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IBC (Amendment) Ordinance, 2020: Seemingly Innocuous Or Detrimental?

In May of 2016, the Insolvency and Bankruptcy Code (hereinafter referred to as IBC) was implemented through the act of the Parliament and the mandatory Presidential assent. At the time, it was estimated that India, on an average, took 4.3 years in insolvency resolutions. Compare this to other global superpowers like the United Kingdom and United States of America (1 and 1.5 years, respectively) and it was evident that we needed another mechanism to expedite insolvency processes in India.

Before delving into the statute, we must understand that insolvency and bankruptcy are not the same thing. In fact, bankruptcy is the solution to insolvency. Insolvency is the inability to pay off one's debts when due. Bankruptcy, on the other hand, is the final alternative to escape insolvency when all methods to pay off the debts fail. Thus, bankruptcy is a court proceeding where the court (or any authority authorised for examination by it) examines the assets and liabilities of individuals/businesses who are unable to pay their debt off and decide on future steps of the insolvent.

The IBC is applicable to partnerships, companies and individuals. The ultimate aim of the statute was to provide for time-bound resolution to insolvency processes. Section 12 of the Code demands completion of the insolvency process within hundred and eighty days from the time of admission of the application to initiate the process. The Insolvency and Bankruptcy Board of India or IBBI has been established as the regulatory body.

It comprises ten members spread across the Finance Ministry, Law Ministry and the Reserve Bank of India (RBI). Adjudication of IBC proceedings are largely carried out by the National Companies Law Tribunal (NCLT) and the Debt Recovery Tribunal (DRT) – depending on the nature of the case. Apart from time-bound resolutions, the IBC has helped India rise in the ‘Ease of Doing Business' index. It also provides for an easy exit from the market – which is just as important as ease of entry in a free market economy, thereby, leading to better and optimal use of resources by the most efficient businesses and entrepreneurs.

To combat the prevalent Coronavirus pandemic, some measures were taken by the government in order to ensure that the companies do not get dragged into insolvency under IBC. On March 24, 2020, the Finance Minister raised the benchmark for initiating insolvency proceedings from Rs. 1 Lakh to Rs. 1 Crore and the idea of suspension of Section 7, 9 and 10 of IBC was discuessd. Subsequent to this announcement, on May 17, 2020, Special resolution for insolvency was notified under Section 240A of the code for the MSME (Micro, Small & Medium Enterprises) sector.

Additionally, a collateral free automatic loan of 3 Lakh Crore has been declared for the MSME sector as part of the economic relief package. Along with this, it was declared that no fresh insolvency proceeding would initiate up to 1 year. The finance minister also empowered the Central Government to exclude Covid-19 related debt from the definition of default under the code.

In furtherance to these measures, the Central Government introduced an Ordinance on June 5, 2020 to facilitate the companies and fill the gaps created by the announcement. The paper aims to examine and understand the impacts and the aftermath of the said ordinance along with the benefits it seeks to reap.

Section 7, 9 And 10 Of Ibc

Section 7, 9 and 10 have been suspended under the Ordinance passed on June 5, 2020. Section 7 provides a power to the Financial creditor to file an application for initiating the corporate insolvency resolution process against a Corporate debtor. Previously, the application could only be filed when the default was not less than 1 Lakh Rupees (Threshold Limit). However, the said amount has been increased to 1 Crore Rupees. The term default has been explained in Section 3(12) of the code as Default means non- payment of debt when whole or any part or installment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor , as the case may be.

Section 9 provides that, if ten days have passed from the date of delivery of notice or invoice that demands payment under Section 8 and the Corporate creditor has not received payment from the Corporate debtor, the Creditor can file an application of insolvency before the Adjudicating authority. It also lays down procedural formalities that are to be read with Section 8 of the code. The section is detailed, specifying what is the relevant information that needs to be mentioned in the application along with pertinent documents to be attached.

While Sections 7 and 9 give power to the creditors of the defaulting company to initiate insolvency procedure under an Adjudicating body, Section 10 provides for initiation of insolvency proceedings by the defaulting body itself. This can be done by approaching the Adjudicating body, in this case, NCLT and declaring it insolvent under Form 6. This section is advantageous to the company because it gives a chance to them to resolve their debts and revive the company through the resolution process provided by the system.

