1. LIFE IN THE TIMES OF COVID-19

What started as a health crisis has transformed rapidly into a pitched battle between lives and livelihoods. The Organization for Economic Cooperation and Development apprehends that the global economy will suffer the biggest peace-time downturn in a century, with equally uncertain and unquantifiable views emerging from the World Bank, International Monetary Fund and rating agencies. Meanwhile, on March 25, 2020, India was put under what many consider the world's strictest national lockdown. It is now followed by an equally guarded and phased easing, after 70 days.

As with every other major economy, the Government has reacted with a variety of fast-paced fiscal and monetary measures. The Ministry of Finance (the "MoF") announced a stimulus package amounting to approximately 0.8% of the GDP on March 26. The Prime Minister then announced a fiscal and monetary package amounting to approximately 10% of the GDP on May 12. Thereafter, the MoF announced a relief package, with stimuli amounting to 2.7% of the GDP being allocated to business, details of which were issued over 4 days from May 13-17. On the monetary side, RBI responded with a 3 month moratorium on payment of all instalments falling due between March 1, 2020 and May 31, 2020, coupled with a standstill relief from asset classification downgrade which was announced on March 27. The attempt was to improve liquidity, stem non-performing assets and prevent a stampede to the insolvency courthouse doors by banks and financial institutions. These measures are further backstopped with rate cuts, money market liquidity measures and sector specific forbearances, to shore up the balance sheets of institutional lenders1. Subsequently, on May 23, the RBI followed through with monetary easing measures, with further extension of the moratorium and asset classification relief until August 31, 20202.

There appears to be no overarchingly "correct" economic model. Measures adopted by each economy vary quantitively and qualitatively, depending on the fiscal headroom available, the ever-changing impact of the pandemic and the size of the population affected. What is common, however, is that such measures are often bookended with economic experiments in amending insolvency regimes. We accept one truism offered by the World Bank3 - that the insolvency system can facilitate recovery as a channel for resolving debt-overhang and preserving employment. To make sense of these experimental amendments, these must necessarily be juxtaposed in the petri-dish setting of the fiscal and monetary packages in place. The pandemic shows no signs of ending, nor is it reasonably foreseeable when it will end. What is reasonably foreseeable is that these experiments no longer have the luxury of gestating in time. Much like the quest for a vaccine, there is no longer the luxury of prolonged clinical trials. The go-to-market time has been significantly truncated. Whether the Indian amendments to the insolvency regime are in service of the economy is perhaps a 3 trillion-dollar question. A large part of the answer is dependent on the adequacy and frequency of the regulatory response, the efficiency of the institutions and the strength infrastructure that support the regime.

  1. THE REGULATORY RESPONSE

2 days prior to the nationwide lockdown announced on March 23, the Supreme Court (the "SC")4, exercising powers under Article 142 read with Article 141 of the Constitution, presciently extended the limitation period with effect from March 15, 2020, until further orders. The SC took suo motu cognizance of the situation arising out of the challenge faced by the country on account of COVID-19. The National Company Law Appellate Tribunal followed suit and excluded the period of lockdown for the purpose of counting of the period for corporate insolvency resolution process (the "CIRP"). The Insolvency and Bankruptcy Board of India, or the regulator, was quick off the blocks - in amending the CIRP regulations and in jump-starting e-filing procedures. India's responses so far appear to be ahead of the curve, with other jurisdictions adopting similar measures a little later. Yet, taking a page from out of the playbook of countries that were ahead of us on the impact curve of the pandemic, the Insolvency and Bankruptcy Code (the "IBC") was amended to increase the minimum amount of default for initiating an insolvency resolution process against a corporate debtor from INR 1 lakh to INR 1 crore5 on March 24, 2020. From as early as March 24, 2020, the MoF has been mulling the more drastic measure of suspension of filing of applications for initiating a CIRP.

