Covid-19: How the pandemic locked down India’s insolvency law
By Urmika Tripathi, Gausia Shaikh and Nikita Mathur (REDD Intelligence)
To cope with the impact of the Covid-19 pandemic, governments across the world have introduced changes to their insolvency and restructuring regimes. India, too, introduced major changes to its insolvency regime: on 5 June 2020, it was released an ordinance amending the country's Insolvency and Bankruptcy Code (IBC) to suspend the initiation of insolvency proceedings by or against companies based on defaults occurring on or after 25 March 2020 (arguably, a date hovering around the period that India began to feel the economic pain from the pandemic). The suspension is, as of now, for a period of six months ending on 25 September 2020. However, this timeline may be extended by up to another six months from September 2020.
The suspension not only bars creditors from “using” or “citing” a financial or operational debt default that occurred on or after 25 March as a reason to initiate insolvency proceedings, but also prevents a debtor from choosing to opt for an in-court restructuring under the law. This move is quite abnormal (much like the times we face). In contrast, other jurisdictions have broadly suspended creditor filings, changed insolvency trigger thresholds or added procedural impediments to creditor filings. India, as of now, stands alone in preventing debtors from self-filing into insolvency.
Driven by the economic upheaval unleashed by Covid-19, India’s move to ringfence certain defaults that took place within a specified time period is intended to protect pandemic-hit businesses from insolvency or possibly shield them from the possibility that no buyers would be keen to make an acquisition (cheap or not) in the near future. Several concerns here crop up: what systemic adjustments are required for this seemingly permanent protection of defaults taking place in a certain time period? Have creditors lost their leverage? Will the founding or controlling members of the company use this period to take advantage of this protection window? What alternative avenues will creditors have to restructure debt, without an in-court restructuring mechanism for certain defaults?
“Lifetime” Immunity
Interestingly, the amendment effectively provides lifetime protection for defaults covered in the suspension period – meaning that a company cannot be dragged to insolvency on account of the “Covid-19” defaults covered by the ordinance ever.
This particular consequence has yielded mixed market reactions. Understandably, the intention of the ordinance is to protect businesses that suffered due to the pandemic. However, on the other hand lies the possibility that a blanket, lifetime protection for defaults might encourage willful defaults within the specified time period. Unsurprisingly, the legality and rationality of this lifetime protection is already facing judicial challenge. Moreover, it is worth noting that if a company theoretically fails to pay its financial or operational obligations even a day before or after the government’s window of protection, that “default” can be cited in court as a reason to trigger insolvency.
Lack of Leverage
In India, many insolvency filings are pending court approval. Often, these lead to settlement talks, since company founders find that negotiating a payment schedule or softly restructuring a missed obligation is a much more palatable price to pay, compared to the risk of a full-blown restructuring with control of the company being taken away from them (India follows the creditor-in-control model of insolvency proceedings).
On 27 March 2020, India’s central bank released a relief package that granted banks and financial institutions the ability to provide their borrowers a moratorium on paying term loan installments, and certain working capital facility payments that fell due between 1 March 2020 to 31 August 2020.
Technically, repayment instalments of credit facilities covered by the moratorium under the central bank's relief package would anyway not become automatically due and payable during the period within which insolvency proceedings have been suspended. This is because the central bank’s moratorium, when granted, modifies the repayment schedule of the credit facility such that no instalment falls due and payable during the moratorium period (which period is largely covered by / overlaps with the IBC suspension period). Therefore, even if insolvency proceedings had not been suspended, the payment obligations covered by the central’s bank moratorium would not become payable between 1 March 2020 to 31 August 2020 and would consequently be ineligible for initiation of insolvency proceedings. However, aside from the cluster of obligations protected by the relief package, several other payment obligations are now thrown under the blanket of insolvency protection. For example, non-bank creditors, such as bondholders, domestic debenture holders and mutual funds have effectively lost the ability to consider triggering insolvency proceedings for defaults that occurred during the ordinance’s protection period. As a result, many creditors to Indian companies that extended these obligations have, possibly permanently, lost a major edge — the leverage that comes from the threat of insolvency — in negotiating settlements or recoveries.