The Ordinance Of June 5, 2020

The Ordinance passed on June 5, 2020 by the Union Finance, Minister Niramala Sitaraman, suspends the initiation of insolvency resolution process of a Corporate Debtor under Section 7, 9 and 10 of the code. The Ordinance, and the amendments thereof, shall be effective from June 5, 2020. This is done for any default arising on or after March 25, 2020, for a period of six months, extendable up to one year (Suspension period). Pre-pandemic insolvency proceedings have been excluded from the ambit of the ordinance.

The banking system has been in favor of the said ordinance for the sole fact that they believe it will take a long time for the companies to heal from Covid-19's detrimental economic effect. Along with the impact the ordinance will bear on the MSME sector, a brand new provision - Section 10A, which makes it clear that no fresh insolvency proceeding can be initiated - is inserted.

Section 10A also has a proviso which states that no proceeding Shall ever be filed for the defaults occurring during the time mentioned in the ordinance. Section 66 (3) is inserted which further suspended filing of an application under Section 66 (2) of IBC, by the resolution professional against Corporate debtor's directors or partners of the default company against which the starting of corporate insolvency resolution process has been suspended. The Ordinance also further notifies to exclude any Covid defaults from the default definition mentioned in IBC.

Cases Prior To 25 March, 2020

While the ordinance issues measures and reliefs for cases after 25th March, the fate of the cases prior to this date is unclear. There can be a couple of situations raising concerns. First is the case where Demand notice has already been issued by the operational creditor prior to 25th of March. Section 8 is the trigger point which mentions an operational creditor, who wants to bring an insolvency proceeding, to give a notice of ten days prior to default.

Here the default has already happened, it becomes a suitable case for insolvency and should be admitted. Second is the situation where the application has been filed before the court but it has not been listed in any NCLT benches and there has been no admission. Third issue is of the threshold of 1 crore which was decided on 24th March. If the application is before 24th March, then there will be no restriction on NCLT to admit those cases. On this issue, the NCLT bench of Kolkata in the case of Foseco India Limited v. Om Boseco Rail Products Limited held that the threshold is prospective in nature and not retrospective. Hence if the case is already filed, it should be admitted.

Next issue is that of the order already issued by the NCLT against the Corporate Debtor. The cases which are already in the pipeline should ideally be admitted considering the fact the NCLT is still functional. NCLT has taken a drastic view looking at the Covid situation and is also trying to help the companies as much as possible. This is seen in the case of Sunil Kumar Agarwal RP of DIGJAM Ltd. Vs. Suspended Board of Directors of DIGJAM Ltd.. NCLT in this case has allowed for a Resolution Applicant to change the payment schedule after the approval of the resolution plan, owing to the pandemic.

Challenges And Issues Of The Ordinance

A Scottish philosopher, Thomas Reid, once said: There is no greater impediment to the advancement of knowledge than the ambiguity of words. This statement holds much truth for Section 10A of the IBC. Arguably, no person can have knowledge about this provision without highlighting its ambiguities. The provision prohibits applications for the initiation of corporate insolvency resolution process of the corporate debtor for defaults arising on or after 25th March, 2020... It is largely justified on the ability to solve a three-pronged problem caused by the pandemic: (i) Difficulty in finding adequate resolution applicants to rescue corporate debtors (ii) To prevent industries and businesses from insolvency in an already distressed economy (iii) To provide exceptions to defaults arising on account of the pandemic.

Section 10A is not applicable to defaults prior to 25th March, 2020 and this is a questionable move. Industries and businesses can continue to be in distressed positions during this pandemic, even if their default occurred prior to the aforementioned date. The provision simply fails to protect them in any way and hence, to a certain extent, this defeats the purpose for which it was established. Not protecting industries who defaulted before this date is inevitably going to lead to problems.

Consequently, a company defaulting on, say, 24th March, is not given any relief under this provision as opposed to a company defaulting a day later for similar defaults and reasons. The provision is also silent on continuing defaults, i.e. defaults that may begin before 25th March, 2020, but due to their nature, carry on for an extended period of time.

Will the entire default be exempt? What about the default caused before the date? There seems to be an assumption that any default occurring within this said period is a consequence of the pandemic. Thus, defaults that were genuine and disconnected with the pandemic, will also enjoy protection under Section 10A. The absence of a definition or explanation of a Covid-19 default makes the provision, in our opinion, arbitrary. The lack of clarity on the exclusion from the definition of default also leads to ambiguity to the fact of future benefits coming out of these, when the suspension is lifted.