India has commenced the daunting challenge of coming out of the lockdown despite the rising number of COVID-19 cases. The battle for livelihoods has seemingly won and the urgent need of the hour is to restart and revive the economy. With an already slowing economy, the complete closure of work for over 2 months has had a devastating impact on the balance sheets of many businesses and, commensurately, their ability to service debts. Emerging economic data indicates that most sectors are reeling from the financial hits and it is a growing reality that several businesses may not survive the pandemic. In formulating a policy response, one cyclic truth has become exigently clear - protecting the lives of people is of paramount importance now; to be able to do that, their livelihoods must be protected, and for this, it is essential to protect the lives of companies.

The IBC was brought into existence as an economic legislation and is recognized as a 'code' that "deals with economic matters and, in the larger sense, deals with the economy of the country as a whole"6. It is only befitting that the IBC evolves to play its part in safeguarding and balancing the stakes of interest holders, in service of our economy. Now, post hibernation, when the country is waking up to catch its first worm, on June 5 an ordinance7 was passed to amend the IBC (the "Ordinance"). The statement of objective of the amendment is clear - it is to safeguard companies from fatality in the midst of a pandemic that continues unabated.

The two amendments that have been brought into force are:

- A new Section 10A - to disable for a limited period (6 months extendable to up to 1 year), application for admission to CIRP of any corporate debtor for what can be called 'COVID defaults', and

- A new Section 66 (3) - to bar the resolution professional from making an application against a director or partner of a corporate debtor, to make contribution to the assets of the corporate debtor, if due diligence is not ensured to minimize potential creditor losses immediately prior to CIRP.

  1. SECTION 10A: SUSPENSION OF INITIATION OF CIRP

The new section 10A states:

"Notwithstanding anything contained in Sections 7, 9 and 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March, 2020 for a period of six months or such further period, not exceeding one year from such date as may be notified in this behalf:

Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.

Explanation- For the removal of doubts, it is hereby clarified that the provisions of this section shall not apply to any default committed under the said sections before 25th March, 2020."

3.1. THE 'WHY'

Of the 5 aims stated in the preamble to the IBC, 2 require constant responses to evolving circumstances. The first is the "time bound manner for maximization of value of assets". The second is "to promote entrepreneurship, availability of credit and balance the interests of all the stakeholders". That the IBC was never intended as a debt recovery tool has been emphasized and re-emphasized time and again. The architecture of the IBC is premised principally on value maximization, to serve the economy and not just creditors. Under normal circumstances, a company that has become unviable is given the opportunity (through a CIRP) to start afresh - a resolution applicant (a non-related party, unless the corporate debtor is an MSME) presents a resolution plan, which, if found viable and acceptable to the committee of creditors (the "CoC") results in a fresh start for the corporate debtor - most often under a new management. If no viable resolution plan is received, the corporate debtor is liquidated on the premise that resources thus freed up may be effectively redeployed elsewhere in the economy.

Today, these "normal circumstances" no longer exist, and have been wholly replaced by a set of circumstances which are hitherto unprecedented and wholly unpredictable. The preamble to the Ordinance summarizes these circumstances8. It is as a response to these extraordinary circumstances, the Ordinance states, that it is considered expedient to provide reprieve on initiation of CIRP for defaults arising on account of COVID-19. The tacit admissions woven into the Ordinance are: (a) it is no longer the inefficient use of resources or inept management that has resulted in unviability of businesses, but the circumstances of the pandemic clubbed with the lockdown; (b) pushing these companies into a CIRP cannot foreseeably result in "value maximization"; and (c) CIRPs leading aimlessly into liquidation will destroy value, if any, that may have been salvageable. The corollaries are clear: (a) due to the nationwide (even worldwide) severity of the financial shock, the prospects of a worthwhile resolution applicant with a worthwhile resolution plan are undeniably slim; (b) in these circumstances, in all likelihood, a CIRP will erode far more value by tearing down whatever has been built this far and is remaining; (c) once dead, these companies will not come back (presumably after the pandemic has done its worst - no one seems to know when); and (d) the value will be lost forever to the economy at large.

