Filings under India’s Insolvency and Bankruptcy Code stand suspended: Some considerations

By Akshaya Kamalnath (Auckland University of Technology)

On June 6th, 2020, the Insolvency and Bankruptcy Code (IBC), was amended via an ordinance. In effect, this amendment suspended filings under the IBC for six months. Despite criticism from various quarters, the government seems to be leaning towards extending the suspension for another six months.

The amendment

Section 10A has been introduced to suspend filings by the corporate debtor and by creditors “for any default arising on or after 25th March 2020 for a period of six months”, thus creating a safe harbour of sorts. It then goes on to say that no application shall ever be filed with respect to debts incurred during this six-month period. The government has retained the right to extend this safe harbour to one year. Presumably, 25th March is used as the cut-off date because that is when India imposed a nation-wide lockdown to prevent the spread of Covid-19.

There is also an introductory statement in the ordinance which says that the purpose of the amendment is to exclude debts incurred as a result of the pandemic.

It is ambiguous whether the NCLTs should read the introductory statement into section 10A and only allow the safe harbour to be availed of if the defaults arising after 25th march 2020 are in fact due to the pandemic.

Even more concerning is the addition of section 66(3). Section 66(1), the operative part of the provision states:

If during the corporate insolvency resolution process or a liquidation process, it is found that any business of the corporate debtor has been carried on with intent to defraud creditors of the corporate debtor or for any fraudulent purpose, the Adjudicating Authority may on the application of the resolution professional pass an order that any persons who were knowingly parties to the carrying on of the business in such manner shall be liable to make such contributions to the assets of the corporate debtor as it may deem fit.

Sub-section 66(3) has been added to ensure that defaults caught during the six-month safe harbour period cannot be the subject of a fraudulent trading application. This sub-section is misguided and will mean that there is no remedy against fraudulent activity. Since section 66(1) already requires an “intent to defraud creditors” no modification was required. While it makes sense to provide some relief to firms affected by the pandemic, it is backwards to also provide relief where the company has engaged in fraudulent activity.

All these ambiguities are bound to create more work for the NCLTs which are already dealing with huge back-logs.

Market for insolvency resolution professionals

A second order effect of suspending IBC filings is that the thriving market of insolvency resolution professionals that had developed since the introduction of the IBC will struggle.

A recent Economic Times article notes that about 115 insolvency professional entities and 3,009 insolvency professionals are registered with the Insolvency & Bankruptcy Board of India. This is the size of the market that will be disrupted. The same article notes that boutique firms focused on providing insolvency professional services will suffer from the sudden suspension.

As Professor Aurelio Gurrea-Martínez emphasizes in a recent paper (insolvency law in emerging markets), although developing a sophisticated insolvency profession is important for an insolvency law to work effectively, this takes “time, resources and political will”. India is squandering the gains of the last few years by disrupting the market for insolvency professionals.

 Since the government has been looking into introducing pre-packs, insolvency professions will most likely be looking to provide necessary services in that regard. However, this will be a different ball game that firms and individual professionals will have to adapt to. Many small and boutique firms may get left behind. When the government lifts the suspension of IBC filings, there will be a fresh demand for insolvency professionals, some of whom may have already moved into other professions.

Restructuring in the shadow of a sleeping IBC and directors' duties

In an article written prior to the COVID-19 crisis and the suspension of IBC filings, I had proposed a modified Revlon duty which would require directors who have entered the zone of insolvency and are actively seeking bids, to either sell to the highest bidder or initiate the resolution process under the IBC. This proposal aimed to prevent promoters seeking to retain control and reject bids merely because they were conditioned on the promoter ceding control. (Jet Airways is a prominent example of a company that could have benefited from such a duty.)

Now that IBC filings have been suspended, new rules should be devised for directors in control of companies that are insolvent or in the zone of insolvency. As Mr. Shardul Shroff noted, when a company is insolvent or near insolvent, the directors’ duties shift from shareholders to creditors. Mr. Shroff has rightly suggested that “a new ‘Code of Corporate Governance’ and ‘Duties of Directors’ during the period of applicability of Section 10A (proposed) for discharging the obligations towards creditors should be urgently introduced…”. Here, I will discuss some principles to be borne in mind while such a code or set of duties is proposed.

Once a company is in the zone of insolvency or insolvent, the directors will have two choices. The last choice is to liquidate the company. The more preferable option for a viable company is to attempt to restructure by negotiating with creditors. However, this would only be possible if there is a moratorium on all actions against a company and so as a first step, the government will have to allow companies to activate the moratorium despite IBC filings being suspended. The next step is for directors to call a meeting of the creditors and attempt to restructure. All parties may be able to agree upon appointing an insolvency professional to help with restructuring. These professionals have gained expertise since the introduction of the IBC and it would be unwise not to utilise their skills.

While these restructuring efforts are being undertaken, the directors should act primarily in the interest of creditors. As Professor Amir Licht has proposed, at the point when the duty to creditors is triggered the directors’ duty of care changes from one of “implementing an entrepreneurial strategy” to “implementing a custodial strategy that focuses on protecting the company’s assets with a view to returning it to a profit-oriented, entrepreneurial strategy when practical”. He goes on to explain that the custodial strategy required of directors at this point is similar to what is required from trustees which is to preserve the trust fund.

Prof Licht’s formulation is partially suited to the Indian context where there is no possibility of entering the resolution process. As I had argued in a post responding to Prof Licht’s proposal, directors should also be incentivised to restructure and rescue the company. Thus, while good faith efforts at restructuring should be allowed, directors should also have a duty to preserve the property of the company. These principles should inform the rules formulated to provide guidance on directors’ duties in the zone of insolvency.

Finally, the government should allow the pre-negotiated agreement to be taken to the NCLT for approval so that the agreement is not open to being challenged in court.

Conclusion

By proposing these principles to inform directors’ duties during insolvency and to facilitate restructuring, I am simply trying to make a bad decision work. It would of course be a better course of action for the government to simply abandon the proposal to suspend filings under the IBC.