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Insolvency and Bankruptcy Code: Suspending IBC may set an unhealthy precedent

Insolvency and Bankruptcy Code: Suspending IBC may set an unhealthy precedent

by Vishrov Mukerjee, Partner, JSA
COVID-19 and the ensuring disruption have thrown up a host of issues for the economy - a vexed one being survival of companies. If news reports are to be believed, with a view to provide companies some breathing space the Government is contemplating an ordinance to prevent initiation of insolvency proceedings for at least six months. Since the specifics are not known, perhaps a blanket measure could lead to unintended consequences and is not advisable.

While the objective is salutary, tinkering with IBC may set an unhealthy precedent. In the past, there have been requests for special dispensation for regulated sectors like power which have been denied. Putting IBC in blanket abeyance will shut out the subjective wisdom of financial and operational creditors which is undesirable, particularly since not all defaults will be Covid-linked and even within Covid-linked defaults, there may be companies where revival is not possible. While IBC is not a recovery tool, it is certainly a right available with the creditor especially in cases where the creditor is of the view that revival of the debtor is not possible. A similar reasoning was adopted by the Supreme Court in the Pioneer Urban Land and Infrastructure case which upheld inclusion of home buyers as financial creditors.

Ultimately, rights and recourse available to parties ought to be governed by agreements between them and their assessment of the possibility of revival. Suspending the right to initiate proceedings under IBC may result in creditors, especially operational creditors getting adversely impacted. Also, prohibiting voluntary insolvency may have the unintended consequence of delaying the inevitable.

The Government should instead look at a solution within the Banking Regulation Act framework to issue directions to Banks and Financial Institutions. In 2017, the Banking Regulation Act was amended to introduce two key provisions being Sections 35AA and 35AB. While the former authorised the Central Government to direct initiation of insolvency proceedings, the latter gave RBI the power to issue directions for resolution of stressed assets. These provisions, coupled with Section 35A of the Banking Regulation and Section 45L of the RBI Act gives the Government and RBI the power to issue directions to banking companies and financial institutions.

In the past, these provisions have been used to identify and initiate insolvency proceedings against defaulters. RBI has also utilised these provisions to introduce frameworks for resolution of stressed assets. The powers of the Government and RBI under these Sections are well-defined and have been upheld by the Supreme Court, thus ensuring that any action thereunder will be protected legally.

Introducing a forbearance framework utilizing these provisions with guidelines to apply or refuse to apply forbearance has certain advantages over suspending IBC. The framework could provide for relaxed provisioning norms along with an extended time period. For one, such a framework will allow banks and financial institutions the flexibility to exercise their wisdom as regards which companies should be referred under IBC. Secondly, it will not interfere with or override existing contracts especially with operational creditors, allowing such creditors the flexibility to exercise their rights as also to put suitable conditions for granting a relaxation.The framework would also have the benefit of RBI oversight. Such a framework would be comprehensive without being absolute.

Ultimately, disruption due to Covid-19 has impacted the entire value chain in any industry. It is inherent in the nature of the disruption that someone will be left holding the bag. Companies are already facing a challenge in enforcing contractual rights due to force majeure claims by counter-parties. IBC has changed the way corporate India treats defaults. By moving to a creditor-driven process, the IBC disincentivized default. Suspending initiation of IBC proceedings may allow companies to escape their obligations while transferring this stress to operational and financial creditors. It may also result in delaying the inevitable which may not desirable given current scenario.

Being largely financial creditor driven, absolute measure of foreclosing the IBC route should be eschewed in favour of a granular framework guiding exercise of discretion in regulating the process through financial creditors such as banks and financial institutions who have their skin in the game.




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