3.2. THE 'WHAT'

The provision is limited in its applicability. It suspends initiation of CIRP for defaults for a period of 6 months (subject to extension for up to 1 year) commencing March 25, 2020 (the "COVID Defaults"). The COVID Defaults will continue to be "defaults" against which claims can yet be made. The only action barred is the initiation of CIRP under sections 7 (by a financial creditor), 9 (by an operational creditor) and 10 (by the corporate applicant). The IBC was designed to speed up resolution or in its absence, liquidation. It resulted in a change in the manner in which business is conducted and debts are treated owing to its expeditious and far reaching impact. While good in usual times, entities now need breathing space (or ventilators even) to recover from the losses they have suffered. Section 10A therefore takes away the threat of admission to CIRP that will inevitably (owing to the circumstances) lead to fatality of the corporate entity on account of COVID Defaults. It does not in any manner 'forgive' the debt. Recovery mechanisms under other laws, including contracts, SARFAESI, etc., continue to be available. In fact, even under the IBC, if a corporate debtor is already admitted to CIRP, COVID Defaults can be made part of the claims. The sole premise behind section 10A is that COVID Defaults cannot be used as grounds for admission to a CIRP.

3.3. THE (POTENTIAL) "IFS" AND "BUTS":

The immediate knee-jerk reaction (so far) to the Ordinance during the past few days appear to be focused on the word "ever" in the proviso reproduced below:

Provided that no application shall ever be filed for initiation of corporate insolvency resolution process of a corporate debtor for the said default occurring during the said period.

Again, section 10A does not impose a blanket ban against making an application under sections 7, 9 and 10. The Explanation to section 10 is crystal clear - Explanation- For the removal of doubts, it is hereby clarified that the provisions of this section shall not apply to any default committed under the said sections before 25th March, 2020. This Explanation neatly takes away the questions that arose in Delhi9 and Mumbai10 High Courts with respect to applicability of the moratorium under RBI's COVID-19 package. The controversy was quickly resolved by the RBI itself pursuant to a timely clarification issued on April 17, 202011.

At a superficial level, the apprehension seems to be that a corporate debtor may default with impunity during this "suspension period" with absolutely no consequences. The word "ever" appears to provide an unwarranted insulation and is a "moral hazard" for corporate debtors who avoid payment with little or no impairment in the ability to pay. This apprehension around the use of the word "ever" probably presumes:

(a) Extinguishment or forbearance of the debt / liability itself (which is definitely not the case); and

(b) A different understanding of the concept of "default" and its occurrence.

The definition of "default" is set out in section 3(12) of the Code:

"default" means non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not paid by the debtor or the corporate debtor, as the case may be;

Sections 6 provides - "Where any corporate debtor commits a default, a financial creditor, an operational creditor or the corporate debtor itself may initiate corporate insolvency resolution process in respect of such corporate debtor in the manner as provided under this Chapter". However, section 7 and 9 provides a CIRP may be initiated by a financial creditor when a default has occurred and may be initiated by an operational creditor upon expiry of 10 days after delivery of a demand notice / invoice on the occurrence of a default.

Under Section 238A (inserted in June 2018), the Limitation Act, 1963 is made applicable to proceedings and appeals under the IBC. Normally, a period of 3 years is provided to file an application for admission to CIRP. The concept of "continuing default" reconciles the "where" and "when" used in the sections - a default is "continuing" if it has not been remedied / waived, until such default is time barred. The word 'ever' in the proviso counters the concept of "continuing default". It seems clear that no CIRP can ever be initiated for COVID Defaults. The rationale seems to be that various sectors have suffered immense losses, which may take years to recover. While 6 months to 1 year is a necessary reprieve to resurrect the economy and get businesses to start repaying their debts, to be asked to continually bear the threat of insolvency post the "suspension period" is considered too heavy a cross to bear. A creditor may enforce its rights under other law, but the Ordinance does not consider it justifiable for the corporate entity to be subjected to CIRP and be liquidated for COVID Defaults. The merits (or demerits) of this experiment should become apparent in due course, hopefully without litigation.

