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An analysis of the impending proposal to suspend sections 7, 9 and 10 of the insolvency and bankruptcy code, 2016

INTRODUCTION

The Insolvency and Bankruptcy Code, 2016 (‘IBC/the Code’) was introduced as need of the hour, to consolidate and revamp the existing insolvency and bankruptcy framework in India by enacting a robust law that would give certainty of process, time and outcome to the creditors, borrowers and other market participants of a developing economy.

Prior to the enactment of the Code, the insolvency procedure was governed by The Presidency Towns Insolvency Act, 1909 and the Provincial Insolvency Act, 1920, which were old and seemed to be ineffective. The dependency thereafter, shifted to laws such as the SICA (Sick Industrial Companies Act), 1985, Recovery of Debts Due to Banks and Financial Institutions Act, 1993, SARFESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act), 2002, Companies Act, 1913, 1956 and later 2013. However, a need arose, to shift the focus to implement a mechanism which balanced needs of both the company as well as the creditors, rather than bluntly liquidating and distributing the remains of a debt-ridden company among its creditors in order of priority. This led to the enactment of the Insolvency and Bankruptcy Code, 2016.

The Insolvency and Bankruptcy Code, 2016 was passed by Lok Sabha on 5th May, 2016 and by the Rajya Sabha on 11th May, 2016. The Code received the assent of the President of India on 28th May 2016 and became effective in December 2016.

Since its inception, the Code has undergone a series of amendments, which have been or are under challenge before the Hon’ble Apex Court. Several notifications, orders and judgements including those from the Apex Court have ensured a near satisfactory implementation of the Code. These developments have enriched the jurisprudence and practice of insolvency law in the country. There have been instances where various sections of the Code and in fact, the Code itself has been challenged, but such scrutiny is essential and inevitable to a relatively new law coming into force.

According to a World Bank statement[1], IBC has improved the recovery rate of stressed assets to 48% in two years from 26% in the pre-IBC era. It is thus safe to say that the Code has largely been able to meet up to its expectations till now. The Courts and Tribunals have also played a key role in upholding its sanctity by adjudicating and disposing the cases in a timely manner, as far as possible. The recent outbreak of Covid-19 and nation-wide lockdown has brought about a significant slowdown to the economy. The ripple effect of the lockdown cannot be ascertained; however, it is likely that innumerable businesses will feel the heat of the lockdown in the coming months. The Central Government in order to aid businesses, which in its view are likely to be most affected, and are likely to be in a position where they would be unable to pay their debts, has proposed the suspension of Sections 7, 9 and 10 of the Code. 

This Article attempts to throw light on the objectives and evolution of the Code and whether the recent proposal to suspend Sections 7, 9 and 10 of IBC for a period of six months to up to one year by the Government, will dent the very purpose and objective, for which the Code was enacted.

KEY OBJECTIVES OF THE CODE

Some of the key objectives of the Code are elucidated hereunder: -

  • To consolidate and amend all existing insolvency laws in India.
  • To simplify and expedite the Insolvency and Bankruptcy proceedings in India.
  • To protect the interest of creditors including stakeholders in a company.
  • To revive the company in a time-bound manner.
  • To promote entrepreneurship.
  • To pass on the necessary relief to the creditors and consequently increase the credit supply in the economy.
  • To work out a new and timely recovery procedure to be adopted by the banks, financial institutions or individuals.
  • To set up an Insolvency and Bankruptcy Board of India.
  • Maximization of the value of assets of corporate persons.

The primary objective of the Code inter alia is to simplify and expedite the Insolvency and Bankruptcy proceedings in India in order to maximize the assets of corporate debtors and provide remedy to its operational and financial creditors. However, one cannot lose sight of the fact that significant amounts of recoveries have been made from the defaulting entities since the implementation of IBC. The Code provides a robust framework for market-driven and time-bound resolution process. The credible threat of IBC process being that, a defaulting company may lose administrative control, has significantly changed the mindset and behaviour of the debtors. Many debtors are now trying to resolve their disputes and find practicable and innovative methods to repay their dues or service loans in order to escape the resolution process under IBC. Sale of non-core assets, divestment in group companies, release of investments, sale of idle properties and even capping diversification plans and focusing on consolidation of business and other options are being weighed by such debtors. Thus, honouring loan commitments is also gradually becoming a priority for borrowers. As a consequence of the above aspects, companies are slowly becoming stable in their functioning, which ultimately is the object of enactment of IBC.

EVOLUTION OF THE CODE AS IT STANDS TODAY

The Code as we see it today has, like various other laws, undergone constitutional scrutiny and has evolved over the short span of time. Sections 7 to 10 of IBC, are the most commonly and widely invoked provisions under the Code, with the maximum number of applications filed before the National Company Law Tribunal (NCLT), under these provisions. 

