Insolvency and Bankruptcy Code (Second Amendment) Act, 2020: Subduing the actual purpose of IBC?
On September 19, 2020, the Rajya Sabha passed the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020 which seeks to replace the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020. This article aims to analyse the intricacies of the Act and assess the impact of the Act on the corporate insolvency process. I. Introduction Due to the drastic impact… Read More »
On September 19, 2020, the Rajya Sabha passed the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020 which seeks to replace the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020. This article aims to analyse the intricacies of the Act and assess the impact of the Act on the corporate insolvency process.
I. Introduction
Due to the drastic impact of the COVID-19 pandemic on the Indian economy, the government is bringing relevant changes in law and policies to facilitate the corporate sector in these unfavourable times. Recently, the Insolvency and Bankruptcy Code (Second Amendment) Act, 2020[1] was passed.
The Act was already in force as an Ordinance, and it aims to temporarily suspend initiation of the Corporate Insolvency Resolution Process for a period of 6 months which can further be extended to one year by amending the IBC Code 2016. The Act has been passed to diminish the financial stress witnessed by companies as a result of a deflating economic condition caused by COVID-19. While the corporates welcomed the step, many objected claiming that it offers blanket protection to wilful defaulters.
The cause for such a claim is that the Act does not differentiate between companies that were already defaulting before COVID-19 and those that were affected by this pandemic. Thus, every company, despite not having anything to do with COVID-19 is getting protection.
II. Analysis of the Act
To facilitate the suspension of initiation of the corporate insolvency resolution process, the Act seeks to suspend the operation of Section 7, 9 and 10 of the IBC Code by introducing Section 10A. Section 7, 9 and 10 allowed the creditors and the corporate debtor itself to file for insolvency. As a result of Section 10A, no application for initiation of corporate insolvency resolution process shall be filed against the debtor on or after 25th March 2020 for a period of six months, and it can be extended to one year from such date.[2]
The Act further incorporates a new clause to Section 66 that protects the director and partner of the corporate debtor and states that a resolution professional can no longer file an application under sub-section(2), in respect of such default occurring in the prescribed period.
III. Section 10A: Puts an end to ‘Creditor in Control’ Regime
The Insolvency and Bankruptcy Code, 2016, was passed to bring a reform in the Insolvency process and bring Indian regulations at par with progressive Insolvency and Bankruptcy laws of other countries. The creditor was given an upper hand, and power was granted to initiate insolvency proceedings against the debtor in case of default, and the procedure of recovery was simplified, and it also promoted ease of doing business. It aimed towards improving debt recovery rates and facilitate the creditors and banks by empowering them to get back their dues through the CIRP or the liquidation of the defaulting debtor’s entity.
Section 7 entitled the financial creditor to file an application for insolvency proceedings[3], and similarly, Section 9 grants power to the operational creditor to file for insolvency proceedings against the debtor[4]. As a result of the Act, the creditor will lose these powers, and eventually, the creditor will have to choose other remedies or accept the debtor’s unfair demands. On the one hand, such a step protects the debtors who are suffering losses due to this pandemic, but on the other hand, it is also guarding the wilful defaulters that were already suffering losses, and thus it puts the creditor in a vulnerable position.
The Act also aims to protect those directors and partners that deliberately entered into a transaction to defraud creditors or for any other fraudulent purpose. The main aim of the Code was to provide a timely remedy to the creditor against a defaulting corporate debtor and gain control over the debtor’s assets, but due to suspension, the creditor is forced to choose other remedies that have cumbersome procedures.
The insertion of Section 10A in the IBC goes against the Code’s objective by ruling out the ‘creditor in control’ regime. The realization for creditors as a result of insolvency proceedings is likely to be lower by 30-40 per cent in the current financial year due to the impact of COVID-19 and the suspension of Insolvency proceedings.[5] IBC was a last resort for creditors and Banks to recover their dues in a time-efficient manner, and its suspension for a year can prove quite detrimental to such creditors’ interest.
