India is not a stranger to her economic legislations being recast or forged anew in the fires of the various crises that have preyed upon her. Legal reforms have undergirded the economic reforms that helped India escape the clutches of its balance of payments crisis in the 90s. Similarly, the Covid-19 pandemic presents a seminal moment for our policymakers to reject the tendency to view the law primarily as a coercive instrument by revisiting the Insolvency and Bankruptcy Code, 2016 (“The Code”) introduced in December, 2016.
The Code has quickly developed a substantial jurisprudence of its own across the NCLTs, NCLAT, certain High Courts and the apex court after successfully weathering challenges to its constitutionality and informing a decidedly mixed bag of insolvency resolution processes of stressed assets. The Hon’ble Supreme Court has upheld the vires of the Code in its landmark Swiss Ribbons judgment in 2019, by explicitly observing that the “defaulter’s paradise” hitherto witnessed under the previous insolvency regime has been demolished by the Code. But the promise shown by the Code as a punitive and recovery tool should not blind us to its general failure at rehabilitating stressed corporate entities.
Tackling the economic fallout of Covid-19 will require legislative interventions that promote cooperation and value creation rather than adversarial courtroom posturing. Gita Gopinath, Economic Counsellor and Director of the Research Department of the International Monetary Fund (IMF), has characterized the economic disruption caused by the pandemic as something akin to the Great Depression of the 1920s. The IMF has urged national policymakers to prevent the demise of companies amidst the COVID 19 pandemic in order to insure the long road to economic recovery once the health crisis abates. It has categorically stated that company closures can cause loss of organizational knowledge and termination of long-term productive projects. This will surely impede a post-COVID-19 recovery that can drive down the unemployment levels expected to be left behind by the pandemic.
The Covid-19 pandemic demands legislative attention to be directed at the divergence between the stated objects of the Code, and the crude impulses that often compel the triggering of the Code by various creditors.
The Code bestows substantial control over the Corporate Insolvency Resolution Process (“CIRP”) solely to the financial creditors of a company who constitutes the Committee of Creditors of the Corporate Debtor. Operational creditors stand to gain almost nothing after the Hon’ble Apex Court affirmed the superiority of financial creditors in deciding the distribution of the resolution funds in the Swiss Ribbons judgment and more recently in the Essar judgment if a CIRP is successfully concluded. Courts have held that the Code aims at resolution and is not a recovery mechanism, yet operational creditors have traditionally misused Section 9 of the Code to arm twist companies into making payments of the operational dues as no solvent company would like to undergo CIRP. The effective conflation of contract enforcement with insolvency resolution by many stakeholders in the economy represents a failure of legislation and policy. It is undesirable at the best of times. It is positively dangerous to a post-COVID 19 economic recovery.
Laws and judicial infrastructure aimed at contract enforcement should ideally be revamped to prevent abuse of the Code. For example, a large number of companies operating in the core sectors of the economy are precluded from paying the dues of their operational creditors in various government partnered/government-contracted projects due to large amounts of money being tied up in challenges by government entities, against arbitral awards made in favour of these companies, before overburdened civil courts. These companies are now expected to tender costly Bank Guarantees to government entities amidst a credit crunch to have access to the benefits of an award in their favour as per NITI Aayog guidelines. This or petitions under Section 9 of the Code clearly cannot be desirable methods of contract enforcement that encourages industry. Introducing strict, short timelines for disposal of such challenges to awards and pronouncement of execution decrees into the Arbitration and Conciliation Act, 1996 and the Micro, Small and Medium Enterprises Development Act, 2006will provide a viable route towards recovery by operational creditors, who are often MSMEs, that does not jeopardize recovery by the financial creditors of the company. This will ultimately encourage the growth of entrepreneurship and infrastructure development amidst grim market sentiments.
The explicitly stated objective of the Code is, inter alia, insolvency resolution in a time-bound manner for maximisation of the value of assets of insolvent entities. Its provisions place a premium on ensuring the viability of a company undergoing CIRP as a going concern. Sadly, none of those objectives were being generally fulfilled prior to Covid-19. The timelines have been progressively enhanced by legislative as well as judicial interventions and delays. Widely circulated statistics have pointed out the gross inefficiency of the Code’s mechanism as a recovery mechanism for financial institutions. As per report by one of the leading financial services company, Credit Suisse, credit disbursement by Indian banks had already dropped in Q2 of the Financial Year 2019-20 to levels last seen during demonetisation. The Indian economy has been afflicted with a slowdown since a time the Code was functioning at full throttle. We have seen successful resolution applicants failing to implement ambitious resolution plans after waging frenetic bidding wars and costly litigation. Liquidation of a company is almost the norm rather than the exception.
The pitiable state of recovery by the banks and the failure of resolution professionals to find viable resolution applicants in most matters point to failures in commercial planning endemic to Indian banking even when a pandemic was not there. Banks, financial institutions have taken substantial hair-cuts. In some cases they have even approved resolution plans where the amounts offered are lesser than the liquidation value of the concerned corporate debtors. Financial institutions left to their own devices have often reduced successful petitions under the Code to Pyrrhic victories. These uncritically instituted, chronically unsuccessful insolvency resolution processes discredit the idea that Indian banks should be allowed commercial discretion over the initiation of insolvency proceedings against struggling industries amid a Covid-19 induced depression. The Code has belied expectations by failing toensure the preservation of a large number of the companies in its crosshairs as going, viable concerns. Therefore, the bite of the Code lies in being the proverbial stick for beating promoters of corporate entities that fail to discharge payment obligations. But a law essentially designed to weed out rotten apples will be useless when the whole crop turns bad.
