COVID – 19 has brought the world to a halt, prompting governments around the world to take strict measures for its containment. India has also announced a 21-day lockdown, starting 25 March 2020. While it is difficult to anticipate the full impact of the lockdown on the economy, it is clear that no business, large or small will remain unaffected.
Recognising that most businesses will face immediate financial stress, the Finance Minister, Nirmala Sitharaman made an omnibus announcement on 24 March 2020, providing certain relaxations in statutory and regulatory compliances under tax and corporate laws. Measures were also announced in respect of the Insolvency and Bankruptcy Code, 2016 (IBC).
On 26 March 2020, the Finance Ministry announced INR 1.70 crore relief package to help the underprivileged – the package primarily focuses on sustenance relief and direct benefit transfers under various schemes. On 27 March 2020, India's central bank, the Reserve Bank of India (RBI) announced a slew of measures, pertaining to monetary policy, liquidity management, regulation and supervision, debt servicing and financial markets.
Here we focus on the IBC and financial sector reforms, aimed at giving businesses a safety net to enable them to continue trading in the current period of uncertainty as opposed to facing imminent insolvency and eventual closure.
A. IBC REFORMS
I. INCREASE IN THRESHOLD
At the media briefing held on 24 March 2020, the Finance Minister announced that the monetary threshold of default for filing an application for initiation of corporate insolvency resolution process under the IBC shall be increased to INR 1,00,00,000 (Indian Rupees One Crore) from the current threshold of INR 1,00,000 (Indian Rupees One Lakh), "so that we can prevent the triggering of defaults against MSMEs"
This change has been brought to force with immediate effect vide Notification dated 24 March 2020 (Notification) by the Ministry of Corporate Affairs. Hence, section 7 (Initiation of corporate insolvency resolution process by financial creditor), section 9 (Initiation of corporate insolvency resolution process by operational creditor) and section 10 (Initiation of corporate insolvency process by corporate applicant) applications can be filed under the IBC only if the amount of default by the corporate debtor is INR One Crore or more.
Applicability of Notification
Interestingly, while the Finance Minister announced that the threshold shall be increased "so that we can prevent the triggering of defaults against MSMEs", the Notification itself does not state that the increased threshold will only apply to MSMEs. Hence, the way the Notification reads, the threshold applies to all corporate debtors (not just MSMEs).
Also, a dreaded outcome of COVID – 19 is unprecedented financial distress for companies across all sectors (not just MSMEs), leading to defaults in repayments. An increase in default threshold to INR 1 Crore would help stave off institution of insolvency petitions for smaller defaults, thus, providing some relief to companies. Absent such increase in default threshold, there would be an exponential rise in filing of insolvency petitions, thus, clogging the tribunals which are already burdened and coping with huge backlogs.
However, the Notification does not mention any outer time period for applicability of the increased threshold and hence, it is unclear if this threshold will be reduced subsequently once the economic conditions stabilize. It may be noted that even previously, on the premise that the IBC is not meant to be solely a debt recovery tool and to keep frivolous applications at bay, there has been a demand for increase in this threshold from One Lakh (which was considered too low).
Is the notification retrospective?
Significantly, the Notification does not clarify if the increased threshold would also apply to applications that have already been filed (but not admitted) under section 7, 9 and 10 of the IBC, before the NCLT, for initiation of insolvency resolution.
In December 2019, an ordinance was passed amending the IBC, barring homebuyers less than 100 or 10 % of total homebuyers from moving insolvency proceedings against real estate developers. Under the ordinance, the home buyers whose petitions for initiation of corporate insolvency were pending before various benches of the NCLT were to comply with the minimum threshold by 28 January 2020. Protesting, inter alia, against such retrospective impact of the ordinance on pending applications, the home buyers approached the Hon'ble Supreme Court of India. The Hon'ble Supreme Court, while taking cognizance of the matter, directed that status quo with respect to the pending applications be maintained in the meanwhile. The matter is yet to be decided finally.
It is well-established that a statute that affects substantive rights is presumed to be prospective in operation unless made retrospective (expressly or by necessary intendment), whereas a statute which merely affects procedure, is presumed to be retrospective in its application. Law relating to forum and limitation is procedural in nature, whereas law relating to right of action and right of appeal, even though remedial, is substantive in nature. Every litigant has a vested right in substantive law but no such right exists in procedural law.
In one case, the Hyderabad bench of NCLT considered the retrospective application of the amendment brought in section 10 of the IBC by way of an ordinance, requiring shareholder resolution for filing of section 10 application. In the said case, the bench noted that the petition for initiation of insolvency under section 10 had been filed by the corporate applicant much prior to the amendment in section 10 and thus, it would not be just and proper to apply the amended section 10 on the corporate applicant retrospectively.
In the absence of any indication in the Notification, a question arises if the increase in filing threshold relates to substantive right of the applicant or is it merely procedural. It can be argued that if the application of the Notification is made retrospective, it would affect the existing substantive right of the applicants (relating to their right of action) who have filed petitions under the IBC as per the previous minimum threshold of default.
Another aspect that may be considered is that the Notification was passed in the wake of announcements made by the Finance Minister to mitigate the economic impact of lockdown on the corporate debtors. Hence, whether the rights of the applicants who had filed section 7, 9 or 10 applications much before such measures were put in place should be affected?
B. CONTINGENCY PLAN
The Finance Minister also announced that if the situation continues to remain what it is, beyond 30 April 2020, the Government will consider suspension of section 7, section 9 and section 10 of the IBC for a period of six months.
