On March 24, 2020, the Union Finance Minister announced that the government is considering the suspension of Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016, to prevent mass insolvency proceedings if disruption of economic life due to Covid-19 continues beyond April 30. This would mean that no one would be allowed to trigger insolvency resolution proceedings in the country for a period of six months.

Notwithstanding that such suspension may not be legally tenable, on the face of it, this seems to be aimed at stopping the Damocles sword of insolvency from hanging on the head of those companies that may default on their loans due to this pandemic. This is premised on the notion that insolvency proceedings are debt enforcement proceedings that companies would not want to resort to.

However, the IBC is not just a debt enforcement tool, it is also the only formal and binding mechanism that a company can resort to in case it wants to restructure its debts and get a breathing period during which debt enforcement against it can stop. In fact, as on December 31, 2019, more than 240 applications have been filed under Section 10 of the IBC, which allows the company itself to file an application for the commencement of its insolvency resolution. By completely stopping recourse to the IBC, one would deny companies the chance to access this mechanism for resolution, and may lead to piecemeal debt enforcement that could result in the closure of businesses.

Lenders’ burden

The government proposal also does not consider that some lenders, including operational creditors, may not be able to absorb the fallout of a high magnitude of bad debts. For instance, individual operational debtors may themselves go under if they are not paid for goods and services they provide to companies (most of which are organised, large-scale enterprises) in a timely manner. Similarly, many financial institutions may already be facing stress on their balance sheets, which they cannot absorb.

Indeed, by not mandating a moratorium on debt enforcement, even the RBI appears to have recognised that at least in some cases, financial institutions should be allowed to recover debts owed to them. Denying lenders the right to invoke the IBC will deny them the right to recourse to the most timely and efficient debt resolution mechanism present today. In fact, it will only prolong their struggle to enforce debt and may both increase the stress on the financial system that was already struggling with bad debt prior to the breakout of Covid-19, and on individual lenders themselves.

Tweak the measures

Does this mean that no IBC-specific relief should be made available to people who would not be able to pay their debts? It does not. But the government needs to come up with more nuanced policy measures, rather than stopping recourse to the IBC on a blanket basis.

First, the government should revisit Section 29A of the IBC, which prevents the incumbent management and promoters from proposing a resolution plan in insolvency resolution proceedings. This section will unfairly prevent existing promoters who may have defaulted due to the conditions caused by Covid-19, from retaining control of the debtor while taking benefit of the formal resolution mechanism offered by the IBC. Further, given the pressure on the economy due to the pandemic, it would mean that in many cases, other persons in the market may not be willing to propose a resolution plan for companies in the near term.

This may lead to oversupply and fire sales of assets. Thus, restricting the applicability of Section 29A, potentially only to wilful defaulters, would go a long way towards ensuring that the distress of firms will get resolved in an orderly and efficient manner, and not impose burdens on promoters who are victims of the economic downturn.

Second, the government should focus on enhancing the infrastructure, particularly the e-court infrastructure, for the NCLTs and consider exemptions from some dispensable process-related requirements so that the system is not overwhelmed by a larger number of insolvency resolution cases, and can in fact help resolve cases of financial distress more efficiently.

Finally, the RBI may consider issuing guidelines on the basis of which financial institutions may consider recourse to the IBC. These guidelines may identify situations in which lenders could generally forbear from enforcement, keeping in mind the state of their balance sheets as well as that of the larger economy. This will streamline creditor-led insolvency resolution processes.

This, in addition to the increase in the default threshold that has been notified already, will ensure that debt enforcement and insolvency resolution in the wake of Covid-19 is done in a humane yet financially sustainable manner.

The writer is a lawyer based in New Delhi

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