The 25th March Watershed
The key premise of this legal amendment is that a default after 25 March 2020 was to some degree due to the pandemic (and in a world without Covid-19, this default may have been avoidable to some degree). Presumably, this date is directly linked to the beginning of India’s nationwide lockdown.
However, a starting cut-off date of 25 March 2020 may have unintended consequences. For one, this does not protect companies that may have still defaulted due to the pandemic but did so prior to 25 March 2020. It makes practical sense that businesses would have started feeling the heat of a brewing economic recession well before 25 March 2020, especially since India was one of the later countries to reckon with the virus.
On the other hand, many Indian companies were likely on the edge of a financial default — pandemic or not. These businesses may have inadvertently received protection, but also a cushioning window to get business back on track, in what may be considered a result of simple, fortunate timing.
Of course, it cannot be denied that protection from insolvency would necessarily have to be linked to some cut-off date. Selecting any particular date would invariably exclude certain defaults tied to Covid-19 and unintentionally protect some companies from facing an in-court restructuring. It is also possible that qualifying for protection under the amendment could have been linked to “a test” of somehow proving whether the company actually suffered due to the pandemic. A potential measure like this could, however, have its own limitations including (but not limited to) added uncertainty of how to decipher the “true cause” of financial or operational distress, the subjectivity and nuances of individual cases, and inevitably in India, possibly hefty litigation and consequent delays.
Possible Alternative Avenues for Creditors
Notably, this amendment solely pertains to the question of insolvency proceedings. Creditors still retain their rights to obtain recoveries through separate enforcement or recovery proceedings in different courts, or in some cases, different jurisdictions. However, processes in India to recover debt or enforce security are often marred with delays and countless adjournments (in enforcement courts, this could be comparatively worse than those delays frequently seen in insolvency tribunals). Considering the fact that courts and tribunals will themselves be resuming full-time proceedings only after India’s Covid-19 lockdown hiatus is lifted, one could reasonably expect overall delays in enforcement or recovery proceedings to be heightened.
Now, take this possibility in conjunction with the very real likelihood that financially stressed companies may choose to wield emotional arguments around devastating distress driven by the unfortunate and unforeseen pandemic: Indian courts might be quickly swayed by emotional business struggle stories.
Arguably, non-domestic creditors — including international bank lenders, hedge funds or bondholders whose instruments are issued by vehicles incorporated outside India — may continue retaining some leverage over their borrowers. These creditors may retain the ability to initiate insolvency proceedings against debtor companies in jurisdictions where insolvency or enforcement proceedings have not been suspended, as long as the facilities in question are governed by those offshore jurisdictions. For example, a company with a USD-denominated bond governed under New York law might default on the bond amid the insolvency suspension period in India: its bondholders would likely be unable to take the company into insolvency in India, but (subject to United States bankruptcy laws) bondholders would keep all rights to pursue bankruptcy and enforcement options in New York.
Also, India does not currently have a legal framework for cross-border insolvency in place. Consequently, even though Indian insolvency proceedings are suspended, a defaulting company itself and the Indian creditors might not be able to prevent offshore insolvency proceedings against the company. In such a scenario, Indian creditors may have to incur further costs in submitting their claims as part of foreign insolvency proceedings. Moreover, absence of a cross-insolvency framework in India means that recognition of foreign insolvency proceedings by Indian courts will be difficult and will need to jump through several procedural and legal hurdles. Delays in restructuring an insolvent company will only lead to more value erosion at the company level. Interestingly, if the defaulting debtor holds assets based outside India, there is some likelihood of security enforcement by secured foreign creditors over any given offshore assets. Such instances may actually put foreign creditors in a more beneficial position compared to their Indian counterparts.
Evidently, issues and concerns spurred by India’s ordinance are neither few nor frugal. Only time will tell of the success of this decision.
(*) A modified version of this post was published on the REDD Intelligence website.