Revoke The IBC Suspension For Greater Economic Good

Once the COVID-19 induced lockdown gets lifted, it will take a few months, if not quarters, before things return to normalcy. The cash flows of most businesses and enterprises have got disrupted so severely that a surge in insolvency and bankruptcy cases was almost a certainty in the post-lockdown phase. To ensure that companies, at large, are not pushed into insolvency proceedings in force majeure causes of default, the government has suspended the Insolvency and Bankruptcy Code (IBC) process for 6 months, and is open to stretching that period up to 1 year depending on the pandemic situation. It has been decided to exclude COVID-19 related debt from the definition of “default” under the Code for the purpose of triggering insolvency proceedings. Also, to protect the micro, small and medium enterprises (MSMEs), the default threshold for triggering insolvency proceedings was hiked from Rs. 1 lakh to Rs. 1 crore. A 6-month moratorium has also been provided on all term loans by the Reserve Bank of India (RBI). But will these steps be of any help to our enterprises, or will these actually push them towards a more uncertain future?

It must be understood that the IBC was designed keeping in mind the interest of the entrepreneurs. This has been clearly outlined in the Preamble to IBC 2016 which goes as follows: 

"An Act to consolidate and amend the laws relating to reorganisation and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximisation of value of assets of such persons, to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders including alteration in the order of priority of payment of Government dues and to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto."

The aim of the Code is to keep alive the spirit of entrepreneurship by enabling a timely resolution for any distressed firm. Under the IBC process, a Committee of Creditors (CoC)-approved restructuring is undertaken. In majority cases, the firm turns around, even if it involves a change in management. A resolution leads to rapid redeployment of the resources trapped in an insolvent firm resulting in optimal value realization for all stakeholders. Only when all efforts for a resolution fail, the end result is liquidation.

On the contrary, this ‘across-the-board’ suspension of the IBC actually defeats the very purpose of this Code by pushing stressed firms to a “trishanku”-like existence. In absence of IBC, distressed firms and entrepreneurs will be flooded with litigation, both by financial and operational creditors. Most such enterprises will not even have the wherewithal and bandwidth to cope with such plethora of lawsuits. Firms would continue to depreciate in value with passage of time. Most such cases would ultimately end up in liquidation, resulting in destruction of capital, job losses and minimum recovery for the creditors. Therefore, suspending the IBC is actually denying the stressed firms a fair chance of revival.

With RBI not agreeing to allow restructuring for troubled loan accounts, too many Indian enterprises are staring at a dismal and uncertain fate. This necessitates access to IBC because it provides a restructuring window for troubled firms. Through this, the CoC can take into account the borrower’s future cash flows and the value of assets and collaterals and work out a revised loan repayment schedule and agreement – which would be a desirable outcome for all stakeholders. Therefore, keeping in mind the core objectives of reorganisation and insolvency resolution, maximisation of value of assets and fuelling entrepreneurship, as outlined in the IBC Preamble, the IBC process should be re-instated at the earliest, but with some key reforms and amendments:

An urgent reform is needed in the Section 29A of IBC. This section presently prevents promoters of stressed non-MSME companies from bidding for the company during the resolution process. Although the MSMEs (which are not willful defaulters and adhere to certain conditions) have been exempted from the applicability of Sec. 29A of IBC, the narrow definition of MSMEs under the MSMED Act 2006 discourages many MSME promoters from acquiring their assets back. This is the most sub-optimal outcome possible – interested promoters getting barred from bidding, while the lenders being forced to take huge haircuts. Sec. 29A should be applicable only in cases where perpetration of fraud by promoters has been established through a forensic audit. In cases where the promoters have been victims of circumstances beyond their control, they should be allowed to bid for their own companies during the resolution process.

Once Sec. 29A of IBC is amended, the government should also consider introducing ‘pre-packaged insolvency’ (or ‘pre-pack’) to enable stakeholders to devise restructuring proposals which only need formal court approval. As experienced in other jurisdictions, the pre-packs get disposed of in a speedy manner and the total cost involved is also substantially less, thus preserving the value of the business. On top of that, unlike a purely private restructuring process, pre-packs operate within the fold of the statutory scheme. Thus, the final outcome is binding on all stakeholders. However, since there is no prevailing market practice or regulatory experience with respect to pre-packs in India, the first step should be to put in place a framework for pre-packs.

Capacity creation at the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) levels should be taken up urgently. The focus should be on the following:

1. setting up dedicated benches of the NCLT can help speed up corporate insolvency cases
2. providing binding guidelines to Committees of Creditors as well as Resolution Professionals would prompt them to work in a time-bound manner
3. creating awareness about the commercial impact of judgments delivered and the economic implications from delays in resolution can vastly improve the role of judiciary

Conclusion

The decision to defer the IBC process can serve no purpose. By temporarily stopping insolvency proceedings against a stressed firm, the problem cannot be wished away. Only its resolution can get delayed, meanwhile the problems will only keep on compounding and can even go out of control. In order to avoid an economic catastrophe, it is high time to start thinking of pragmatic solutions. The IBC process, therefore, needs to be re-instated with the right reforms. It can salvage many distressed firms while keeping the spirit of entrepreneurship alive.