Sections 7 to 10 of the Code, deals with the initiation of the insolvency resolution process of a Corporate Debtor by either a Financial Creditor, Operational Creditor or Corporate Applicant. On many occasions, the provisions have been misused which has led the Courts to delve upon strict interpretation of these provisions and bring about changes/ amendments where ever necessary. A few notable judgments, which have played a key role in the evolution of the insolvency process under the IBC are worth highlighting.

M/s Innoventive Industries Ltd. vs. ICICI Bank [2]

In this case, the Hon’ble Supreme Court expounded the legislative intent behind enactment of the Insolvency and Bankruptcy Code, 2016. The Court, in this case explained the paradigm shift in Law to render guidance to Courts and Tribunals while dealing with cases under the Code. The Court has held that the moment initiation of the corporate insolvency resolution process takes place, a moratorium is announced by the adjudicating authority under the Code by which institution of suits and pending proceedings etc. cannot be proceeded with until the approval of a resolution plan as required by the Code.

Swiss Ribbons Pvt. Ltd. & Anr. vs. Union of India & Ors. [3]

The judgment of the Hon’ble Apex Court inter alia laid down the reasoning behind the differential treatment of financial creditors and operational creditors; clarified the role of a Resolution Professional who acts as the facilitator to the resolution process; and stated that IBC is not a mere recovery legislation for creditors but actually provides an opportunity for a debt-ridden organization (legally known as the 'Corporate Debtor') to be back on its feet.

Mobilox Innovations Pvt Ltd vs. Kirusa Software Private Ltd. [4]

The Supreme Court, in this case held that while determining if a dispute exists with the debtor in regards to the payment of any debt, the NCLT will be required to see only if there is a dispute and that the NCLT may not go into the merits of such dispute.

Macquarie Bank Limited vs. Shilpi Cable Technologies Ltd.[5]

In this case, the Supreme Court settled the legal proposition under the Insolvency and Bankruptcy Code, 2016 to hold that Section 9(3)(c) of the Code is directory and not mandatory in nature and secondly, the Demand notice under the Code can be issued by the Advocate on behalf of the operational creditor.

PR. Commissioner of Income Tax v. Monnet Ispat and Energy Ltd.[6]

The Apex Court, while referring to statutory provision under Section 238 of the Code, held that the Code will override anything inconsistent with the Code contained in any other enactment, including the Income-Tax Act.

Shah Brothers Ispat Pvt. Ltd. v. P. Mohanraj & Ors. [7]

The National Company Law Appellate Tribunal (NCLAT) in the case while brushing aside the Respondent’s contention noted that since Section 138 of Negotiable Instrument (NI) Act is a penal provision, it empowers the court of competent jurisdiction to pass order of imprisonment or fine, which cannot be held to be proceeding or any judgment or decree of money claim.

It was also opined by the Appellate Tribunal that imposition of fine cannot held to be a money claim or recovery against the Corporate Debtor nor order of imprisonment, if passed by the court of competent jurisdiction on the Directors, thus offence under Section 138 of NI Act does not come within the purview of Section 14 of the Code. In fact, no criminal proceeding is covered under Section 14 of IBC.

Alchemist Asset Reconstruction Company L. Vs. Hotel Gaudavan[8]

The Supreme Court held that the mandate of the new Insolvency Code is that the moment an insolvency petition is admitted, the moratorium that comes into effect under Section 14(1)(a) expressly interdicts institution or continuation of pending suits or proceedings against Corporate Debtors and Arbitration proceedings are also hit by moratorium.

Chitra Sharma Vs UOI [9]

As a result of the amendment brought about in the definition of ‘financial debt’, amounts raised from allottees under real estate projects are deemed to be amounts “having a commercial effect of a borrowing”. Hence outstanding amounts to allottees in real estate projects are statutorily regarded as financial debts and such allottees have been brought within the purview of the definition of ‘financial creditors’.

B.K. Educational Services Private Limited Vs  Parag Gupta And Associates [10]

It was held that the Limitation Act, 1963 is applicable to applications filed under Sections 7 and 9 of the Code from the inception of the Code. Article 137 of the Limitation Act, 1963 gets attracted. “The right to sue”, therefore, accrues when a default occurs.

Pioneer Urban Landand Infrastructure Ltd Vs UOI [11]

The Supreme Court, in this case, has dealt with the amendment of inserting an Explanation to Section 5(8)(f), which  made allottees of real estate projects to be “financial creditors” so that they may trigger the Code, under Section 7, against the real estate developer, which was upheld. In addition, being financial creditors, allottees were held to be entitled to be represented in the Committee of Creditors by authorised representatives. It was also observed and opined that remedies that are given to allottees of flats/ apartments are therefore concurrent remedies. Such allottees of flats/apartments are in a position to avail remedies under the Consumer Protection Act, 1986, Real Estate Regulatory Authority (RERA), as well as under the IBC.

