Pandemic Bedlam: Prorogation of Insolvency Proceedings

– Chaitanya Kashyap & Varun Singh

Introduction

The Insolvency and Bankruptcy Code (“Code”) 2016 passed by the Parliament has been a welcome reconditioning of the prevailing structure, which deals with insolvency of corporates, partnerships, individuals and other entities. The Code has made insolvency a time-bound process. The Code makes way for much needed reforms while focusing on creditor-driven insolvency resolution. The Code has emerged as one of the most efficient debt recovery mechanisms in India.

Ordinance

Recently on June 5, 2020, the Insolvency and Bankruptcy Code (Amendment) Ordinance,2020 was promulgated. It has made certain amendments to the existing Code amid the current pandemic outbreak, in order to support the companies and prevent them from becoming bankrupt. Firstly, Section 10A has been inserted, which provides for suspension of the applications under Sections 7, 9 and 10 of the Code, for a period of six months starting from March 25, 2020, to September 25, 2020 and, this period can be further extended up to six months i.e. till March 25, 2021. However, the proviso to this section states that no application shall ever be filed for initiation of Corporate Insolvency Resolution Process (“CIRP”) for the said default i.e. the default made by the debtor during the period between March 25, 2020 to September 25, 2020. Secondly, Section 66 (3) has been inserted, which suspends the filing of insolvency application by the resolution professional under Section 66 (2) of the Code.

Explanation

The suspension of these sections has laid out four scenarios which are available to the Financial or Operational Creditors, as well as the Corporate Debtors.

• If the default is made by the corporate debtor prior to the disruption period i.e. before March 25, 2020 and is continued during this period, then there is no abatement regarding filing of Insolvency Application.
• If the default is done after March 25, 2020 and the recovery is made within the disruption period, then there will be abatement to filing of Insolvency Application i.e. no application can be filed to initiate insolvency proceedings.
• If the default is made within the specified period and is continued after the disruption period, as default is a continuous process, then also there will be abatement on filing the application. Moreover, the proviso to Section 10-A provides that no application can ever be filed for this.
• If the default is made after the specified period, i.e. after September 25, 2020 or March 25, 2021 as the Government of India shall specify, there will be no abatement of filing of application.
• If the default is after the disruption period, then there will be no abatement to the filing of application.

Impact on Micro Small and Medium Enterprises (MSME) Sector

Among five aims highlighted in the Preamble of the Code, one is ‘to promote entrepreneurship, availability of credit and balance of interests of shareholders. MSME sector in India is considered very important, owing to its large employment potential and entrepreneurs that it can produce. This Ordinance of the Insolvency and Bankruptcy has certain provisions which affect MSMEs’ sector directly.

The lockdown resulted in total disruption of the economic activities. The MSME sector, which constitute up to 30 per cent of the total GDP, has been the worst affected by imposition of the lockdown. In the fifth tranche of the Atmanirbhar Bharat Abhiyan Package, the Finance Minister (FM) gave a new definition to the MSMEs.  Now the composite criteria will be based on the investment and annual turnover.

The ordinance tends to provide aid to the corporate debtors, especially the MSMEs, whose businesses were severely affected due to the imposition of lockdown. We are living in an epoch of darkness, with the worst economic crisis that the world has seen since the Great Depression in 1928. This move comes as a sigh of relief to those corporate persons who are facing distress, as the ordinance prevents them from being dragged into insolvency proceedings and provide them with adequate time to revive their business.

Between the two types of creditors’ i.e. financial creditors and operational creditors, MSME businesses are generally operational creditors-which supply raw material or perform logistic operations for other businesses or companies.  The Ministry of Corporate Affairs vide notification S.O. 1205(E) dated 24.03.2020 increased the minimum default amount to initiate corporate insolvency resolution from Rs 1 lakh to Rs 1 crore. The NCLT, Kolkata Bench on May 22, 2020 held that the increased minimum threshold of the default will not be applicable retrospectively. But due to the suspension of Section 9, MSMEs cannot initiate insolvency proceedings against their debtors. This is going to have an adverse effect on MSMEs, as even if their debtor defaults on the threshold amount, they cannot file an insolvency application to recover their debt now. As per the data available till December 31, 2019, 49.21% of the CIRPs have been filed by Operational Creditors, which are mainly MSMEs. The Only option they are left with is approaching the civil court for their debt recovery. Moreover, there has been no change in Section 16 of the MSME Act, which gives them the right to charge interest for delay in payments. This gives some relief to the MSMEs as they can still earn something and sustain their business.

Critical Analysis

The provision says that, no application for initiation of CIRP of a corporate debtor shall be filed, for any default arising on or after March 25, 2020 for a period of six months, further extendable up to a period of six months. However, the proviso contradicts this provision. It says that no application for insolvency resolution shall “ever” be filed against a corporate debtor for any default occurring during the suspension period. The purpose of a proviso is to restrict the application under exceptional circumstances. On the contrary, provision under section 10-A broadens the applicability of the main provision.

The ordinance talks about excluding the defaults arising on account of unprecedented situation for the purposes of insolvency proceeding under IBC. However, nowhere has the definition of Covid-19 related default been mentioned. This problem could be solved by making an amendment to Section 3(12) of the IBC which defines the meaning of the term ‘default’. Considering the fact that ordinance being silent specifically about MSME, amendment of Section 3(12) to define the meaning of ‘Covid related default’, could have helped, which is kept in grey area. Section 10-A further suspends voluntary insolvency resolution. This will lead to decrease in value of a company, which is already under a lot of distress and wanting to undergo insolvency.  Government has ended up making the Insolvency and Bankruptcy Code a debtor-centric code from being a creditor-centric code. Its creditor-centric nature was the main reason behind its success and it was widely hailed across all sectors due to this nature.

The ordinance was expected to bring some separate provisions for MSMEs under Section 240A of the IBC, but the ordinance fails to mention any such provision. Denying MSMEs the right to file CIRP is against the principles on which Insolvency and Bankruptcy Code was based upon, i.e. encouraging entrepreneurship in India. This ordinance will end up limiting the growth of MSME sector in India and winding up of many small businesses, unless the government roles out some relief plan for MSMEs affected by this ordinance.

Conclusion

This Ordinance will definitely prevent Indian businesses from being driven into insolvency, but this will help only the debtors. The government needs to reconsider the position of prorogating all the insolvency proceedings. The ordinance is ambiguously worded and having opened the Pandora’s box, the debtors will look at it as an opportunity to get rid of the liability that they owe to the creditors on the pretext of the pandemic. It is for the legislature to ensure that Section 10-A does not become a tool for regaining the defaulter’s paradise.

This article is authored by Chaitanya Kashyap & Varun Singh. They are students of law at Rajiv Gandhi National University of Law, Punjab.