Tweak the triggers for invoking IBC

Radhika Merwin | Updated on November 19, 2019

The low default threshold of ₹1 lakh and assumption of insolvency in all cases can be counter-productive to the resolution process

Recently, Flipkart was dragged by one of its operational creditors — CloudWalker Streaming Technologies — to the NCLT, on the ground that it had defaulted on an amount of ₹26.95 crore. While the NCLT ruled that Flipkart had committed debt and default and ordered for initiation of insolvency proceedings, the Karnataka High Court stayed the NCLT order, providing respite to the e-commerce giant.

Last week, Aviva Life Insurance was admitted into insolvency by NCLT over non-payment of licence fees for use of premises and service tax thereon.

These cases raise some unsettling questions. The Insolvency and Bankruptcy Code (IBC) provides an objective criterion to trigger insolvency — a minimum default of just ₹1 lakh. Can every such default then, even if isolated, lead to a presumption that the corporate debtor is insolvent? Should the adjudicating authority be given judicial discretion to consider other factors as well before admitting a case under insolvency?

Also, in India, once the debtor is admitted under IBC, it is an irretrievable process (barring some leeway to withdraw under Section 12 A of the Code). Hence does the ‘creditor in possession’ regime work in all cases? For an e-commerce giant like Flipkart, which has a customer base of over 200 million, would banishing the existing management and placing the control of the company in the hands of lenders/resolution professional, result in efficient resolution? What will be the fate of lakhs of policyholders, if Aviva is dragged into insolvency? There are no easy answers.

Facts of the case

CloudWalker, engaged in the business of import and supply of LED and TVs, had entered into an agreement with Flipkart in December 2016. After the first few orders being delivered and payment made by Flipkart, CloudWalker in its petition stated that Flipkart avoided taking delivery, giving lack of warehouse space as excuse. On June 8, 2019, CloudWalker issued a demand notice under Section 8 of the Code, for which there was no reply by Flipkart. The NCLT had ruled that Flipkart had committed debt and default and there is neither pre-existing nor post-existing dispute made out by Flipkart. Hence Flipkart should be admitted under insolvency.

The Karnataka High Court, however, stayed the NCLT order stating that the latter has jurisdiction only in respect of debts and that CloudWalker’s petition before NCLT was with respect to damages.

In the case of Aviva, the insurer had entered into an agreement for office premises with Apeejay Trust, which filed for insolvency on account of non-payment of dues of about ₹27 lakh. Despite Aviva claiming relief from IBC on the ground that it is a financial service provider, the NCLT admitted the case for insolvency, considering the nature of the claim, rather than the business of Aviva.

Low threshold

These cases throw up some key aspects of the Code which need a re-think. Under the Code, aside from a financial creditor, an operational creditor — supplier, employee and workman — can also initiate insolvency proceedings on a default of just over ₹1 lakh. Of the 2,542 cases admitted under NCLT for insolvency proceedings, about half have been initiated by operational creditors.

While it is welcome that the IBC has given more teeth to operational creditors, the low threshold has led to other issues. Aside from the cluttering of cases under NCLT, it could derail efforts of lenders who may be trying to resolve the issue with the borrower.

The biggest worry always has been that an operational creditor could possibly be looking at the IBC only as a ‘recovery’ tool. After all, it does matter who initiates the process and for what motive or consideration. There is an urgent need to review the very low threshold of ₹1 lakh. Instead of a fixed amount, the trigger point could also be defined as a per cent of overall dues (say 10 per cent of the debtor’s total liabilities).

Companies do default from time to time, but all may not be due to a mala fide intent of the promoter/management. There may be temporary liquidity issues. Hence this begs the question: Can every default be treated as a case for insolvency?

Presumption of insolvency

In India, the test for commencing CIRP (Corporate Insolvency Resolution Process) does not involve satisfying the adjudicating authority that the corporate debtor is insolvent. Rather, the Code provides an objective criterion (default of ₹1 lakh). The idea was to ensure an early initiation, as it prevents the ballooning of insolvency to an unresolvable proportion.

But is the presumption of insolvency based on just an isolated failure to pay, justified? The non-payment could be due to the debtor’s inability to pay or negligence. It is the former that is critical for assessing the debtor’s state of solvency. But how does one draw the connection?

Currently, the trigger point is rigid, leaving little discretion with the adjudicating authority. This needs to be reviewed. The adjudicating authority should be allowed to consider multiple factors, aside from the failure to pay, while admitting a case.

In many other jurisdictions, insolvency of the debtor has to be established for commencing insolvency proceedings. The relevance of ‘presumption of insolvency’ becomes evident under the UNCITRAL Model Law on Cross-border Insolvency. Article 31 provides that on recognition of a foreign main proceeding, the debtor shall be presumed to be insolvent for the purposes of commencement of a domestic insolvency proceeding.

The Insolvency Law Committee (ILC) that had come out with recommendations on cross-border insolvency last year, had proposed ‘a presumption of default’ trigger for commencing insolvency proceedings in India.

One-size-fits-all approach

Currently in India, it is a ‘creditor in possession regime’ where the resolution professional takes over the reins of the company after the powers of the board are suspended. This has been instrumental in bringing about a sea change in the credit behaviour of debtors and also helped in preventing fraudulent and errant promoters from gaming the system.

That said, can the ‘creditor in possession’ principle fit all cases? In the Flipkart or Aviva case, getting rid of the promoter and giving the control of the company to the resolution professional or creditor may serve little purpose in as far as resolution is concerned.

The essence of IBC is value preservation. In certain cases, it may be essential to alter the ‘creditor in possession’ process to ensure revival and effective resolution. In these cases, the control of the company may still be considered to remain with the debtor, but under the monitoring of the CoC and resolution professional. This can ensure minimal disruption in the day-to-day affairs of the company as a going concern, without prejudice to the working of the RP.

In the US, the Chapter 11 bankruptcy cases are undertaken on the principle of ‘Debtors in Possession’. Here, the debtors are closely monitored, and a Chapter 11 Trustee is appointed if there are concerns over the way the company conducts the Chapter 11 process.

In India, a re-think may be needed to ensure that a frivolous application does not jeopardise an otherwise sound business and leave all stakeholders — including employees and customers — in the lurch. After all, a liquidity issue may not be akin to a solvency risk in all cases.

Published on November 19, 2019

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