IBC amendments: Lessons India could have learnt from the world

Dakshita Chopra | Updated on July 01, 2020 Published on July 01, 2020

Like many other countries, India sought to help save ailing corporates by amending the IBC. Yet, in order to truly help companies, these changes should have been complemented with legal measures and financial stimulus

Covid-19 has been catastrophic for the health of corporates across the world. As a means to cope with the far-reaching impact of the virus on all sectors of the economy, countries are making temporary changes to their insolvency regimes.

India recently jumped on the bandwagon by promulgating the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020. Spanning barely three pages, this amendment introduced Section 10A and Section 66(3), that have imposed a moratorium on insolvency applications for a period of six months- one year with effect from March 25, 2020. Additionally, the minimum threshold for insolvency was increased from ₹1 lakh to ₹1 crore by means of a notification issued by the Insolvency and Bankruptcy Board of India dated March 24, 2020.

This is undoubtedly a judicious step to mitigate the fallout of the pandemic on the viability of businesses. Yet, in order to truly achieve the goal of stabilisng the economic and assisting the survival of companies, the Ordinance ought to have been complemented with additional legal measures and financial stimulus. In this regard, policies adopted by other nations to counter the economic rampage of Covid-19 become a germane consideration. The discussion below would concentrate on three relevant reforms — amendment in contract law, liquidity infusion and compensation for certain fixed costs.

Amendments in contract law

The overarching purpose that the IBC serves for creditors is the recovery of their dues, either during liquidation or through the resolution plan drawn up by the Committee of Creditors. Currently, even though initiation of insolvency processes under the IBC is suspended, creditors continue to have recourse for the payment of their claims under contract law. Consequently, the Ordinance remains to be a half-hearted protectionist measure as companies are susceptible to attack by the creditors from other routes. To shield vulnerable businesses from all quarters, India could have taken inspiration from Singapore’s Covid-19 (Temporary Measures Act), 2020. This Act provides temporary relief to corporates and individuals who are hard-pressed to fulfil their contractual obligations due to Covid-19 related distresses.

Adopting such a model would supplement the Ordinance in making the economic climate of the country more debtor-friendly, by allowing the debtors to notify the creditors regarding need for relief on account of the pandemic. Subsequently, the onus of proof will shift on the party claiming that the inability to perform the contract does not stem from the pandemic. This would provide debtors the much-needed succour from creditors seeking to enforce payment obligations. This is also a more viable alternative to invoking the force majeure clause, for which establishing the direct causal link between the pandemic and non-performance of the contract may prove to be cumbersome.

Such a heavy burden was evidenced in the recent Bombay High Court decision of Standard Retail Pvt Ltd vs Global Corp, wherein an injunction was sought to prohibit certain letters of credit from being encashed, as Covid-19 had made it impossible to fulfil contractual obligations of selling steel. The Court refused the plea for injunction on the ground that the pandemic could not have affected the steel industry as it was categorised as an essential service.

Liquidity infusion

The Ordinance prevents the initiation of insolvency proceedings under the IBC for a particular time duration. However, this directive merely postpones the inevitable, ie, a surge in bankruptcy filings when the prescribed time period under the Ordinance comes to an end. Instead, the need of the hour is to enhance healthy companies’ chances of survival by subsidising businesses. When the scourge of Covid-19 was just beginning to surface in Europe, Germany suspended insolvency filing obligations for six months, just like India has done presently. However, what stands out is Germany’s decision of also extending lines of credit, providing liquidity guarantees as well as an economic grant for businesses to the tune of €750 billion.

The economic package announced by India’s Finance Minister, which apparently accounts for 10 per cent of the country’s GDP, contains direct bailouts only for micro, small and medium businesses (MSMEs) by providing an emergency credit line of collateral-free loans. This excludes the remaining companies from the infusion of much-needed liquidity for possible recapitalisation that will help maintain solvency. Besides, it is dubious to think whether even MSMEs will be able to stand on their feet again, considering that interest rates for these collateral-free loans have not been decreased.

Increasing the fallaciousness of this incentive is the fact that the benefit of collateral-free loans is neither available for first-time borrowers nor for stressed MSMEs. Consequently, such firms are facing a double whammy — fall in demand due to the pandemic as well as lack of finance.

To make optimum utilisation of the hiatus in the IBC’s operation, the government should consider making loans available even to those companies whose accounts are bad. It would also be desirable to waive the burden of interest on loans up to a certain limit.

Compensation for business overheads

The Ordinance also prevents corporate debtors themselves from filing an application to initiate insolvency resolution. This may have been done on account of the lack of creditors who are in a sufficiently stable fiscal condition to be able to rescue debtors during the corporate insolvency resolution process. The flipside to such an embargo even on voluntary insolvency processes is that companies will have to continue paying certain fixed costs, compelling it to incur more debt. This is a bigger threat where companies physically run out of cash — changing insolvency rules then is a futile exercise.

In such cases, it would be pragmatic to either allow debtors to file for insolvency — even if there is a slim chance of resolution — or provide temporary compensation for fixed costs, as has been done in Denmark. In a well thought-out manoeuvre, the Danish government has decided to compensate for some of the fixed costs that a cash-strapped company may have to pay. These costs would include rent, interest, leasing among other documented expenditure. Introducing such a scheme in India would at least serve as a stop-gap measure to prevent companies from continuing to bleed until insolvency proceedings can begin. Otherwise, on seeing a dead-end debtor may choose to file for voluntary liquidation, an option still available to them under Section 59 of the IBC. Needless to say, this would be counterproductive to the Ordinance’s aim of putting off insolvencies until creditors are in a position to bail out companies through their resolution plans.

It is evident that governments across the world have stepped up in times of this unprecedent crisis by supporting the economies through various incentives and safeguarding measures. It was anticipated that India would follow suit with the abatement of insolvency filings, but it was unexpected that it would be limited to a tokenistic gesture without really attenuating the impact of Covid-19 on businesses. This could have been avoided by announcing accompanying economic policy changes and initiatives which would have accentuated the Ordinance.

As it is, some aspects of the recent legislation are somewhat ambiguous – for instance, the fate of insolvency resolution plans that were submitted but not voted on by the Committee of Creditors due to the lockdown is still unknown. An atomistic approach by the government coupled with uncertainties in the application of the Ordinance itself presents a very faint glimmer of hope for India Inc.

The writer is a recent graduate of NUJS, Kolkata

Published on July 01, 2020
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