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After the lockdown is over, several companies are likely to default on their dues to both operational and financial creditors. The latter include banks and others who have given financial assistance to a company in the form of loans and debentures.
The lockdown has badly affected the service sector, particularly travel, hospitality, and wholesale and retail trade. (File Photo/Representational)
The economic consequences of the COVID-19 pandemic and the lockdown that followed will undoubtedly be disastrous. These crippling blows have come close on the heels of the worst economic slowdown experienced by the country in the recent past. Almost every sector was badly affected. The manufacturing sector had seen a drastic drop in production due to a steep fall in consumption. The lockdown has badly affected the service sector, particularly travel, hospitality, and wholesale and retail trade.
After the lockdown is over, several companies are likely to default on their dues to both operational and financial creditors. The latter include banks and others who have given financial assistance to a company in the form of loans and debentures. According to a 2018 amendment to the Insolvency and Bankruptcy Code (IBC) 2017, flat purchasers are also deemed as financial creditors. An operational creditor is just about anyone who has to receive money from a company. The IBC provides a fast-track mechanism to deal with companies which are unable to repay their creditors and have become financially unviable. Section 22 of the Code mandates the appointment of a Resolution Professional (RP) who is expected to miraculously turn around the company in 330 days. If this attempt fails, the company goes into liquidation.
The IBC’s provisions have been extensively used by various creditors whose dues were not paid. Initially, the threshold limit was just Rs 1 lakh and the IBC became an effective recovery mechanism for all operational creditors. Just before the lockdown, the finance minister raised the threshold for invoking the insolvency provisions to Rs 1 crore. She said that this limit was being raised to prevent proceedings being initiated against small and medium enterprises.
After the lockdown, several enterprises, large, medium and small, might not be able to pay their dues, at least in the short-term. The easiest way for a creditor to recover money is to initiate insolvency proceedings against the debtor company and threaten it with liquidation. The shutdown of business after the lockdown could have a domino effect. If an auto-manufacturer has shut down its operations, the ancillary units will not get their dues. This would then lead to non-payment to downstream vendors and service providers as well. It might take at least three to four months for the situation to stabilise.
The most important, and immediate, step that needs to be taken is to have a six-month moratorium on the IBC. It may be necessary to promulgate an ordinance suspending the prospective operation of Sections 7 and 9 of the IBC so that no fresh petition is filed against a company. While this could hurt some of the creditors, the damage that could be done to the corporate sector by invoking the IBC is likely to be far greater. A distressed creditor is not without a remedy as he can always approach the civil courts for relief, which will not be so severe on a defaulting company.
If an insolvency petition is filed and the RP appointed, it is difficult to stop the insolvency process. The IBC requires a financially-stressed company to be taken over by a financially-sound one. For example, Essar Steel was taken over by ArcelorMittal and Bhushan Steel was taken over by Tata Steel. In the current scenario, it will be difficult, if not impossible, for an RP to find a suitable buyer and the only option would be to liquidate the company.
Suspending the IBC for a short period would enable several companies to return to normalcy without the constant threat of an insolvency application and its Board of Directors and management being taken over by the RP. Moreover, the National Company Law Tribunal benches will simply be unable to take any additional workload.
Using the insolvency process to recover dues is contrary to the IBC’s objectives. Its preamble indicates that the objective of the IBC is not just insolvency but the reorganisation of companies, maximisation of value of assets and the need to balance the interests of all stakeholders. Therefore, suspending the IBC for six months would be a much-needed step to prevent further damage to the economy. It would be in the larger public interest. Indeed, at this critical stage, permitting the legal remedy of insolvency could be the last nail in the coffin of many companies.
The writers are practicing advocates in the Supreme Court and the Madras High Court