4 min read.Updated: 15 Apr 2020, 10:54 PM ISTRohit Prasad,Yogesh B. Mathur
The crisis will lead to a spike in bankruptcies and we need to strengthen the code to be able to handle them effectively
The lockdown, occasioned by the spread of the novel coronavirus, is causing significant stress for Indian business. Even though the Reserve Bank of India (RBI) has instituted debt moratoriums and finance minister Nirmala Sitharaman has announced a slew of relief packages, one expects a significant spike in the number of bankruptcies. Is India’s Insolvency and Bankruptcy Code (IBC) up to the task of this new normal? While much depends on how things pan out in the next few months, here are some pressing issues:
Insolvency resolution traffic jam: According to Injeti Srinivas, corporate affairs secretary, since the commencement of the IBC and setting up of the National Company Law Tribunal (NCLT), 12,000 cases have been filed. Around 4,500 cases have been settled before resolution, with a settlement amount of almost ₹2 trillion. 1,500 cases have been admitted and 6,000 cases are waiting in queue. The covid-19 epidemic will only increase this traffic jam. The pile up of cases needs to be addressed by increasing capacity of the NCLT, and by ensuring that as many cases as possible are settled without going to the IBC.
Changing the locus of the promoter of the corporate debtor: Under section 29A(c) of the IBC, a promoter associated with any account which has been classified as a non-performing asset (NPAs) for a period of one year or more is ineligible to bid for any corporate debtor. It is pertinent to recall that the intent of section 29A is to prevent persons who, by their misconduct or fraudulent motives contributed to the default of the corporate debtor, from “buying back" the corporate debtor from the creditors, potentially at steep discounts. While this is clearly a justifiable objective, the short window of one year has prevented even genuine promoters who faced major setbacks on account of unforeseen circumstances from being given a second chance, even though such promoters are often in a good the best position to revive their businesses. In view of the current force majeure, we recommend that the grace period of one year under section 29A(c) be extended to two years, with further extensions possible on the approval of a supermajority (i.e. 75%) of the Committee of Creditors. Further, the newly introduced Section 12A allows the bank, which was the insolvency applicant, to exit the insolvency process—thus bringing the promoter back in control—provided 90% of the Committee of Creditors agrees and the public bidding process has not commenced. We suggest that the requirement for exit be reduced to 75% of the committee.
Extension of timelines: Recently, the Supreme Court did well by passing a suo moto order on the extension of limitation generally, based on which the National Company Law Appellate Tribunal has ordered that such extension also apply to the outer limit of 330 days for the resolution of corporate insolvency cases. This could be further extended once the gravity of the situation becomes clear over the next few months. The moratorium period on debt financing recently announced by RBI should also be extended to cover money market instruments.
More financing options: While the IBC does provide for interim finance with a preferential position for a corporate debtor, there are known limitations and residual risks on the provision of such finance. The government would do well to look at expanding the market by making changes, including permitting interim funding by asset reconstruction companies even without being creditors, making provisions for a minimum return even in case of liquidation, and extending the enhanced priority standing given to interim financiers in the IBC phase to the pre-IBC phase.
Post the lockdown, incremental working capital support upto, say, 25% of existing working capital exposure could be allowed in deserving cases even if the account is in default or NPA. This can be deemed to be priority lending to also protect bankers’ interests. Provision could also be made for the extension of concessional finance within limits based on demonstrated export potential (e.g.: order, short lead time business, margin adjustments) in order to contribute to the recovery of exporting industries.
Equitable treatment of operational creditors: In the Swiss Ribbons judgment, the Supreme Court urged equitable, though not equal, treatment of operational creditors. The need to protect the interests of operational creditors in bankruptcy proceedings is all the more critical in difficult market conditions where credit would be hard to obtain. Some broad guidelines appear to be desirable. For instance, one could stipulate that in the absence of quality issues, two operational creditors belonging to the same sub-class in terms of the type of product or service sold, should be treated equally, irrespective of group relationships or continuity in the business of the resolved entity.
On the issue of closing a case before the onset of insolvency proceedings, there was a case for doing this even before the corona outbreak, and even without the paucity of processing capacity. The labelling of a company as insolvent or bankrupt has a chilling effect on its already dim prospects. Vendors, customers and employees start having second thoughts about associating with this company. Certain rules get triggered—for instance, the rule barring an infrastructure company from accepting new orders. The current outbreak amplifies the case for facilitating resolution outside the corporate insolvency resolution process, while at the same time attempting to streamline the process to ensure enhanced proceeds. Two possible measures are extending enhanced protection from legal action to bank officials with respect to their decisions on discounts to corporate debtors in the period prior to the admission of a case to the IBC, and enabling the provision of incremental finance, as detailed earlier, not just during the IBC process, but also before.