Since the outbreak of the COVID-19 pandemic in India, there has been speculation in relation to whether the government of India would alter the operation of the Insolvency and Bankruptcy Code, 2016 (IBC). On March 24, 2020, the Union Finance Minister announced that the central government is considering the suspension of Sections 7, 9 and 10 of the IBC which deals with initiation of insolvency proceedings against corporate debtors by financial and operational creditors, in an attempt to prevent companies from being forced into insolvency proceedings for defaults owing to the pandemic. Following the announcement by the Union Finance Minister, there has been a talk of the government introducing an ordinance to suspend fresh insolvency action against companies by lenders or other creditors for six months.
This action would be another step in a series of steps taken by the government to mitigate the impact of the pandemic starting with raising the threshold for invoking insolvency proceedings from Rs 1 lakh to Rs. 1 crore to restrict initiation of insolvency proceedings against small and medium enterprises. The insolvency regulations were also amended to incorporate a special provision whereby the period of lockdown imposed by the central government would be excluded from the timeline for any activity that could not be completed due to the current scenario, in relation to a corporate insolvency resolution process. This is subject, however, to the overall time limit. Even the Reserve Bank of India has permitted a moratorium of three months on repayment of term loans outstanding on March 1, 2020, to curb defaults in repayment of loans.
The proposed ordinance suspending filing of fresh proceedings under the IBC for six months may impact lending activity in the country on account of lenders being circumspect as to the limited remedies available in the event of default. Lenders could also be concerned that the suspension could be extended beyond the original period of six months based on market and other macroeconomic factors. This could result in inadequate liquidity in the market and reduced avenues for raising debt which may contribute to a further slowdown in the economy. Further, a blanket suspension without consideration of merit may also discourage foreign creditors (both financial and operational) looking at a time-bound resolution process under the IBC.
Further, the position of operational creditors, being suppliers of goods and services, differs from the financial creditors. The lockdown imposed by the government of India to contain and control the outbreak of COVID-19 has resulted in a near-complete cessation of business and economic activity thereby affecting revenues and cash flows of all enterprises. Suspension of filing of fresh proceedings by any creditor for six months would leave such operational creditors without recourse to insolvency proceedings against their defaulting customers which may considerably affect their businesses and adversely impact the already disrupted supply chain in the country and globally. As a consequence, this may also result in a cascading effect of defaults by these operational creditors to other suppliers of goods and services or other financial creditors resulting in a spiral of insolvency cases on the lifting of the suspension of IBC increasing the burden on the already overburdened insolvency courts in India.
While this move to suspend initiation under the IBC in the wake of COVID-19 comes to forestall lenders from driving otherwise standard accounts into insolvency. Distinction needs to be drawn between such accounts and non-standard accounts or accounts classified as NPAs in the books of the lenders before the pandemic. In the event this distinction is not drawn with all accounts in default, before COVID-19, would seek refuge under the suspension merely delaying the initiation of insolvency proceedings against such borrowers.
In this context, it is also worth examining the applicability of the force majeure provision under the lending arrangements. The global economic slowdown on account of the COVID-19 pandemic may have long term consequences on the ability of certain borrowers to generate revenues adequate to repay their debt obligations. Therefore, while the COVID-19 pandemic may fall within the purview of force majeure provisions under some of the lending arrangements between borrowers and lenders, the treatment of borrowers which are unable to repay their debts due to the long-term impact of the pandemic has to be considered.
It is pertinent to keep in mind that the IBC is a time-bound mechanism for debt resolution by way of restructuring and not a debt recovery mechanism. While the proposed ordinance to suspend filing of fresh proceedings under the IBC for six months may be intended to protect defaults arising on account of the pandemic, a blanket suspension of proceedings could result in further delays in an overburdened system and result in other unintended consequences. Perhaps the central government, to balance all interests, may consider providing an exemption to defaults arising during a defined period considering a reasonable period for recovery.
The author is the Principle Associate, J.Sagar Associates