment coupled with notification may be inimical to the interest of MSMEs rather than protecting them. Furthermore, the Ordinance is silent about any special insolvency resolution framework for MSMEs under section 240A of the code.

Suggestions

Keeping in mind the above questions, the following suggestions should be to take to clear the ambiguities of the Ordinance;

  1. It is unclear whether the perpetual bar is the intended effect of the proviso. However, instead of a perpetual immunity, temporary protection can be given to the corporate debtors who affected by financial distress arising as a result of the COVID-19 pandemic.
  2. A notification can be issued by the Insolvency and Bankruptcy Board of India to clarify that the ordinance has retrospective effect i.e. the applications which have been filed from 25th March 2020 to 5th June 2020 concerning the defaults caused due to pandemic, will be suspended.
  3. The proviso would create a legal fiction as if defaults occurring during this period, cannot be termed default in law, for the sake of IBC, ever. However, instead of a blanket ban on the initiation of CIRP for the defaults categorized under section 10A, the NCLT can be empowered to determine whether the defaults caused due to pandemic. And if the default is not caused due to distress caused during COVID-19, then the initiation of CIRP against corporate debtors will provide an absolute relief to the creditors. Additionally, it may restrict the undue advantage of such immunity.
  4. The aforesaid Ordinance provides an excuse to the directors/partners of corporate debtors during the exemption period to initiate CIRP even if they do not take due diligence. This issue can be addressed by empowering NCLT to determine whether the directors or partners involved in wrongful or fraudulent trading and also to decide their liabilities if they fall under activities.
  5. The Ordinance does not come with an alternative regarding MSMEs for initiating CIRP against the corporate debtors. However, to avoid any further problems, the government can issue a notification to allow MSMEs to initiate proceedings against corporate debtors and also to allow MSMEs to approach the adjudicating authority to declare them insolvent if they wish to do so. Otherwise, if the exception is not made then it will severally affect the financial interest of MSMEs.

Conclusion

The instant Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 has provided much-needed relief to corporate debtors and companies. It has provided a period of at least six months (or maybe extended to one year) to the companies to get back to its normal condition which is affected during the pandemic. However, the Ordinance has its consequences with more questions than answers over a while. Therefore, it is expected from the Government Ministry and Insolvency and Bankruptcy Board of India to provide some clarifications regarding the unanswered questions of the Ordinance.

Furthermore, in the case of Swiss Ribbons Pvt. Ltd. v. Union of India[19], the Supreme Court by upholding the constitutionality of the statue brings back the focus on the intent of the IBC to resolve and revive a corporate debtor. And it supported the much-needed economic law of the country. Similarly, despite all the shortcomings in the Ordinance, it has been passed to enable and safeguard the corporate debtor and companies who are experiencing financial distress due to unprecedented situations. However, the ambiguity regarding the Ordinances needs to be resolved on an immediate basis.

By-

 Yash Tewari

Dharmashastra National Law University

[1] The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (No. 9 of 2020).

[2] Economic Times, FM provides COVID-19 relief, no fresh insolvency proceedings against MSMEs for 1 year, https://economictimes.indiatimes.com/small-biz/sme-sector/fm-provides-covid-19-relief-no-fresh-insolvency-proceeding-against-msmes-for-1-year/articleshow/75785351.cms, Last seen 17/05/2020

[3] Press Information Bureau, Finance Minister announces Government Reforms and Enablers across seven sectors under AatmaNirbhar Bharat Abhiyaan (May 17, 2020), https://pib.gov.in/PressReleasePage.aspx?PRID=1624661.

[4] Siddharth Batra and Abhinav Sood, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 and Remedies Available to Creditors, LiveLaw, https://www.livelaw.in/law-firms/articles/the-insolvency-and-bankruptcy-code-amendment-ordinance-2020-and-remedies-available-to-creditors-158323, Last Seen 14/06/2020.

[5] Insolvency and Bankruptcy Code 2016 $ 7

[6] Insolvency and Bankruptcy Code 2016 $ 9

[7] Insolvency and Bankruptcy Code 2016 $ 10

[8] Clause 1, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020.

[9] Ibid

[10] Insolvency and Bankruptcy Code 2016 $ 66, cl. 2

[11] Clause 2, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020.

[12] Supra 6

[13] Insolvency and Bankruptcy Code 2016 $ 4

[14] Pallav Rathi, An Insight into The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, India Law Journal, https://www.indialawjournal.org/an-insight-into-the-insolvency-and-bankruptcy-code-ordinance-2020.php

[15] Supra 12

[16] Supra 16

[17] Anant Nerathia and Poornima Devi, IBC Amendment Ordinance 2020: No fresh insolvency for default after lockdown declaration, The New Indian Express  https://www.newindianexpress.com/business/2020/jun/08/ibc-amendment-ordinance-2020-no-fresh-insolvency-for-default-after-lockdown-declaration-2153907.html Last Seen on 08/06/2020

[18] Notification Under Section 4 of the IBC, 2016, MCA Notification S.O. 1205(E) (24/03/2020), https://ibbi.gov.in//uploads/legalframwork/48bf32150f5d6b30477b74f652964edc.pdf,last seen on 19/06/2020.

[19] Swiss Ribbons Pvt. Ltd. v. Union of India,