IBC Amendment Ordinance, 2020 – Opening A Pandora’s Box?

The Insolvency and Bankruptcy Code would only open up fault lines within the banking system unless structural changes are brought in to combat the challenge of NPAs.

R. Vishnu Kumar | July 7, 2020

IBC Amendment Ordinance, 2020 – Opening a Pandora’s Box?

  The Daily Guardian

The COVID pandemic has impacted not only the medical frontier but also businesses, financial markets and the economy, both nationally and globally. The lockdown, announced abruptly by the Government, in an effort to contain the pandemic, naturally resulted in a temporary disruption of business operations, forcing the closure of several small businesses and startups. As a counteractive measure, the Central Government passed a Notification on 24th March 2020, under the Insolvency and Bankruptcy Code, 2016 in an attempt to help small businesses. This was followed by IBC (Amendment) Ordinance, 2020 promulgated on 5th June 2020, just as the country was preparing to come out of the lockdown. Both these measures were arguably aimed at safeguarding the MSME sector from being pushed into insolvency during this period of lockdown and to suspend the insolvency proceedings under the Code for a temporary period. But a closer analysis of these laws reveals that in all likelihood, it would only open a Pandora’s Box for India’s already struggling banking sector.

Ambiguities in both the Notification and the Ordinance

As mentioned, the main aim and objective of the Notification and the Ordinance was to safeguard the MSME sector from being pushed into insolvency. For this, the Notification raised the pecuniary jurisdiction to initiate proceedings under the Code to Rs. One Crore as the minimum amount of default from the existing threshold of Rs. One Lakh. However, several aspects here remained ambiguous. It is silent on the prospective or retrospective nature of the amendment as well as on its applicability on applications filed during various stages of Insolvency Proceedings under the Code. For example, the new changes have now made it unclear as to whether the increase in the pecuniary jurisdiction will be impacted when a) the Demand Notice under Section 8 of the Code has already been sent, but the Applications are yet to be filed by the Creditors or b) when the Application has already been filed by the Creditors but has not been admitted by the Adjudicating Authority or c) when the Application has already been admitted by the Adjudicating Authority for initiation of Insolvency Resolution Process.

The applicability of the Notification was neither clarified by any further Notification nor by any statement of the Ministry of Corporate Affairs. It was eventually clarified only by the National Company Law Tribunal, Chennai Bench (NCLT), in the matter of M/s. Arrowline Organic Products Private Limited Vs. M/s. Rockwell Industries Limited, where it held that the said Notification was prospective in nature.

Similarly, the Ordinance passed on June 5th, presented its own set of irregularities and inconsistencies. Aimed at preventing insolvencies temporarily, the main aspect of the Ordinance was the incorporation of Section 10A which suspends the initiation of the Corporate Insolvency Resolution Process of a Corporate Debtor, for a period of 6 months. However, it covers only those defaults which arise on or after 25 June 2020 for a period of 6 months to one year, making its application narrow.

The Ordinance is silent on its applicability when the Creditors hold raising of invoice as per the Purchase Order and issue them post the completion of exemption period of the Ordinance. This will allow Creditors to change the date of “Default” being committed according to their convenience in order to evade the applicability of the Ordinance, thus defeating the whole purpose for which the Ordinance was introduced. Further, it is not clear whether the Ordinance would apply also to unsecured loans where the payments are usually settled in instalments. In these instances, there is a continuous cause of action where the date of Default can fall prior, during or subsequent to the period of exemption provided by the Ordinance.

Problematizing these measures in a struggling economy

It is important to remember that the Ordinance was introduced with an intention of combating the COVID crises and to help small business owners emerge out of the pandemic period without being insolvent. But its impact on the ground will continue to be limited as long as crucial facets of the law are not clarified and dealt with systematically. The government appears to have glossed over the fact that suspending insolvency proceedings across the board will disallow a company to file for Voluntary Insolvency under Section 10 of the Code and thereby waste all the trapped resources of that company. The need rather was to restore the provision for voluntary insolvency instead suspending the Code across the board.

At a time when commercial banks and co-operative banks have shut down due to an increase in their Non Performing Assets (NPA), suspending insolvency proceedings across the board is going to add more burdens on the banking sector. According to the report on Trend and Progress of Banking in India – 2018 -2019 filed by the Reserve Bank of India, Recovery of stressed assets by Scheduled Commercial Bank improved during 2018-19 propelled by resolutions under the Code, which contributed more than half of the total amount recovered. Scheduled Commercial Bank recovered about Rs. 1,26,085 Crores of value of NPA’s through various channels during 2018 -19, out of which recovery through IBC alone accounted for about 56% of the total value of NPA’s (Rs. 70,819 Crores). This trend of suspension of insolvency proceedings is going to push the banking sector to sell off past bad loans to Asset Reconstruction Companies to decrease their NPA burden, as the recovery horizon is blurred due to the suspension.

After the drastic increase of NPAs between 2014-18, there was a decline in gross NPAs during 2018 – 19 and more than 50% of it was recovered through the insolvency of the Code. Now, suspension of insolvency proceedings under the Code will increase the burden on other channels like the SARFAESI Act, 2002, Lok Adalats, and Debt Recovery Tribunals. Since the Schedule Commercial Banks recover only 3% and 8% of the total NPA from Lok Adalats and Debt Recovery Tribunals, the burden will increase tremendously on the SARFAESI Act.

The Ordinance at times, is also inadvertently self-defeating. It amends Section 66 of the Code which prohibits fraudulent or wrongful trading by incorporating Section 66(3) to prohibit the Resolution Professional from filing an appropriate application. The intention behind Section 66 (3) of the Code is to create an exception to Section 66 (2) of the Code which creates a liability on the Corporate Debtor for failure to exercise due diligence, so as to avoid initiation of insolvency proceedings. Whereas, contrary to the intention, Section 66 (3) actually ends up safeguarding the management of the corporate debtor for their wrongful acts committed during the period of exemption provided by the Ordinance. This statutory protection given by Section 66 (3) of the Code seems to extend beyond the exemption period of the Ordinance as the proviso for Section 10A restricts any application to be filed against the corporate debtor for initiation of insolvency proceedings when the date of default falls under the said period. Since Section 66(3) is read along with Section 10A as per the Notification, the statutory protection is extended to this provision also. This is not only likely to encourage fraudulent acts by the management but also defeats the whole purpose of enacting the Code.

Just mere good intention on its own isn’t enough to make an action right. Like most of the other decisions by the Central Government, these changes in the Code also appears to have been done in haste. The Ordinance is at best a stop gap solution aimed at ensuring survival of the smaller businesses temporarily. But throughout this entire process from March to June, it has completely overlooked the ground reality and how these changes will play out in Courts. This will, as argued above, will only open up fault lines within the banking system unless structural changes are brought in to combat the challenge of NPAs.

R. Vishnu Kumar is a lawyer practising in the Supreme Court and National Company Law Tribunal.