IV. Suspension of Voluntary initiation of CIRP by the Corporate Debtor
According to Section 10 of the Code, the corporate debtor was given the power to voluntarily file for insolvency proceedings[6]. The suspension of the provision defeats the purpose of the Code by robbing the corporate debtor of the right to initiate voluntary insolvency proceedings. Thus, it gives no other option but to continue with the business even on the occasion of losses and defaults, which would leave no scope for revival. The Code was passed with the primary objective to mitigate the suffering of corporate debtors and help them recover from financial stress by ruling out the immediate threat of being pushed to insolvency proceedings.
The Supreme Court has also reiterated the same in the case of Swiss Ribbons Pvt. Ltd. v. Union of India[7]:
“The primary focus of the legislation is to ensure revival and continuation of the corporate debtor by protecting the corporate debtor from its own management and from a corporate death by liquidation”.
It was also argued in the petition challenging the suspension of Section 10 that:
“Suspension of this Section for a period of 6 months and up to 1 year would result in further deterioration of the affairs of the corporate debtor and result in making the restructuring/revival of the corporate debtor unviable. This one side sits all approach is contrary to the main objectives of the Code and instead of promoting the objective of maximization of value, will result in defeating the objectives of the Code as no restructuring/ revival/ resolution will be now possible.”[8]
Voluntarily liquidation was a great option for those companies and entities which realized that there is no point in continuing business as they don’t have enough resources. Thus, it was feasible for them to opt for voluntary liquidation when they were solvent, i.e., companies possess sufficient assets to pay off all the liabilities. Suspension of voluntary liquidation is detrimental to the corporate debtor’s interests, and it violates the primary purpose of the Act.
V. Conclusion
The objective of the Act is justified and it is essential to protect those corporate debtors who are suffering losses as a result of COVID-19, but the Act failed to recognize the overall purpose of the IBC and thus neglected the interest of creditors by giving an upper hand to the wilful defaulters and at the same time suspending the right of the debtor to apply for voluntary insolvency is also going to worsen the situation because the business will continue to exist despite losses. As a result, many companies may lose their last chance of resolving and restructuring themselves through the IBC regime.
If we consider the international scenario, many countries like India have given direct blanket protection to the debtors by suspending the right of the creditor to opt for insolvency proceeding, but there are countries like Singapore that have opted for a moratorium against initiation of insolvency in case of an affected debtor. According to Section 5 of the Singapore COVID-19 (TEMPORARY MEASURES) ACT 2020:
“If a party to a scheduled contract is unable to perform any contractual obligation and the inability to a material extent is caused by Covid-19 event, then he can seek temporary relief.”[9]
India should also bring a law on the same footing so that the wilful defaulters cannot seek blanket protection and come up with a reform that protects only those corporate debtors that are actually suffering loss as a result of the pandemic. To combat the problem, the government can also provide power to the tribunal to determine the reason for the default. Such a step will not only help the actual corporate debtors who suffered losses but it would also help weed out those corporate defaulters who are willingly seeking protection so as to delay and defeat the objective of IBC.
References
[1] The Insolvency and Bankruptcy Code (Second Amendment) Act, 2020, Available Here
[2] Insolvency and Bankruptcy Code, 2016, Section 10A.
[3] Insolvency and Bankruptcy Code, 2016, Section 7.
[4] Insolvency and Bankruptcy Code, 2016, Section 9.
[5] Realisation for financial creditors from resolution of stressed units may be lower by 40 per cent in FY21: ICRA, The Economic Times, June 03 2020, Available Here
[6] Insolvency and Bankruptcy Code, 2016, Section 10.
[7] Swiss Ribbons Pvt. Ltd. v. Union of India, 2019 SCC Online SC 73.
[8] Rajeev Suri v. Union of India, SPECIAL LEAVE PETITION (CIVIL) 8430/2020.
[9]COVID-19 (TEMPORARY MEASURES) ACT 2020, Section 5, Available Here