The Code was designed for optimum deployment at times when market sentiments are robust so that unethical promoters are replaced by eager resolution applicants who survive a process similar to competitive bidding. It was not designed for deployment during a repeat of the Great Depression. A defaulting company will be liquidated if a CIRP fails to find a resolution applicant. The probability of failure is lowered when the number of potential, eager participants in the bidding process and availability of capital in the market increase. A global lockdown, its knock-on effects and threats of recurring waves of infections do not mesh with the objectives of value maximisation and continuance of a defaulting company as a going concern.
With liquidity crisis looming large in the economy, the question is whether any investor or company would like to invest money in a stressed asset? The answer perhaps is NO. What happens to companies which are already undergoing insolvency resolution? In most likelihood, all such companies will go to liquidation for want of resolution plan which will perhaps be the final nail in the coffin. Another pertinent issue which requires attention is the fate of companies which have successfully undergone CIRP but where the successful resolution applicant has not implemented the resolution plan. Under the Code, the consequence of not implementing the resolution plan is liquidation. Thus, in order to protect the companies as well as the successful resolution applicants at large, it is imperative that a moratorium is granted to such Resolution Applicants and the timeline to make payment under a Plan be extended and modified to a suitable extent by the Creditors or by the monitoring committee so as to avoid liquidation at any cost. In our opinion, necessary amendments are required to be made in the Code making provisions for even modification of a resolution plan after its approval or even rebidding in case, a successful resolution applicant is unable to implement the same due to the COVID-19 scenario.
The suspension of Sections 7 and 9 of the Code is stated to be up for consideration by the Central Government if the Covid19 situation extends into May. As we write this article, the Cabinet has already given its nod to suspend some provisions of the Code.
It is essential that Sections 7 and 9 of the Code be suspended till the beginning of the next financial year with the proviso that declared wilful defaulters will not be entitled to the protection.It is also recommended that the suspension be liberal in its content and also mandate the cessation and/or suspension of proceedings already initiated against corporate entities that had not yet been finally adjudicated upon by the pertinent National Company Law Tribunals (NCLT) prior to the imposition of the lockdown measures. The legislative focus must remain on avoiding risky, unpredictable insolvency resolution processes during this economic crisis rather than merely accommodating extenuating circumstances behind corporate defaults.This is essential since insolvency resolution should not be viewed solely as a punitive measure against promoters but must privilege its objectives of value maximisation and preserving companies as going concerns.
The post Covid-19 recovery should not commence from a wasteland of stripped down shells of once bustling industries. The judiciary seems to have recognized the urgency of the situation. The Hon’ble Supreme Court and various High Courts have interpreted the extant limited moratorium on debt repayments allowed by the RBI through its March 27, 2020, Circular expansively. The Delhi High Court has declared a particular loan, wherein the borrower was in default since January 1, 2020, (whereas the RBI Circular baldly states the cut-off date to be March 1, 2020 in respect of all term loans to be eligible for the RBI moratorium benefits. The Bombay High Court has extended interim protection against even a mode of recovery by financial institutions (e.g. invocation of pledged shares) left unaddressed by the RBI Circular. This was duly upheld by the Apex Court. Restructuring of loans should be encouraged. Innovative policy making can even tie the restructuring of loans and/or availing of settlement schemes by companies in labour and skill intensive sectors to its retention of the services of its employees, workmen and undiminished payments of their wages despite the bleak economic circumstances. The Central Government can partly actualize its advisories and directives regarding the protection of employment and wages by employers without resorting to legally coercive measures. It should be explored whether restructuring of loans extended to corporate and entrepreneurs by public sector banks can be a substitute for wage subsidies that may be required to maintain employment levels in those organizations if the disruption and lockdown continues in the foreseeable future.
‘Normal’ will not be what it used to be even after the pandemic abates. Insolvency law stands at a crossroads today. It can choose to stay benign only for a short while and resume its myopically punitive stance without regard for its original objective of maximising value of assets of companies facing payments crises and maintaining them as a going concern after resolution. Alternatively, legislatures can engage in a dialogue with all stakeholders in Indian industry to further the aim of protecting employment and preserving the value of industrial assets in order to secure economic revival at the first opportune moment presented to us hereafter.
About the authors: A graduate of GNLU, with an LLM from the University of Cambridge, Rishav Banerjee is an advocate practicing before the Calcutta High Court and the Supreme Court, as well as the NCLAT and NCLTs. He deals in matters pertaining to IBC. The author expresses his gratitude to Pooja Chatterjee, practising Company Secretary, for her valuable views on the article. Rishav Banerjee can be reached at firstname.lastname@example.org
Rajarshi Banerjee graduated from NLSIU, Bangalore and is a practicing advocate of the Calcutta High Court. He regularly appears for clients in insolvency matters before the NCLAT and NCLT. Rajashri Banerjee can be reached at email@example.com