View: IBC requires urgent need for clarity

By Ritin Rai
Businesses and individuals alike are struggling with the significant uncertainty that the covid pandemic has brought to their plans and their lives. In this atmosphere of uncertainty, it is incumbent on the government to lend as steady and as sure a hand as possible. This must reflect, of course, in its handling of the spread of the virus but also in its macroeconomic policies and the legal regime to give effect to those policies. In respect of the Insolvency and Bankruptcy Code, the government must now urgently promulgate an Ordinance amending the IBC that addresses all aspects of the proposed framework rather than on a piece-meal basis.

For instance, at the end of March, the Finance Minister announced that the threshold to institute insolvency proceedings was being raised from Rs. 1 lakh to Rs. 1 crore to protect the interests of Micro, Small and Medium Enterprises. The Finance Minister also indicted that the government would consider suspending the IBC for a period of time if the lockdown extended beyond the middle of April. This move to enhance the threshold to commence fresh insolvency proceedings appeared premature at that time. After all, if the IBC itself was to be suspended, there was no necessity at that stage to enhance the threshold to initiate an insolvency proceeding. Equally, if MSMEs were to be protected, a more tailored approach would have been recourse to Section 240A of the IBC, a provision that deals specifically with MSMEs.

Subsequent developments have borne this criticism out. In her first press conference a few days ago, the Finance Minister re-defined (and expanded) the entities that would qualify to be MSMEs and in her fifth press conference earlier today, the Finance Minister has now indicated that a special insolvency framework for MSMEs will be notified under Section 240A of the IBC. Even now, it is not clear what this special insolvency framework will entail and why it needs to be different from the insolvency framework for non-MSME companies.

It is easy to be critical of past steps but it is more important to look forward. As corporate India aims to get back on its feet, there is an urgent need that the Finance Minister's policy and directional statements are reflected with clarity in the proposed Ordinance. The criticism in the past with the IBC itself was that it witnessed multiple amendatory Ordinances. It is imperative that this does not repeat itself and the Ordinance now being proposed by the government be comprehensive.

The Finance Minister has stated that there will an embargo on fresh insolvency proceedings being initiated for a period of upto one year. It appears that this embargo will also apply to Section 10 of the IBC. Section 10 is the provision that allows a corporate debtor to put itself into voluntary insolvency on the basis that its financial and operational viability is no longer secure. It is unclear why this provision is also sought to be suspended. After all, the right to close down a business is as much a fundamental right as the right to conduct a business. A suspension of Section 10 may also result in forcing unviable businesses to continue, effectively only pushing an insolvency further down the road with negative consequences for all stakeholders concerned. The Ordinance must therefore exclude Section 10 filings from its ambit.

The consequences of suspending the IBC on operational creditors are equally unclear. The current IBC regime treats operational creditors very much as "second class" creditors at the mercy of the Committee of Creditors during the insolvency resolution process. Given the precarious financial position of many corporates, operational creditors will insist on shorter payment terms or protection for transactions entered into so that, in any subsequent insolvency, they are not left without any prospects of recovering their operational debt. The Ordinance must address that concern so that transactions of corporate debtors with operational creditors can be maintained with as little disruption as possible.

In addition to corporate debtors and operational creditors, it is critical that the Ordinance provide clarity to financial creditors. A mere suspension of the IBC for a certain period of time without more creates uncertainty in respect of transactions effected during the period of the suspension. The viability of businesses will entail significant restructuring of their debts and balance sheets. Here, the provisions of the IBC which guard against preferential or undervalued transactions by corporate debtors require consideration. Most restructurings that entail a sale of assets will be regarded as "preferential transactions" under the IBC. In the event of subsequent insolvency proceedings, these preferential transactions come under a cloud and can be subject to court orders, including that the assets be vested back in the corporate debtor. A similar concern arises with respect to the IBC provisions on "undervalued transactions." The Ordinance therefore needs to address how such restructuring transactions will be treated in future insolvencies if the goal of giving corporate debtors some time to reorganise their affairs and get back on their feet is to achieve its objective.

There is no gainsaying that the challenge posed by the covid pandemic is enormous and unprecedented. Across the world, jurisdictions have acted to amend various aspects of their commercial laws, including contract law and insolvency law, as they re-start their economies. It cannot be disputed that the absolute liability regime contained in the IBC must be suspended for a certain period of time as businesses will inevitably have (at least) short term cash flow problems and will need time to find their feet. But even as the operation of the IBC is suspended for a defined period of time, the government must look at the various approaches adopted globally to amend the IBC to address the concerns and interests of all stakeholders. An Ordinance merely suspending the IBC may not be enough and may only compound the problem in the longer term.

(Ritin Rai is a Senior Advocate based in New Delhi, practising in the area of commercial and regulatory disputes. Views expressed are author's personal and not of economictimes.com)