The proviso of Section 10A reads as follows: provided that no application for insolvency resolution shall ever be filed against a corporate debtor for any default occurring during the suspension period. The role of the proviso is questionable. Typically, a proviso in statutes helps restrict the power and application of the main provision for exceptional circumstances. In this case, however, on a plain reading, it seems that the proviso is in fact enhancing the scope more than what is envisaged in the main portion of the provision. A proviso usually helps eradicate any ambiguity about the main provision.

Here, the main provision is clear while the proviso seems vague. Section 10A also suspends Section 10 – which is strange because if the purpose of the amendment to the IBC was to absolve financial distress, voluntary insolvency under Section 10 would only make it easier for those under duress. The ordinance and particularly Section 10A has, without a doubt, opened itself up to a host of legal issues on arbitrariness and its utter disconnect with the controversial proviso to Section 10A.

Another part of the Ordinance deals with the wrongful trading, i.e. Section 66(2). This provision fairly deals with director's liability to act diligently in the penultimate phase of insolvency. Section 66(3) added by the Ordinance says that a resolution professional should not file an application for defaults covered under section 66. It is pertinent to note, however, that this section is not applicable to Section 66(1) which deals with fraudulent trading. If an individual continues to deal fraudulently in the suspension period and defrauds its creditors, no protection under Section 66(3) will be provided.

The relaxation provided here is quite similar to the one introduced in the United Kingdom; a vote of confidence was given to directors to continue trading during the pandemic without the risk of personal liability if the company falls into insolvency. The challenge that comes along with this kind of leeway in India is high risk of misutilisation and is likely to encourage wilful accumulation of debt. It is unclear if in the look back period the suspension period is going to be involved or not by the resolution professionals. This uncertainty leaves scope for misuse.

This Ordinance also has an impact on the MSME sector. Whether the impact of the Ordinance is positive or detrimental in nature is still debatable. Definition of MSME has been revised and the threshold has been increased. With the increased threshold, however, there is no relaxation under Section 16 of the MSME Act, which calls for interest in payment in case of delay. This can be detrimental to the MSMEs. On one hand, while the increase in the threshold amount to Rupees One Crore is supposed to give some relief to small companies - specifically the MSMEs - it will also be detrimental to the operational and financial creditors. MSMEs cannot invoke Section 9 of the Code as operational creditors even when the default amount is more than the threshold limit.

This makes the sector privy to wilful non-payment of the amount, thereby taking advantage of the pandemic. The MSME already enjoys the benefit of Section 29A of the IBC. Along with this, a parallel regime for payment of debt, under Section 240A, in the form of a special insolvency framework is still in the structuring zone. K.R. Saji Kumar, the executive director of the IBBI said:
the board envisaged a shorter time limit than the current 180 days for an MSME insolvency resolution process, along with cost effective and easier procedures where the debtor continues to run his business while negotiating with the creditors.

Additionally, the stimulus package announced by the finance minister, and offering them easier loans might add to the already existing debt on the small companies.

Another issue with regards to the ordinance can be that of Limitation. It is unclear whether the suspension period will be excluded from the limitation period. The right of the creditor is hampered during this period, consequently if the timeline is not adjusted accordingly, it might be prejudicial to the operational creditors. There is a dire need for clarification/ notification or an order by the Supreme Court on this issue. It is difficult to see how this ordinance will succour those in financial distress. Even more distressing, however, is the fact that this ordinance was passed despite its evident flaws and vagueness.

A Way Forward: Alternative Mechanisms

These unprecedented times of Covid-19 have taken a huge toll on the businesses of many companies across the globe. The move by the government does offer some sort of relief. However, the companies still aggrieved can move under the umbrella of different parts of law. The Government indeed needs to consider the supplement of such suspension.

Companies Act

Since companies now will not have any shelter for debt resolution under IBC, they can move under different schemes provided by the Companies Act, 2013. The act provides for a scheme for corporate debt restructuring under Section 230-32. Section 230, in particular, is a useful alternative to the use of IBC, Section 10. Firstly, the costs associated under the Companies Act is lower than what it is in the IBC. Secondly, it is a collective process and is binding on the company along with all its creditors and shareholders, after getting sanctioned by the NCLT.

The sanction is received after an approved scheme of plan by the majority of the shareholders or creditors. Thirdly, except in the case of fraud or wilful default, the directors of the company still stay in charge - unlike IBC, where the creditors work with the existing management body, thereby enforcing the ‘Debtor in possession' model rather than ‘Creditor in control' model . Fourthly, the courts have a lesser hold over the scheme approved by the company. They are mostly concerned whether the process used to arrive at such a scheme is fair and just.