It is to be noted that while the first reform has been brought to effect vide the Notification, the second is a contingent plan in case the current situation continues (or becomes worse) till 30 April 2020.
While suspension of involuntary insolvency proceedings (i.e. under section 7 (financial creditors) and section 9 (operational creditors) of the IBC) may be justifiable as a protective relief measure, it is not clear as to why companies should be barred from voluntarily taking recourse to section 10 of the IBC, for resolution of their insolvency.
II. RBI REFORMS
The economic and legal impact of COVID-19 and the measures taken to prevent its spread could see many otherwise profitable and viable businesses undergoing financial distress. Already, businesses across all industries are reporting cash shortages, sparking fear of failure amongst the companies and its employees.
Recognising this, the RBI made significant announcements on 27 March 2020. These announcements relate to three aspects.
One relates to expanding liquidity in the system to ensure that financial institutions are able to function normally. For this, RBI has announced measures in respect of conducting auctions of targeted term repos, reduction of the cash reserve ratio, increase in limit of borrowing by the bank under the marginal standing facility and widening of the existing monitory policy rate corridor.
Second relates to financial markets in the context of the increased volatility of the rupee caused by the impact of COVID-19 on currency markets. For this, the RBI has permitted banks in India which operate International Financial Services Centre (IFSC) Banking Units (IBUs) to participate in the Non-Deliverable Rupee Derivative Markets with effect from 1 June 2020 through their branches in India, their foreign branches or through their IBUs.
The third relates to easing financial stress caused by COVID-19 disruptions on the borrowers. For this, the RBI has, inter alia, announced as follows:
- (a) In respect of all term loans, all lending institutions (banks, financial institutions, non-banking finance companies) have been permitted to allow a moratorium of three months on payment of all instalments (principal, interest, bullet repayment, EMIs, credit card dues) falling due between 1 March 2020 and 31 May 2020. Accordingly, the repayment schedule and tenor for such loans may be shifted by three months. Interest on outstanding amount would continue to accrue during this period.
- (b) In respect of working capital facilities sanctioned in the form of cash credit/overdraft, lending institutions are permitted to allow a deferment of three months on payment of interest in respect of all such facilities outstanding as on 1 March 2020. The accumulated interest for the period will be paid after the expiry of the deferment period.
- (c) In respect of working capital facilities sanctioned in the form of cash credit/overdraft, lending institutions have been permitted to recalculate drawing power by reducing margins and/or by reassessing the working capital cycle for the borrowers. This relief shall be available in respect of all such changes effected up to 31 May 2020. Further, the relief shall be contingent on the lending institutions satisfying themselves that the same is necessitated on account of the economic fallout from COVID-19 and is subject to subsequent supervisory review with regard to their justifiability on this account.
Significantly, it is now left to the lending institutions to come out with policies in respect of these reliefs and provide the same to their borrowers (the RBI reforms do not itself grant the moratorium/ effect restructuring). However, what has been clarified by the RBI is that the grant of these reliefs (i.e. moratorium/ deferment/ recalculation of 'drawing power') shall not, by itself, result in asset classification downgrade under the RBI prudential norms.
Further, the same would also not qualify as a default by the borrowers for the purposes of supervisory reporting and reporting to credit information companies (CICs) by the lending institutions and the CICs are to ensure that the same does not adversely impact the credit history of the borrowers.
Questions arise when the RBI reliefs in respect of relaxing repayment pressures on borrowers are read in light of the announcement made by the Finance Minister on 24 March 2020 regarding possible suspension of insolvency petitions under IBC for a period of six months. If any such suspension is imposed – it will need to be evaluated if the suspension should be for all corporate debtors or only for corporate debtors that were not in default prior to COVID-19 disruptions (but started defaulting on account of COVID-19 disruptions).
In case the suspension is given for corporate debtors that were in default even prior to COVID-19 disruptions, then parallel relaxation in prudential norms for lending institutions would be desirable. In case the suspension is intended to be given for corporate debtors that face financial stress on account of COVID-19 disruptions, then additional issues may need to be examined – for instance, was such debtor given any relief by its lending institution in terms of moratorium/ deferment/ recalculation of 'drawing power' for preventing a default, what if such corporate debtor itself wants to initiate insolvency resolution, would applications by both operational as well as financial creditors be entertained? In any event, the eligibility of corporate debtors to avail the benefit of suspension of insolvency proceedings would need to be examined thoroughly.
For the present, the measures announced by the Government have been designed to give confidence and assurance to the industry to continue their business activities without the pressure that they would end up being in default to their lenders and might land their enterprises into insolvency. Further, measures have been taken to improve the overall liquidity and provide impetus to the banks to lend to borrowers facing distress on account of COVID-19 disruptions.
As of now, the full impact of COVID-19 disruptions is not known. Large scale bankruptcy reforms may still need to be undertaken subsequently, to help both big and small companies that may become distressed in the very near future. Simultaneously, more impetus and reforms are needed in the financial sector to not only prevent any bankruptcies in the sector itself but to also aid them in giving relief to the businesses. Besides this, the debtors and creditors would need to work together (including outside IBC) to find solutions that allow distressed companies to weather this crisis and stave off bankruptcy.
1. Manish Kumar v. Union of India, Writ Petition (Civil) No. 26 of 2020
2. Hitendra Vishnu Thakur v. State of Maharashtra, (1994) 4 SCC 602
3. In the matter of Supraja Textiles Private Limited v. Supraja Textiles Private Limited, CP (IB) No. 188/10/HDB/2018
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