IBC: Increasing threshold to ₹1 crore for insolvency plea is a welcome move

In a bid to ease the economic fallout of Covid-19 on small businesses and prevent many companies from being pushed into insolvency, Finance Minister Nirmala Sitharaman has announced the much-awaited relief under IBC with respect to initiating insolvency proceedings.

At present, under the code, a financial creditor or an operational creditor can initiate insolvency proceedings on a default of just more than ₹1 lakh.

This threshold has now been increased to ₹1 crore up to April 30. This essentially means that a financial creditor or operational creditor can now initiate insolvency proceedings only if the corporate debtor defaults on an amount of more than ₹1 crore.

With many businesses, in particular small businesses, likely to be hit hard by the outbreak of Covid-19, increasing the threshold for filing insolvency plea is welcome. The ₹1-crore cap, however, will aid only small businesses; larger businesses may still be pushed into insolvency.

The Finance Minister also stated that if the situation warrants Section 7, 9 and 10 of the code will be suspended for six months after April 30. Section 7 of the IBC pertains to the initiation of the insolvency process by a financial creditor, while Section 9 covers insolvency plea by an operational creditor – supplier, employee and workman. Section 10 of the IBC comes into play when the corporate debtor defaults on a debt files for insolvency.

Suspension of these sections (if it happens) under the code, would, in effect, imply that insolvency proceedings cannot be initiated against any company (across the board) for a period of six months.

Case for higher threshold

Under Section 4 of the IBC, insolvency proceedings can be initiated if the corporate debtor defaults on an amount of just ₹1 lakh. The minimum amount of default of higher value can be notified by the Central Government, provided it is not more than ₹1 crore.

Using the leeway under the code, the Centre appears to have increased the threshold for insolvency plea to ₹1 crore. This is welcomeas some segments such as small businesses are more vulnerable to the Codiv-19 impact and a higher threshold will prevent large-scale applications under the IBC.

In any case, the low threshold of default was due for a revision, even before the Codiv-19 outbreak. In India, the test for commencing corporate insolvency resolution process (CIRP) does not involve satisfying the adjudicating authority that the corporate debtor is insolvent (as is necessary in other jurisdictions). Rather, the code provides an objective criterion (default of ₹1 lakh). While the idea is to ensure an early initiation, the low and fixed threshold of ₹1 lakh has led to operational creditors’ use of IBC as just a recovery tool.

While increasing the threshold to a higher default value is welcomeinstead of a fixed amount, the trigger point could have been set as a per cent of overall dues (say 10 per cent of debtor’s total liabilities).

This way the benefit for higher threshold could have been available across the board to all companies. This is something that the Centre can look into when the economy recovers from the Covid-19 impact, which could take a long while. It is possibly for this reason that the Finance Minister has proposed to suspend all insolvency plea after April 30 if the situation worsens.

Banks to face the brunt

Suspending insolvency plea by a financial or operational creditor (if implemented after April 30) can help prevent all companies from being pushed into insolvency for most of this year. Given that the impact of Covid is expected to be brutal and long-drawn, such a move will offer respite to India Inc at large.

But on the flipside, banks that are already reeling under the possibility of sharp slowdown in credit and rise in delinquencies may be left in the lurch.

With track record of recovery under the IBC already abysmal, the inability to proceed under the IBC for fresh defaults could hurt significantly in the coming quarters. Banks will have to substantially increase provisioning and provide adequate capital buffer to absorb losses on account of large defaults.

Stuck with debt

Suspending Section 10 of the code will also hurt businesses stuck in the vicious cycle of debt and wanting to exit. Of the 3,312 cases admitted under the NCLT for insolvency proceedings, 243 have been initiated by corporate debtors themselves.

The beauty of the IBC is that under Section 10 a corporate debtor can initiate insolvency resolution process once it has defaulted on a debt. This allows a business stuck in the vicious cycle of debt to move on and start with a clean slate.

Suspension of this provision could back fire as small businesses unable to recover from the Covid impact may be stuck in debt and not have a timely and viable exit option.

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