To mitigate the impact of the economic disruption caused by Covid-19, the Government took a series of steps to help struggling businesses stay afloat last year. One was to prevent the initiation of the corporate insolvency resolution process (CIRP) against any corporate debtor for a default committed between March 25, 2020 and March 25, 2021 (“period of suspension”).
Coupled with restricted functioning of the National Company Law Tribunal (NCLT), activity under the Insolvency and Bankruptcy Code, 2016 (IBC) slowed significantly. For instance, only 161 new CIRPs were initiated between March and September 2020, in contrast to 889 CIRPs being initiated between March and September 2019 (per data reported by the Insolvency and Bankruptcy Board of India) .
With this period of suspension revoked, and NCLT returning to physical hearings, the IBC will return to ‘full steam’ in the coming months. There is speculation that activity under the IBC will be even more hectic than before the pandemic on account of the new financial stress induced by Covid-19.
However, as yet, it is not clear if a CIRP can be initiated for defaults that first occurred during the period of suspension and continued after March 25, 2021.
It is also not clear whether bankers will be keen to take accounts that are stressed on account of Covid and that have not suffered an asset classification downgrade yet, into the CIRP, which dispossesses the existing management of control of the corporate debtor and is typically contested even at the stage of admission.
In this background, reports suggest that the Government is likely to introduce a new pre-packaged insolvency resolution process (pre-pack), based on the recommendations of the Sub-Committee of the Insolvency Law Committee.
The recommended pre-pack framework envisages that creditors and debtors will negotiate a resolution plan prior to initiation of formal proceedings. However, the resolution plan will be finalised only once formal proceedings are started, and after the requirements for marketing, such as the conduct of a Swiss Challenge (in specified circumstances) are complete. Even during the formal proceedings, the debtor will remain in possession, and the existing management will not be displaced. Given this, it is likely that this mechanism will be presented as the preferred route for resolution of Covid-induced distress, particularly for cases where default amounts are less than ₹1 crore
Reports also suggest that the Government is keen to take steps to further bolster NCLT capacity, so as to ensure that the new phase of IBC activity is ‘time-bound’. While the scope of these measures is unclear at present, it is expected that NCLT capacity will be further bolstered and dedicated Benches to deal with IBC cases will be set up.
Both are welcome initiatives, as and when they are implemented by the Government. However, it will also be important to ensure that the IBC, as well as market participants adapt to a new macro-economic scenario, where third-party resolution applicants, particularly strategic investors, may be fewer for a larger number of corporate debtors in distress.
For one , lenders would have to become more comfortable restructuring with existing promoters/management within the framework of IBC (both under the pre-pack and CIRP), where such promoters are not barred under Section 29A of the IBC. Given that Section 29A(c) bars only promoters of those debtors whose accounts are classified as non-performing assets for more than one year, its applicability to Covid-19 induced defaults will be limited.
As such, lenders should consider using the IBC as a tool to ‘restructure’ with existing promoters as well, particularly since it allows a cram-down on operational creditors, including statutory creditors.
For greater comfort of lenders to restructure with existing promoters, the Reserve Bank of India should also consider relaxing some asset classification requirements for such restructuring, particularly since the IBC ensures that the restructuring is opted for only after sufficient marketing is conducted and lenders are certain that no third-party is willing to offer a better price.
Secondly , further steps should be taken to ensure that the IBC is preferred not only for acquisition by strategic investors, but also for acquisition by financial investors. Financial investors are often well-placed to turnaround a distressed debtor in the short to medium term, and then exit when market conditions are conducive to listing or a strategic sale of the debtor.
This will help avoid liquidation of the debtor, particularly when there is sectoral distress and strategic investors are less forthcoming. In this regard, greater regulatory clarity on whether institutions such as Asset Reconstruction Companies can propose a resolution plan, would be welcome. Equally, more clarity should be forthcoming on whether a ‘credit bid’-style ‘turnaround and sale’ model will be considered a legally tenable form of resolution under the IBC.
These adjustments will help ensure that a wider variety of resolutions can be achieved through the IBC. As the types of resolution possible through the CIRP increase, more options will be available to address different types of insolvency situations. Consequently, a larger number of corporate debtors that enter the IBC process would exit with their insolvency resolved viably, and avoid liquidation in the long run.
Misha is a Partner and Shreya Prakash an Associate with Shardul Amarchand Mangaldas & Co. Views are personal