The IBC dilemma: Will Covid-19 relaxations render insolvency laws ineffective?

IBC may be better served by an overhaul
There has been doubts over the efficacy of the IBC, mainly due to the over-burdened adjudicating system, large haircuts for lenders, and a large number of liquidations.

Governments across the world have granted relaxations and moratoriums on legal operations and compliances to bring some relief to the functioning of corporates and businesses till the economy restarts after the lifting of restrictions imposed to curb the spread of the Covid-19 pandemic.

The Indian government has increased the threshold of default under Section 4 of the Insolvency and Bankruptcy Code, 2016 from Rs 1 lakh to Rs 1 crore for the initiation of insolvency proceedings. It further proposes to suspend Sections 7, 9 and 10 of the IBC and provide relaxations on the strict timelines for resolution under the code. Sections 7 and 9 of the IBC allow a financial creditor or an operational creditor to initiate proceedings and the government’s proposal to suspend the same seems viable considering that businesses are facing severe losses and insolvency proceedings in such trying times and would further damage the essence of the IBC. However, suspension of Section 10 that allows the corporate debtor to initiate the resolution process seem dubious.

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A look at the relief measures adopted in other countries show that the corrective steps taken by the government of India are not very different from those adopted in other jurisdictions.

In Australia, the government has passed temporary amendments to its insolvency and corporation legislation by allowing businesses to operate during a temporary six-month period without having to enter voluntary administration or liquidation and the statutory minimum for the issuing of a statutory demand has been increased from A$2,000 to A$20,000. The amendments temporarily increase the minimum amount of debt required to be owed before a creditor can initiate involuntary bankruptcy proceedings against a debtor from A$5,000 to A$20,000. The period for compliance to a statutory demand and a bankruptcy notice has also been extended from 21 days to six months.

The German parliament has passed a Bill for the temporary suspension of the obligation to file for insolvency which provides that the obligation to file for insolvency as well as the payment prohibitions will be suspended until September 30, 2020, unless the insolvency is not due to the effects of the Covid-19 pandemic or there is no prospect of eliminating a payment default that has occurred. Further, during the three-month transition period, creditors are prohibited from commencing insolvency proceedings against businesses and it has been provided that these measures may be extended by the government until March 31, 2021.

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The UK government has announced various financial packages to help businesses. However it is still contemplating a moratorium for companies to give them some relief from creditors in enforcing their debts whilst they seek a rescue or restructure, protection of their supplies to enable them to continue trading during the moratorium, and to come up with a new restructuring plan with no materialised action plan yet.

Though Hong Kong lacks a formal corporate rescue procedure, the government has indicated that it may come up with a draft bill providing for a six-month moratorium from any hostile acts by creditors to prevent corporate failures following the Covid-19 pandemic.

On April 1, 2020, the Singapore government announced its plan to introduce the Covid-19 (Temporary Measures) Bill in Parliament which provides that the monetary thresholds and time limits for bankruptcy and insolvency will be increased. For companies and partnerships, the monetary threshold for insolvency will be increased from S$10,000 to S$100,000 and the time period to satisfy a statutory demand will increase from 21 days to 6 months.

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With the disruption in businesses, such measures to combat the negative economic fallout of the pandemic could prove to be a viable solution to the tardy logjams faced by corporates.

The government of India is also contemplating suspension of the provisions for initiation of a default by the creditors from a period of 6 months to 1 year that may be extend further. It is difficult to assess whether such drastic moves will have everlasting consequences on the efficacy of the IBC and whether they will lead to a situation where it will be difficult to roll back such provisions.

In almost four years of its implementation, the IBC ecosystem has been successful in addressing faster recovery of stressed assets, quicker resolution timelines and a huge behavioural change among corporate promoters, shifting the balance of power from the creditor to the borrower.

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The economic support provided by the government may save several corporates from the exigencies they face and the impending burden on sustainability. The government’s contribution to the Insolvency and Bankruptcy Fund constituted under Section 222 of the Code could be a step in this direction. Monitored support provided for a temporary period to sustain Covid-19 affected corporates could go a long way in fulfilling not only the spirit of resolution, but also offer relief to the financial burden faced by businesses.

Whether moratoriums and stop gap arrangements are a better course of action without compromising the spirit of the IBC is left for the lawmakers to decide as the economic impact is global and many countries have amended legislations or enacted new legislations to provide temporary relief to entities struggling under the impact of the Covid-19 pandemic.

(Anubha Agarwal is a lawyer based in New Delhi. She is a Senior Associate at Corporate Law Group.)