Does the IBC still owe its allegiance to its stakeholders?

by June 25, 2020 0 comments

Does the IBC still owe its allegiance to its stakeholders?

The on-going COVID-19 pandemic has uprooted the lives and livelihoods, routines, structures and fundamental ecosystems of many across the globe. While those with resources – financial and otherwise – have been able to weather the storm of uncertainty brought on by the pandemic, there are many left to fend for themselves in cutthroat and ruthless situations.

With due sensitivity and deference to the difficulties faced by individuals of various means, one cannot lose sight of the fact that many businesses and corporates are now faced with dilemmas of survival. Businesses, especially industrial and supply chain oriented businesses, have faced the brunt of closed factory floors, voluminous lay-offs and retrenchment of employees, closed borders, dishonoured contracts and tenancies and contentious insurance claims. The Insolvency and Bankruptcy Code, 2016 (“IBC”) introduced as a mechanism for prompt and timely resolution, and a potent sword to prevent defaults on payments, has been sheathed away, in a time when businesses are in dire need of financial security and stability.

The IBC, 2016 as amended to date, oft referred to as a ‘game changer’ for debt restructuring and resolution of ailing businesses, has been rendered toothless in the face of two developments. The first, is an amendment notified by the Central Government on 24th March, 2020, amending Section 4 of the Code, by raising the pecuniary jurisdiction for filing insolvency and bankruptcy petitions, from Rs. 1 lac, to Rs. 1 Crore, meaning that the threshold for filing fresh cases has been increased 100-fold, and is also the highest possible enhancement permissible under the existing Code. Although the notification itself is silent on the reasons, various press reports claim the rationale behind it as protecting Micro, Medium and Small Enterprises (MSME’s) by prohibiting initiation of petitions against these enterprises, unless the threshold limit is satisfied. The actual notification, however, is neither limited to MSME’s, de-facto according the same treatment and protection to even the largest conglomerates, and nor does it set any time limit for restoration of the earlier threshold, preventing petitions against corporate debtors of any stature, unless the default reaches the threshold of Rs. 1 Crore.

The second, is the Ordinance promulgated by the President of India on 5th June, 2020 suspending the initiation of corporate resolution proceedings, by the insertion of Section 10A into the Code, which prohibits the filing of petitions by financial creditors, operational creditors, and even the corporate debtor itself, on account of any default arising on or after 25th March, 2020, for a period of 6 months. The ordinance further mandates that no application “shall ever be filed” for default occurring in this 6 month period, and is extendable by another 6 months, by appropriate notification. Again, if one is to review the factors mentioned in the notification, one sees reference made to uncertainty and stress on business on account of the COVID-19 pandemic, and a perceived difficulty in finding adequate number of resolution applicants to rescue corporate debtors.

Looking at the spectrum of business arrangements – transactions, supply chains, payments, credit facilities, guarantees, letters of credit, and countless other business arrangements that are possible and entered into on a daily basis, the rationale behind the neutralizing of the IBC, 2016 appears myopic at best, while the consequences of these changes are overarching and accord blanket protection to all across the board.

The Preamble to the IBC, 2016 lays out its objects as “reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time-bound manner for maximization of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all stakeholders […]”. In a recent Supreme Court judgment, related to the Essar group, an enunciated and comprehensive approach to the IBC, 2016 has fallen from their Lordships, focusing squarely on resolution by value maximization and a consideration of balancing the interests of the breadth of relevant stakeholders. The law, therefore, is undeniably value oriented and requires accounting for all stakeholders, rather than a binary approach of “do or die”.

According blanket immunity to defaulters and turning off the IBC, 2016 regime appears contrary to this legal policy, and comes across as a knee-jerk reaction, without accounting for genuine cases in which businesses, but for enforcing debts, run the risk of running under and succumbing to COVID-19. While the law aspires for equal treatment in all cases, the approach to suspend the IBC, 2016, even temporarily, takes away the need and opportunity to separate the wheat from the chaff and can prevent even those meritorious claims where default was on the horizon and protects the defaulters, at the expense of the creditors. This is especially so in view of the Ordinance, which states that no cases in this time period shall ever be filed and is the very antithesis of a stakeholder and creditor oriented approach. A planned, comprehensive stakeholder oriented approach would have been preferable, to strike a balance between protecting businesses suffering genuine difficulty on account of COVID-19 as against preventing abuse by people by re-structuring corporate debts and liabilities to take advantage of the lockdown and the reprieve now granted, by deploying corporate ingenuity.

The developments also seem to disregard the fact that a limitation of 3 years generally applies to such proceedings, and peremptorily prohibiting initiation of proceedings appears prima facie premature, as nobody can conclusively predict the economic and commercial scenario three years ante. If the idea was solely to protect MSME’s, an additional layer of protection could have been accorded without diluting the core of the Code, in a manner akin to requiring a report from an Information Utility (IU) in cases under Section 7 of the IBC, but not under Sections 9 or 10.

On the issue of a perceived dearth of adequate number of prospective resolution applicants, there are many factors that may have missed deliberation. First, there are many entities engaged in the very industry resolving and turning around ailing enterprises, deploying vast financial, expert and consultancy resources which even enables them to churn profits from the process. Second, preempting a lack of prospective resolution applicants, cannot possible justify a refusal to even grant an opportunity to seek resolution, in a situation where a depressed valuation may actually be more attractive to investors and more mutually beneficial schemes may be introduced. Third, the Hon’ble Supreme Court has already held that the timelines under the IBC, 2016 are not mandatory, especially when the possibility of resolution is real, which is the primary purpose of the Code, and as already stated, even defaults occurring now have a 3 year gestation period, over which a lot can transpire, both economically and commercially.

On a conspectus of the above, the shutting down of the IBC, 2016 is ill-advised and comprehensive, in-depth analysis and implementation of appropriate safeguards could have been undertaken to protect the interests of the breadth of stakeholders involved. The suspension of the IBC, 2016, coupled with the increased pecuniary jurisdiction which for now remains applicable even if the suspension is lifted, can be counter-intuitive even for MSME’s who would have been entitled to relief under the regime of the IBC. To discard the IBC, 2016 is tantamount to giving a licence to default to corporate debtors, which is to the prejudice of all stakeholders in the economy.

Of course, the above does not comment on the current limited, virtual functioning of the Courts, if at all that was a factor in the incorporation of the changes discussed above. As proactive as our Hon’ble Courts have been, there are logistical and practical challenges in taking up the full range of matters as in the pre-COVID era, in view of social distancing and lockdown protocols. This may lead one to argue that remedies against defaulters survive in other statutes, and before other legal fora. However, relegating such creditors and businesses to alternate legal remedies, which are not as specialized as the IBC and may involve lengthier processes and more burdened legal fora, cannot possibly be consistent with the regime that was propounded under the IBC, 2016. At the very least, with the continued existence of the IBC, there would have been hope on the horizon that defaulters would not have been able to go scotfree without even stepping into the arena with impunity.

Karn Bhardwaj is an Advocate practicing before various courts in Delhi and enrolled as Attorney-at-Law in the State of New York, USA. The views expressed are personal.

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