Flattening the Insolvency Curve: Have India and Australia Done Enough Towards Corporate Rescue During the Pandemic?
By Preeti Nalavadi (PhD Candidate, University of Adelaide)
Introduction
The COVID-19 outbreak was declared a global pandemic by the World Health Organisation (WHO) in March 2020. Countries have worked ceaselessly on their rescue laws in order to provide “breathers” to ailing businesses, aiming to avoiding a meltdown of their economies. There have been some dramatic changes to the law as a result of the pandemic’s impacts, particularly in Australia and India.
Australia was quick to respond with Coronavirus Economic Response Package Omnibus Act 2020 (Cth), passed by Parliament in March 2020. Similarly, India declared a special reform package in May 2020, followed by an ordinance, and the Insolvency and Bankruptcy Code was amended several times in response to the pandemic. It is worth noting that the pandemic only exacerbated the challenges faced by MSMEs in insolvency, considered by the World Bank in a report published in 2017.
The Australian Story
Australia enacted The Omnibus Act which made temporary changes to the Corporations Act (with the majority of changes applicable to Chapter 5). Key changes include:
1. An increase in the minimum threshold amount to commence insolvency proceedings from $2,000 to $20,000 and extension of statutory period for notice from 21 days to 6 month with an option for further extension. There is an option to defer repayment for the loans for up to 6 months, and the deferral period would not be treated as a period of arrears for capital adequacy and regulatory reporting. This temporary relief was further extended till 31st March 2021.
2. The provisions on voluntary administration continue to be in operation and it is unclear if the Government plans to introduce significant changes to the area in light of a potential surge in such filings.
Additionally, the Federal Government in Australia announced the Coronavirus Small and Medium Enterprises (SME) Guarantee Scheme (see Scheme). As per this scheme, eligible businesses would be able to seek additional funds on lower rates to encourage timely assistance for working capital needs. Recently, the Federal Government has also made a dramatic announcement on a potential law based along the lines of a DIP (debtor in possession) model, mirroring the US approach on corporate rescues, that would aim to provide relief to SMEs. This would be a permanent law reform on corporate rescue and would apply only to SMEs. Under this new model, the management of such businesses would be able to continue to manage their affairs as they seek restructuring.
The Australian Small Business and Family Enterprise Ombudsman Report on small business loan suggests various reforms on small debt hibernation, cost effective procedures, simplifying liquidation process, streamlining information sharing, improving handling of complaints to mention a few. It is still not clear if these recommendations were fully accepted.
Challenges Ahead
There are a few impediments ahead of Australian law reforms, which are as follows:
1. The two changes introduced in the law, namely the suspension of s 588G (liability on directors for insolvent/wrongful trading) and s 588GAAA (safe harbour provisions), may be controversial. These changes are particularly contentious because other provisions, such as the general duties owed by the directors under the Act, continue to remain in force, thus causing uncertainty in their application.
2. It is likely that the COVID-19 pandemic will result in an increase of insolvency filings. There may also be an increase in zombie companies, which are entities that use borrowing to repay old debts and wages, and continue to operate under the guise of viability.
3. There is another argument that holding DOCAs (Deed of Company Arrangement) could be the new norm, and they have been discussed as a viable option during the pandemic. These “Holding” DOCAs provide breathers to companies which could use this time to restructure before voluntary administration commences (See Mighty Murray River judgement ). However, it could be an expensive option and it may not be a solution for all problems that may arise.
4. The response to the Report of the SME Ombudsman, in the form of an Exposure Draft Bill, is designed to assist ailing businesses. However, it has evoked mixed responses so far. Although the aim of these reforms is to reduce costs and establish a time-efficient model, it is yet to be seen how these goals are sought to be achieved and what incentives would be made available to the businesses to encourage them to use this model.
The Indian Journey
The Government of India was swift in announcing changes through a five stage approach, followed by an ordinance (The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020).
A few of the key changes are:
1. An increase in the threshold of the amount for filing of the application, introducing special provisions for timelines resolution mechanisms. This provides exemptions for the period of lockdown and exclusion of the lockdown period in computing timelines in liquidation.
2. Another significant change that was initiated is the insertion of a non-obstante clause in s 66, to protect the debtor against an application for wrongful trading during such suspension. This serves as an embargo against the filing of such applications against the corporate debtor.
