Covid-19: Indian insolvency ordinance leaves many open questions

Out-Law Analysis | 30 Jun 2020 | 11:25 am | 3 min. read

Whilst the intention of the government is to protect businesses during the pandemic, it must also seek to ensure that there will not be a 'defaulter's paradise'.

Written by Ishan Zahoor, a commercial law expert at Pinsent Masons, the law firm behind Out-Law.

The economic downturn triggered by the Covid-19 pandemic has caused unprecedented havoc on businesses in India in almost every sector, which has been dubbed by the Organization for Economic Cooperation and Development (OECD) as the biggest peacetime downturn in a century.

To offer respite to stressed businesses, the government of India has announced the suspension of corporate insolvency under the Insolvency and Bankruptcy Code, 2016 (IBC) for a period of six months commencing 25 March 2020. This suspension is given effect through an IBC (Amendment) Ordinance, 2020 effective from 5 June 2020.

Prior to this, the government of India had amended the IBC to increase the minimum amount of default for initiating an insolvency resolution process against a corporate debtor from INR 1 lakh ($1,325) to INR 1 crore ($132,500).

The second section of the insolvency ordinance deals with insertion of a 'non-obstante provision'  to the IBC-section 10A, which concerns the suspension of initiation of the corporate insolvency resolution process. This removes the right to apply for corporate insolvency by financial creditors under section 7, by operational creditors under section 9 and by corporate debtors themselves under section 10 of the IBC. This applies for any default which has arisen in the exempted period starting on 25 March 2020 and ending six months thereafter, "or such further period, not exceeding one year from such date, as may be notified in this behalf".

Owing to the language of the insolvency ordinance, it is clear that the right of the applicants to file for insolvency under sections 7, 9 and 10 of the IBC has not just been suspended, but indeed permanently taken away for any defaults that have occurred in the exempted period.

It is not far fetched to think that this may provide certain companies with a leeway to default, even if they have the capacity to pay their debts and escape insolvency 'forever', since the right to insolvency by creditors for default during the exempted period has been permanently taken away.

Though the spirit of the insolvency ordinance as envisaged in its preamble refers to the impact of Covid-19 on business, financial markets and world economy in general, the relationship of the default arising due to the Covid-19 pandemic is not clearly linked under section 10A.

The ambiguous language of section 10A can give rise to future issues where stakeholders involved may seek recourse under section 10A for any default, leading to considerable time and resources being spent in establishing the link between the default and the Covid-19 pandemic.

It would also be interesting to see how the date of default is deciphered by the adjudicating authority, which may be a disputed question of fact, since it is critical in establishing the applicability of section 10A, especially when applications under sections 7 and 9 have been barred, too.

Another, important aspect of the insolvency ordinance is that it suspends the right of the corporate debtor under section 10 for voluntary insolvency proceedings.

This may seem reasonable at first, however, on a deeper observation it seems that the distressed corporate debtor's prohibition on voluntary insolvency, in genuine cases may lead to attrition of the value of its assets and push the corporate debtor into unintended liquidation at a later stage, where the sale of such distressed assets would afford diminutive or no realisable value at all.

Additionally, the third section of the insolvency ordinance deals with insertion of a 'non-obstante provision' to section 66 of the IBC, which concerns fraudulent or wrongful trading. This change to section 66(3) bars the resolution professionals from filing any application under section 66(2).

The section 66(2) provides that the director or partner of the corporate debtor can be ordered to personally contribute to the corporate debtor's assets if the director or partner knew or ought to have known that there was no reasonable prospect of avoiding the corporate insolvency resolution process and did not exercise due diligence to minimise potential losses to the creditors.

This embargo from filing an application under section 66(2) seems to open up an escape route also for unlawful behaviour of the directors or partners of the corporate debtor, even where they may have been involved in intentional oversight or any misappropriation leading to considerable loss to creditors during the exempted period.

The insolvency ordinance also does not provide any reprieve or opportunity to the ongoing corporate insolvency proceedings for any resubmission of any revised plans or revised valuations, which under the current economic lockdown seems aptly justifiable.  

Whilst the intention of the government is to protect companies, promoters and directors during these unprecedented times form any unjustifiable liability, it must also seek to ensure that  there will not be a metamorphosis into 'defaulter's paradise'.

These are unchartered waters, which require careful and timely re-evaluation and monitoring. The insolvency ordinance might not fill all the important gaps but it does appear to be a step in the right direction. Stakeholders should also consider it as an opportunity to develop alternative approaches to resolve disputes, for instance by means of one time settlement, out-of-court enforcement and restructuring, change in ownership or other innovative mechanisms.