IBC (2nd Amendment) Act, 2020 - A creditors' nightmare
Published: Oct 09, 2020
By Srivatsa P Rao
INTRODUCTION
The estimated 23.9% dip in the first quarter GDP of India has brought to the fore the chilling effects of the novel corona virus on our economy. Back in the early months of 2020, the central government was running short of options to arrest the slide in GDP as the once-in-a century pandemic waged a coup against normalcy around the globe. As regards to the Insolvency and Bankruptcy Code, (hereinafter referred to as "IBC"), the virus necessitated dramatic changes in the way insolvency proceedings against corporate debtors would go ahead.
Sensing the impending doom and to help spur growth, the central government had, on 24th March, 2020 made changes as per Section 4 of IBC whereby it increased the threshold limits to initiate CIRPs against corporate debtors from Rs. 1 lakh to Rs. 1 Cr. This brought huge relief to many small and medium scale companies that were faltering even before the effects of the pandemic started to unravel.
Foreseeing the plight of corporate debtors afflicted by weak demand during the months of lockdowns, it was apparent to the central government that the additional stress of court proceedings amid the volatile times of COVID would further jeopardise the interests of businesses. So, in June 2020, the government promulgated an ordinance whereby new provisions were enacted through the insertion of Sections 10A and 66(3) in the IBC.
Section 10A effectively bars creditors from moving fresh applications to initiate Corporate Insolvency Resolution Process (CIRPs for short) against the defaulters for the default occurring on or after 25th March, 2020, for a period of 6 months (extendable up to a year).
Section 66(3) bars any insolvency professional from filing any application under Section 66(2) of the Code, where CIRPs were suspended as per the provisions of Section 10A. It was made amply clear that the provisions of the ordinance would have retrospective effect.
While these provisions of ordinance were cheered gleefully by corporate debtors heavily burdened by the nation-wide lockdown that was imposed by the central government to curb the spread of COVID-19, they wreaked havoc (and continue to do so) among creditors who's painstakingly formed financial structures were upended overnight, further adding to their virus woes.
THE AMENDMENT
To give effect to the temporary ordinance, Parliament, in September, passed the Insolvency and Bankruptcy Code (2nd Amendment) Act 2020 (hereinafter referred to as the "Amendment") to temporarily suspend any creditor from applying for corporate insolvency regulation process against any corporate debtor for a default that occurred on or after 25th March, 2020.
As an effect of the Amendment, the earlier ordinance to this effect was repealed. It is also explicitly made clear that the Amendment does not bar creditors from initiating CIRPs for defaults that occurred before 25th March, 2020.
As per Section 10A, no application under Sections 7, 9 and 10 of the IBC can be filed for defaults occurring in the specified period. While Section 10 talks about voluntary method of initiating CIRP by corporate defaulter, Sections 7 and 9 relate to provisions to initiate the process by financial and operational creditors, respectively.
The objective of this newly inserted section is to provide companies the relief desperately required to recover from the ordeal caused by the pandemic. It was natural of the government to initiate a ceasefire of sorts between the creditors and the errant corporate debtors. Forcing companies into insolvency as a result of the pandemic would be counter-productive. Little doubt remains that the Amendment brought some much-needed respite for defaulting companies.
THE PRESENT SCENARIO
The sudden tweaking of rules per Section 4 of the Code, though called for keeping in view the extreme situations that were present in the early months of COVID-19's spread, snatch away the lenders' right to move NCLTs to get swift resolutions to their disputes. Lenders will now have to move traditional courts, in respect to such defaults that are below the threshold of Rs. 1 Crore - a rather slow process.
The measures of government to provide for a moratorium on CIRPs of defaulting debtors are highly skewed in favour of the defaulting companies. It sends across a message (and a bad one for creditors) - that any default would be put up with. This measure is antithesis to the objectives of the Code, which are - maximization of asset value, availability of credit and balance of interests of all stakeholders, among others.
Changes brought in by the Amendment, though necessitated by the unprecedented scenarios usurp the rights of the lenders. Government has apparently failed to strike the right balance between the interests both the lenders and the debtors.
TYPES OF CREDITORS AND EXISTING WOES
IBC distinguishes between creditors according to their roles. Financial creditors are those to whom the corporate debtor owes financial debts. Banks and other financial institutions lending money or other financial instruments to debtors make up the bulk of financial creditors in India. Operational creditors (Ocs) are those creditors who supply companies with goods and services to the debtor company. Most of the operational creditors in India are small and medium scale companies that supply goods and materials to other industries. Survival of these OCs depends heavily on periodical receipts of their dues.
As such, lenders are forced to take a haircut from their rightful dues - thanks to the provisions of Section 53 of the IBC. Section 53 substantially muddies the waters for financial and operational creditors in getting their share from the proceeds of the sale of liquidation assets. The waterfall mechanism (as the section is popularly known) has operational creditors' priority ranking at a dismal 6th out of 8 stakeholders when receiving such proceeds. This Amendment, thus, comes as a double whammy for both these categories of creditors.
To add to the conundrum of financial creditors already beaten up by the Amendment and the pandemic, the government has informed the apex court that waving interest on loan of moratorium period for loans up to Rs. 2 Crores is the only option to ease the burden of debtors. While the top court too had suggested that the government come up with a plan to counter the issues of debtors having to pay interest, banks are aghast with the prospect of writing off debts in future. This may lead to a liquidity crisis in the economy in future.
It is amply clear that many companies would be swept away in the tsunami that is the pandemic. In majority of the cases, creditors approaching NCLTs for CIRPs have had to write significant portions of their loans off after liquidation of assets of defaulting companies. The move of the government to increase threshold limits and to issue a moratorium on filing new applications for CIRPs have significantly crippled the creditors.
CONCLUSION
By disproportionately favouring the debtors against the creditors, the Amendment sets a bad precedent for the future. Institutional investors would be wary of lending in future if their interests aren't adequately safeguarded in times of upheaval. Ratings agencies around the world too are keenly watching the steps being taken by the central government. Any delay in payment of dues to creditors has a ripple effect on the economy.
The Amendment skews entirely in favour of the corporate debtors without taking into account the additional stress piling up in lenders' balance sheets. There is no doubt that a high number of debtor companies will shut shop. Wheels of the economy will move efficiently only when all the stakeholders are taken care of - but creditors in this case were completely snubbed.
The only certainty in times of pandemic is uncertainty. The central government's moves to curb creditors' rights may result in financial institutions exercising more scrutiny when issuing loans in future. Many operational creditor companies will cease to exist if the effects of pandemic continue to ravage us for a longer period of time. As the economy starts to pick up steam, one can only hope that the government will assuage creditors' fears by effectively implementing IBC, keeping in mind its objectives.
(The author is a final semester student of law and the views expressed in the article are his own.)
