Not the Best Solution for Insolvencies–Economic Times

By Anirudh Wadhwa

On April 23, GoI passed a resolution to amend the Insolvency and Bankruptcy Code (IBC) to suspend up to one year the provisions that trigger corporate insolvency proceedings. The operation of Sections 7, 9 and 10 of IBC would reportedly be suspended for 6-12 months.

The move is purportedly to prevent cash-strapped companies from being forced into insolvency in light of the Covid-19-instigated economic crisis. It also comes on the heels of another decision made on March 24, to raise the threshold of default under Section 4 of IBC from Rs 1lakh to Rs 1crore. Despite good intentions, the move is both over- and underinclusive, and requires a rethink.

The rationale of protecting companies from being unwillingly dragged through the insolvency process by financial or operational creditors does not justify suspending Section 10 of IBC, which provides for a defaulting corporate debtor to itself initiate the insolvency process.

Many companies, including some very large conglomerates, have voluntarily initiated resolution under Section 10, since their stakeholders realised that continued operation had become unviable and desired resolution under IBC. Data released by the Insolvency and Bankruptcy Board of India (IBBI) reveals that about 10% of all admitted corporate insolvencies were initiated under Section 10.

The present economic crisis calls for keeping open this avenue for corporate debtors facing financial stress, rather than opting for its closure. Sections 7 and 9 provide for initiation of the insolvency resolution against a corporate debtor by financial creditors and operational creditors, respectively. The suspension of these provisions seeks to prevent a spate of insolvency petitions by such creditors against companies whose finances are strained by the pandemic.

However, if a creditor is unable to exercise remedies against its defaulting corporate debtor, it is likely to lead to a domino effect of defaults. The suspension of these provisions removes an important and necessary incentive for companies to clear dues, disrupting the flow of capital in the economy when it is needed the most. A creditor that does not receive dues from its corporate debtors would be very likely to default on its own debts, and the entire ecosystem would be destabilised.

Further, IBC does not operate in legal isolation. Rather, it is part of an interdependent ecosystem of complex financial legislations. The creditor still has the legal right to enforce recovery under other laws, against which there is no reprieve proposed. If the creditor is a bank, it can seek recovery under the Recovery of Debts Due to Banks and Financial Institutions (RDDBFI) Act, 1993.

If there is a security (like mortgage) involved, it can also proceed under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfeisi) Act, 2002.

Further, although creditors may be unable to initiate insolvency against corporate debtors, they would be able to drag promoters who have given personal guarantees through the bankruptcy process, as provided for in Part 3 of IBC.

In fact, that IBC insulates a corporate debtor is arguable, since the initiation of the insolvency process triggers a moratorium, suspending all coercive civil proceedings against the corporate debtor, shifting the focus from recovery of debts to preservation of the debtor as a going concern and consequent successful resolution of insolvency.

It is neither practicable nor desirable to suspend the entire ecosystem of financial laws. Look to other measures. Raising the default threshold to initiate insolvency proceedings to Rs 1 crore has already precluded a large number of insolvency moves against corporate debtors, especially micro, small and medium enterprises (MSMEs). If the concern is that this measure is still not enough, enhance the threshold further.

The government should further encourage lending in this time of economic distress to allow businesses to meet their dues. RBI should also extend the 3-month financial moratorium both in time period and scope. In fact, an extension of the moratorium on repayment of term loans would be a more moderate and effective approach. This would allow banks and NBFCs to shift repayment dates as per their discretion, and be favourable to further lending activity.

A blanket suspension of initiation of all corporate insolvency proceedings seems to be a disproportionate move, likely to cause more problems than what it aims to solve.

(The writer is an advocate)

via Not the Best Solution for Insolvencies

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