Suspension of IBC in the coming: A tool for borrowers or a dagger to the lenders?

In order to prevent community transmission of Covid-19, the government has extended the pan India lockdown. India’s Lockdown 2.0 commenced on April 15, 2020 and shall continue until May 3, 2020. The total count takes it to 40 days since the first phase of the lockdown!

Lockdown has brought India Inc to a standstill, although considering the need to bring the economy back into motion, certain activities in the essential goods and services sector have been allowed, subject to conditions, with effect from April 20, 2020.

The Insolvency Bankruptcy Code, 2016 (IBC) was enacted in order to provide a solution to creditors, resolve the insolvency of corporate debtors and very importantly, provide a time bound mechanism to the creditors for debt resolution. Amidst Covid-19, the government has taken several necessary yet difficult measures like lockdowns, which may render resolution of debts by corporate debtors, strenuous.

Will the IBC be suspended?

As a protectionist move for the corporate debtors under the IBC, on March 24, 2020, the Union Finance Minister, for the first time, had announced the intention of suspending Sections 7, 9 and 10 of the IBC, in case the difficulties faced by the corporates continue beyond April 30, 2020, amidst the lockdown. Now that the lockdown has been extended, the government is mulling on promulgation of an ordinance for suspension of the said sections of the IBC. The suspension shall not allow financial and operational creditors as well as corporate debtors themselves from initiating insolvency proceedings. This is primarily aimed at protecting the medium and small enterprises, which are hit the hardest due to the pandemic, because of disruption of supply chains and disabilities caused by lockdown in carrying out the business and generating revenue. However, a blanket ban on initiation of insolvency proceedings may have been uncalled for as it is likely to give severe adverse repercussions for certain sections –e.g. the creditors! But, the situation may well be unavoidable since initiation of insolvency proceedings during these times are likely to severely clog the courts and therefore, the government may well press the suspension button, albeit for a temporary period!

We have already seen various measures under the IBC being taken since the last few months including the threshold of minimum default under the IBC being increased ten times from Rs. 1 lac to Rs. 1 crore thereby swiping off a large number of operational creditors from filing applications for recovery and leaving them toothless under the IBC.

The 'Force Majeure’ difficulty!

Force majeure is basically a clause which provides an ability to contracting parties to not perform their obligations without being held responsible for it, due to the happening of extraordinary events which were not in their control. Importantly, force majeure is generally not seen in loan agreements! However, business contracts do contain such clauses, are likely to see parties invoking it, thereby rendering the performance of contract for the time period, impossible, which means that a corporate debtor, owing to zero or substantially lowered revenues during the lockdown, is likely to default on its pay-outs to financial creditors as well as operational creditors. Worst, force majeure clauses in certain contracts may well be drafted in a manner which may not allow an interpretation to be taken such that a pandemic of this nature does not get covered.

If the IBC is suspended, without a doubt, creditors, especially the operational creditors, shall be hit hard. Operational creditors, unlike financial creditors are engaged in the supply chain of the corporate debtor and if they are not paid due to invocation of force majeure, this shall further impact their ability to repay their creditors, thereby showcasing a devastating ripple effect on the economy.

RBI’s Covid-19- Regulatory Package

Reserve Bank of India has allowed financial creditors, i.e., all banks and financial institutions (including NBFCs) to grant a moratorium of 3 months on payment of all term loan instalments (including agricultural, retail and crop loans) and interest on working capital loans (such as overdraft facilities), which are due between March 1, 2020 and May 31, 2020. This not being mandatory in nature, poised a difficult question for borrowers and lenders alike, until India’s largest public sector bank, State Bank of India, opened this line of moratorium and others followed suit. Such moratorium has already eased out for the debtors to repay their loans and interest after the end of moratorium. However, this moratorium shall restrict the liquidity of the creditors and pose difficulty in extending credit to the potential borrowers. Even if the credit is extended to the potential borrowers considering the hiatus in business activities created by the pandemic, such borrowers shall be in limited or no capacity to repay at this juncture, which shall only further dry up the liquidity of the creditors. If creditors run out of liquidity, since the Indian banking sector is already exposed to several NPAs, businesses shall be hampered, as a substantial majority run on credit.

How will a suspension be brought about?

The central government may exercise its powers under Section 242 and other provisions of the IBC to issue a notification suspending Sections 7, 9 and 10 of the IBC, in order to prevent the companies at large from being forced into insolvency proceedings. Section 242 empowers the central government to make such provisions not inconsistent with the provisions of the IBC in order to remove any difficulty.

Will a temporary suspension be really useful?

Suspension of the IBC for a period of 6 months shall further disable the creditors from initiating insolvency resolution proceedings against the corporate debtor, thereby further blocking the mechanism to resolve the debt and recover the credit. In light of the aforementioned measures already taken by the government to ensure the corporate debtors to sail through this period of financial stress, suspension of IBC may be a little too much of an overprotection of the corporate debtors. Certainly, this suspension will put the creditors into dire financial crisis, as despite the end of the second phase of the lockdown, they will have to remain remediless for atleast a period of 6 months, only after which they may seek redressal under the IBC, which shall further take a period of 330 days to recover the loan from the corporate debtors. This is a long period to throw a lot of creditors, especially the operational creditors out of business. Also, during this extended time, the quality of the asset is most likely going to further decrease.

It is imperative to question that whether the period of 6 months be enough for the corporate debtors in regaining the same financial position, as was before the first phase of the lockdown so that repayment towards loan can be made? Especially since no economy in the world knows the end date for the current pandemic. Despite that, optimist economists predict the economic recovery to take atleast a span of 9-12 months. During the IBC’s temporary suspension, corporate debtors may not be reinstated into the pink of their financial conditions, so as to repay their loans. The feeble repayment capacity of the borrowers is evident from various circulars released by RBI upon requests of various stakeholders amidst Covid-19. For instance, RBI released a circular upon requests of exporters, seeking relaxation in the timeline for realization and repatriation of funds to India from 9 months to 15 months. Hence, unless the proceeds are realized, payment of borrowings made by the exporters is only a dream for creditors not coming true anytime soon, even after the period of 6 months for suspension of the IBC is over. This implies that the period of six months may not be enough for the borrowers to regain their repayment capacity, hence the suspension of the IBC may not render envisaged outcomes.

How necessary is a suspension of the IBC?

However, suspension of IBC appears to be the last resort before the government to prevent initiation of mass insolvency proceedings against the companies that may have defaulted during the pandemic impacted period. Mass insolvency proceedings may cause retardation of economic growth, as vital activities to keep the business going are carried out during the insolvency proceedings. Additionally, the already overburdened National Company Law Tribunals shall become further burdened.

Strangely this time, the debate on whether or not a suspension be imposed, may lie on different pedestals which may not have been why the IBC was brought into at the first place! Unfortunately for the government, Corporate India Inc’s engine are corporates themselves and the burden of keeping this engine running may push the government to once again require banks and financial institutions to shoulder this responsibility! In turn, the government may infuse funding to these banks for sustenance!

Originally published by Business Today with a different title, available at: https://www.businesstoday.in/opinion/columns/coronavirus-outbreak-ibc-suspension-creditors-to-hit-hard-businesses-corporate-debtors-lockdown/story/401333.html