3. The prudential norms introduced by Reserve Bank of India, revised in 2019, have a special mechanism to provide relief to those businesses who have flourished well except during the pandemic. This scheme appears to be promising, as long as it continues to serve deserving businesses.
4. A significant milestone has been the insertion of s 240A, a special provision under the Code that would empower the Central Government to issue regulations on resolution of corporate debts of MSMEs.
5. Other significant changes include the redefining of businesses falling under the definition of MSMEs. The threshold for such recognition has been increased, and this could ease the burden on ailing ones to a certain extent. The Government also announced additional support by way of the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).
6. Another ambitious project called the “Atmanirbhar” scheme, announced by the Government in different phases since 13 May 2019, has evoked positive responses. Under this project, local businesses are promoted to grow with incentives and an effort towards self-reliance is made.
7. Another very recent change, announced on 8 January 2021, is the proposal to introduce pre-pack resolution of debts (see IBBI pre-pack).
The Indian Challenges
There are a few challenges that are likely to surface under the new rescue regime:
1. There is ambiguity in the law as to whether the default must have been as a result of the pandemic, for a business to seek protection. This would mean that corporations who are otherwise healthy could misuse this provision and default on their debts claiming that they were affected by the COVID-19 pandemic even if this was not, in reality, the case.
2. It may seem that India has adopted timely remedies to its rescue laws to provide proper support to the country’s ailing businesses. However, the challenges of enforceability and ensuring that these reliefs are extended only to those companies in real need have not been properly addressed.
3. Although the proposed introduction of a pre-pack procedure is a welcome step, it is yet to be seen how this will be achieved. India has had a history of introducing legislative changes due to global pressures, and this has often resulted in inadequate or complex laws. If the changes merely add layers to the existing, already over-burdened system, they will be rendered inefficient or futile. Thus, India has to be careful to avoid creating a mechanism that would only become a replica of the existing one. The challenges of providing a swift, transparent, and time-efficient model, coupled with the need for sufficient infrastructure and skill enhancement for the relevant professionals remain in India’s path.
Suggestions for Reform
There are several steps that may be helpful in strengthening the reforms:
1. Implementing recommendations suggested by the IMF Special Series on COVID-19, advising phase-wise initiatives. A common thread of these recommendations is the emphasis on encouraging private debt resolution mechanism, out of court restructuring, and private debt enforcement actions to ensure payments to creditors and increase their efficacy.
2. A promising solution could be incentivising the use of pre-insolvency workouts to improve the efficiency of the system and reduce costs associated with the formal, court-supervised procedures. Apart from being more time and cost efficient, this would drastically reduce the number of court filings and reduce the burden on the judiciary. The workouts could create greater flexibility for debtors and the creditors for negotiation, as they are more informal than court proceedings.
3. Both the Australian and Indian Governments must plan to write off a portion of debts, as no amount of restructuring is likely to be sufficient to deal with the pandemic’s impact. There may be several businesses that were already on the brink, and the pandemic has only been the last straw tipping them into failure. A mechanism to ease the restructuring or winding up of such entities with less damage could inevitably become necessary. Reliefs for lenders on overdue taxes can also reduce the financial burden.
4. The digitalisation of court systems will reduce administrative burdens and save costs and time.
5. It may be useful to tweak the corporate law framework to adapt to the changing times. These amendments may be temporary, to deal with the pandemic situation, or more permanent reforms to enhance the insolvency and restructuring frameworks. Ultimately, there is a need for countries to change their corporate laws to address the current challenges and facilitate rescue of businesses.
6. The creation of a framework that would identify the genuinely affected distressed businesses who truly deserve to be rescued and streamline resources to make such concerns viable is highly necessary. Such a system would not only save businesses but would protect the interests of the directors, creditors, employees and all other stakeholders, and would create opportunities for economy to flourish.
Conclusion
These unprecedented times have also created opportunities for countries to learn from one another and has opened doors to exciting collaborative practices as well. Although the massive impact of the COVID-19 pandemic may mean that no reform can save the significant number of businesses that are already perishing, the journey towards insolvency law reforms might have just begun. Countries will need to prepare themselves for the phases ahead, as the impacts of the pandemic continue to reverberate around the globe.
(*) A detailed version of this article is a forthcoming publication by INSOL ERA of INSOL International.