Although the Company Act seems like a potent alternative, there still needs to be some changes in order for it to work flawlessly. Firstly, the requirement of at least 75% written approval by the secured creditors who must also provide a ‘creditor responsibility statement' should be made feasible and less time consuming. Companies and creditors can consider appointing insolvency professionals to look into the procedural requirements.

There should ideally be a timeline to make sure there is no delay. Secondly, the NCLT can ensure that the people who have no economic interest in the scheme are dispensed from the approval process. This will protect a viable scheme from getting frustrated. Thirdly, NCLT should consider re-establishing the moratorium (‘Calming period') for the companies which was present in the previous Company Law Act, in the form of stay proceedings. To prevent the misuse moratorium, the NCLT can lay down criteria based on the possibility of the success of the scheme filed before it.

RBI's Framework & Pre-Pack Agreements

Other than the studying the Companies Act for alternative mechanisms, the RBI has also issued the Prudential Framework for Resolution of Stressed Assets in 2019. This framework allows for the restructuring of Non-Performing Assets (NPAs) of banks that are beyond the scope of the IBC. It envisages a bank-led recovery process which is time-bound and is initiated before filing under the IBC. This option can be used during the suspension of the IBC.

The drawback of this framework is that it is only available to RBI-regulated entities. Thus, several creditors under duress will not be able to exercise this framework. Over the course of time, if the suspension of the IBC is extended, a framework available to all classes of creditors would lead to a more efficient asset-restructuring alternative to the IBC.

Another viable alternative is Pre-packs. These are arrangements between companies under duress and their creditors regarding the sale of a company's assets before the appointment of an insolvency profession. It is a fluid system wherein the debtors can reach an agreement with the creditors and the people willing to buy the business. Despite being a fluid system, the agreement is legally binding between the parties and can serve as an enforceable option. However, to ensure that the confidentiality of such agreements does not lead to a disadvantage to creditors – they should be allowed to raise objections before the NCLT in case they are unsatisfied with the agreement. The purpose of this framework, after all, is to secure operational creditors in the absence of the IBC.

Other Alternatives
The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interests Act of 2002 (SARFAESI Act) also provides alternatives – although with obvious flaws. The simplest of this is to enforce the security interest that would be secured by the creditor. The other is to secure undivided interest in the Non-Performing Assets (NPAs) of the defaulter which will be acquired by an Asset Reconstruction Company or ARC.

However, this again applies only to secured creditors. In addition, SARFAESI matters go to the Debt Recovery Tribunal or DRT. DRTs have a reputation of being largely inefficient as an adjudicating body and have not been effective in curbing bad debt.

Along with the SARFAESI act, the creditors can also seek relief under the Civil Procedure Code, 1908 (CPC). They can move under Order 37 of CPC, thereby, instituting summary suits and initiating arbitration proceedings. They can also seek refuge under a standard suit as amended by the Commercial Courts Act, 2015. The introduction of the said act has reduced the adjudicatory processes and broken the stereotype of long litigation delays.

There are Other provisions under these acts which the Financial Creditor can use to his benefit. Firstly, they can file an application for a summary judgement under Order 13A. Secondly, they can file an application for a judgment on admission under Order 12, Rule 6 of CPC.

MSME being the most cash flow generating sector in our country, the government has put in a lot of money in the sector. With the deteriorating condition of this sector due to the pandemic, the industries can take recourse under the MSMED Act, 2016. This act can be used till the time the legislation comes out with the new mechanism under 240A. MSMED Act will certainly provide temporary relief to the aggrieved companies.

In the midst of an economy crushing pandemic, it is clear that the decision to suspend IBC provision without clearing the ambiguities has its consequences. The suspension of the sole mechanism created to solve the insolvency problems has taken India backwards. Also, the miscalculation of the drawbacks of the suspension and the lack of insight into the alternatives might prove to be advantageous to the debtors who might get a permanent escape out of the situation.

Regardless, to accelerate the economy at this point, the government should strive to strengthen the provisions of alternative legal provisions, which can be done by bringing amendments to clear ambiguities and to fast track the resolution process. This way the catastrophic time can be used to fix the lacunas in the laws of our country, strengthening the debt resolution structure, and preventing the economy from taking a nosedive.

Written By:
  1. Shraddha Chirania - Final Year Students, B.A. LL.B, O.P. Jindal Global University and
  2. Sanat Prem - Final Year Students, B.A. LL.B, O.P. Jindal Global University

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