  1. SECTION 66(3): LIABILITY IN THE TWILIGHT PERIOD

Section 66(3) of the IBC was introduced to amend Section 66(2), to cater to the prevalent circumstances. Section 66 (2) allows the resolution professional to make an application to the National Company Law Tribunal (the "NCLT"), to order a director or partner of a corporate debtor to contribute to the assets of the corporate debtor for actions (or lack thereof) taken by the director/partner in the period prior to CIRP. It states:

"On an application made by a resolution professional during the corporate insolvency resolution process, the Adjudicating Authority may by an order direct that a director or partner of the corporate debtor, as the case may be, shall be liable to make such contribution to the assets of the corporate debtor as it may deem fit, if-

(a) before the insolvency commencement date, such director or partner knew or ought to have known that the there was no reasonable prospect of avoiding the commencement of a corporate insolvency resolution process in respect of such corporate debtor; and

(b) such director or partner did not exercise due diligence in minimising the potential loss to the creditors of the corporate debtor.

Explanation. - For the purposes of this section a director or partner of the corporate debtor, as the case may be, shall be deemed to have exercised due diligence if such diligence was reasonably expected of a person carrying out the same functions as are carried out by such director or partner, as the case may be, in relation to the corporate debtor."

The rationale of this section is that a director/partner is well aware of the goings-on of the corporate debtor. If a director/partner knows that the entity will default and its admittance to CIRP was likely, the director/partner is required to act with due diligence to prevent losses for the creditors of the corporate debtor. If the director/partner does not act with due diligence, reasonability and care, the resolution professional can appeal for them to contribute to the assets of the corporate debtor once the CIRP is initiated.

In the given circumstances, however, 'ordinary course of business' itself will mean trying to manage resources and recover from the extreme and parlous financial threats. Section 66 (3) provides that "Notwithstanding anything contained in this section, no application shall be filed by a resolution professional under sub- section (2), in respect of such default against which initiation of corporate insolvency resolution process is suspended as per section 10A."

The circumstances are unprecedented and to set out a benchmark of diligence "reasonably expected of a person carrying out the same functions" is considered unreasonable. Further, under Section 10A, application for a CIRP cannot be made for a COVID Default. This means that if the entity has become irrecoverably unviable, it may still be required to ride out the relief period before a director/partner can take action to mitigate losses for creditors. It is, therefore, essential to relieve this obligation on a director/partner. Suspending the personal liability of directors has now become a standard "boiler plate" response in quite a few jurisdictions, including commonwealth jurisdictions.

There are apprehensions in some quarters whether this relief will encourage fraudulent and wrongful transactions by directors. This apprehension probably arises from the fact that Section 66 bears the heading "Fraudulent trading or wrongful trading". Section 66 consists of 2 limbs - Section 66 (1) deals with business being carried on with an "intent to defraud creditors of the corporate debtor or for any fraudulent purpose", while Section 66 (2) deals with insufficient diligence to reduce potential losses of creditors in the "twilight zone" prior to CIRP where a director or partner knows that the company will face insolvency. Section 66 (3) only bars applications under Section 66 (2) and does not in any manner condone fraud.

  1. CONCLUSION

The IBC is an economic legislation. Its purpose is to serve the economy. The SC judgment in Swiss Ribbons provides an illuminating insight on the mindset of courts in the interpretation of economic legislations. The SC recognizes that "there may be crudities and inequities in complicated experimental economic legislation" and also reiterates that "to stay experimentation in things economic is a grave responsibility, and denial of the right to experiment is fraught with serious consequences to the nation"12. The Ordinance is supplemented by a host of other fiscal and monetary measures and is perhaps better appreciated as sum of all components. Nevertheless, in its bare-bones simplicity too, the Ordinance may indeed provide an optimum remedy.

Section 10A is intended as a lifeline, providing an opportunity to ride through and survive the COVID-19 storm. To some, the seeming inattention to establishing bona fide cause of default and the obvious one-size-fits-all approach (especially for certain sectors that have gained from the pandemic) are irksome. To others, the Ordinance (buttressed with the RBI Covid-19 package) appears stilted in favour of financial creditors. The argument is that 90% of operational creditors are MSMEs, and their interests are apparently not considered in economic modelling and policy response. RBI's COVID-19 package, however, does consider incentivizing credit flows to MSMEs (through regulatory forbearance on asset classification). Meanwhile, a special insolvency resolution framework under Section 240A of the IBC is on the anvil and may be announced soon for MSMEs. Whether these measures are too less and / or too late is, should not be countenanced (presently) as a valid criticism of the Ordinance.

Given the context, paucity of time, India's variegated economy, lack of fiscal space for direct benefit stimuli and practicalities involved, it does not appear there is much "wriggle room" to consider a more nuanced or bespoke precision-based approach. This is a young regime and the infrastructure is being built-up (and not without complaints on speed). From a practitioner's practical viewpoint, we believe a different approach would lead to undesired ambiguity and much litigation in circumstances where the need for speed is paramount. We have already witnessed an epic 850-day marathon CIRP and in the present circumstances that is not a burden that should be readily imposed on entities that are on the edge of survival or on the nascent institutions that have learnt to run before they could walk. It cannot be denied that Section 10A may result in dragging the life of "zombie" unviable entities on for a while longer, but the alternative appears to be much worse. It is important to be mindful that the provisions are temporary and will at best be extended to 1 year (fingers crossed). In the circumstances, we believe it will first do no harm and perhaps indeed be of service to the economy.

We do admit that the Ordinance does not fully address issues pertaining to ongoing CIRPs. Cases having received CoC approval, with only the NCLT approval pending might yet require renewed scrutiny and adjudication, and it is possible that provisions for that have not been included by design. Perhaps, however, there are other important gaps that could have been plugged - for example, for resolution plans submitted but not voted on by the CoC owing to the lockdown, a fresh valuation process and the opportunity to revise, withdraw or submit a new plan without being penalized could have been a reasonable reprieve.

We hope that absence of more stifling restrictions will make room for innovative solutions - speedier out of court settlements, innovative one-time-settlements, informal restructuring, and workouts. This may be an opportunity for stakeholders to explore and develop alternate mechanisms to resolve disputes. This may be an opportunity for the various authorities to streamline the processes and the infrastructure. The average time taken for completion of the 221 CIRPs yielding resolution is 415 days. Perhaps the forced "innovations" of e-filing and digital hearings are serendipitous and may usher in a low-cost technological revolution in enhancing capacity. Pre-packs are popular in various jurisdictions around the world, India is yet to embrace the concept. Perhaps the circumstances will serve as the proverbial necessity, the mother of inventions. Another silver lining is possibly that the adjudicating authorities can use the "suspension period" to clear logjams and build capacities for what is to come after the reprieve.

COVID-19 and the lockdown have forced us to evaluate subjects and approaches we would ordinarily relegate to "better minds". We have all had to take a step back and refocus, regroup and heal. It is what the Ordinance is looking to do for corporate entities, and it may not be perfect, but it is a step in the right direction, of healing and serving the economy.

We are tempted to end with this quote from an economic modeler and a statistician, George Box (which has since become an aphorism in statistics) - "Since all models are wrong the scientist must be alert to what is importantly wrong. It is inappropriate to be concerned about mice when there are tigers abroad."

Footnotes

4. Suo Motu Writ Petition (Civil) No(s)3/2020 dated 23 March 2020.

  • 8. "COVID-19 pandemic has impacted business, financial markets and economy all over the world, including India, and created uncertainty and stress for business for reasons beyond their control",
  • "a nationwide lockdown is in force since 25th March, 2020 to combat the spread of COVID-19 which has added to disruption of normal business operations",
  • "it is difficult to find adequate number of resolution applicants to rescue the corporate person who may default in discharge of their debt obligation"

9. Anant Raj Limited v Yes Bank Limited - on April 6, 2020.

10. Transcon Skycity Private Limited & Ors v ICICI Bank & Ors - on April 11, 2020 and earlier in Ideal Toll & Infrastructure Private Limited & Anr v ICICI Home Finance Company Limited & Anr, on April 7, 2020.

12. We have analyzed Swiss Ribbons and its implications in an article available at: https://www.mondaq.com/india/insolvencybankruptcy/781154/swiss-ribbons-and-its-implications--the-supreme-court-on-the-constitutionality-and-key-provisions-of-the-insolvency-bankruptcy-code and https://induslaw.com/app/webroot/publications/pdf/alerts-2019/Swiss-Ribbons-InfoLex-12Feb19.pdf

Originally published 12 June 2020

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