It can be seen that the Courts have also played a significant role in the evolution of IBC. The IBC is a step towards regularizing the insolvency process in India. It has amended over 11 legislations in India, bringing about one of the most significant change to commercial laws in recent times. It has also become a very important tool for banks to regularize multitudes of non-performing assets plaguing the country’s economy. The IBC has brought a plethora of changes and aims to reduce the amount of bad debts that have saddled the economy. We are beginning to see this through various companies successfully concluding their insolvency process. The Code in itself is a comprehensive legislation with a speedy and specific procedure for dealing with insolvency. The time-bound nature of IBC is a win-win situation as the resources of the companies are placed at the right place in time, whether it is by payment to creditors or by winding up. The company does not keep running in losses for endless time period causing a setback to the economy in whole and affecting the creditors individually, in the process.

As per data released by the Insolvency and Bankruptcy Board of India (IBBI) [12], as of 31st December, 2019, the 190 companies that had defaulted on loans yielded resolution plans with different degrees of realization. Claims worth ₹3.52 trillion in total had been filed by financial creditors, primarily banks. Of this, around ₹1.52 trillion 43.1% of the claims under consideration have been recovered. This is much better than the rate of recovery before IBC was put in place.  India's positive leap in the ease of doing business is attributable to continuous, conscious and collective efforts of the legislature, Ministry of Corporate Affairs, as well as the Indian judiciary.

IBC has played a pivotal role in the aforesaid improvements in India's overall rankings. Thus, one can say that the Code as we see today has evolved drastically from a series of amendments and the judicial pronouncements by various Courts and Tribunals, which have made it more robust and meaningful. However, this is not the end of the various changes we are seeing in the Code. IBC, like any other law, will still undergo challenges and tests of law, where its provisions and the Code itself will be questioned. This process will bring about several rounds of amendments to this relatively new law and make it more evolved and stronger, which would thus cater to the larger good.

NOTIFICATION TO INCREASE THE THRESHOLD LIMIT TO INITIATE INSOLVENCY PROCEEDINGS AND THE SPECULATION SURROUNDING THE PROPOSED SUSPENSION OF SECTION 7, 9 AND 10 OF IBC

In a very recent development, due to the emerging financial distress faced by most entities on account of the large-scale economic distress caused by COVID 19, the Central Government vide a notification on 24th March, 2020[13], raised the threshold of default under Section 4 of the IBC from the existing threshold of Rs 1 Lakh to Rs 1 Crore. The Central Government is further proposing to suspend Sections 7, 9 and 10 of the Code for a period of six months to up to one year, in order to protect borrowers, affected by the pandemic, from probable insolvency proceedings.

Although, the proposal of the Central Government appears to be based primarily on the exigencies of the borrowers, however, one cannot ignore the cascading effect of such a proposal on the creditors, who are also equally affected financially, due to the pandemic. It is undisputed that the Code, when it was introduced had come as a breath of fresh air, for several classes of creditors. These included Financial Institutions, individuals and MSMEs, who were struggling to recover their dues from their debtors for the undisputed amounts including the smaller amounts, but had no other remedy than to approach the Civil Court or seek recourse to Arbitrations, as the case may be, and entangle themselves into a long drawn litigation to recover their dues. However, with the introduction of IBC, and most importantly the provisions under Section 7, 9 and 10 of the Code, the Creditors appeared to have found an expedient, cost effective way to recover their undisputed amounts. Debtors, pushed under the Code by the invocation of the provisions under Section 7 to 10, always have a threat looming over their heads, where they could lose control of their company and be subjected to a resolution process. Resultantly, there have been increasing number of debtors who are repaying their loans and settling their dues to avoid the insolvency process, which otherwise, in any Civil Court would take several years, where the debtors would drive the creditors to undergo the ordeal of long trials, even in cases, where the amounts due were undisputed. The plight of the aggrieved would never end there, as a lot of creditors, would then be required to initiate execution proceedings. This would again be time consuming, where after too, the possibility of recovery remained uncertain. This scenario has been completely changed by the introduction of the IBC, where the debtors are themselves approaching the creditors for settlement of their dues. Though, it has been very clear through various judgments that IBC is not a tool for recovery mechanism, however, it certainly has become a mechanism to recover the undisputed debts, in a more efficient, expeditious and cost-effective manner.

With the implementation of IBC, thousands of cases were brought to the NCLT, the adjudicating authority under the IBC, and were settled even before admission. As per a report available on IBBI’s website [14], almost Rs 2.02 lakh crore of debt pertaining to 4,452 cases were disposed of even before admission into the IBC process, as the borrowers made good the amounts in default to the creditors. If these recoveries are accounted for, IBC might have helped resolve cases involving over Rs 5 lakh crore unpaid dues. As a percentage of claims, banks recovered on average 42.5% of the amount filed through the IBC in the financial year 2018-19, against 14.5% through the SARFAESI resolution mechanism, 3.5% through Debt Recovery Tribunals and 5.3% through Lok Adalats. Against Rs 1.66 lakh crore claims involved under IBC, the recovery was Rs 70,819 crore. Through the SARFAESI mechanism, it stood at Rs 41,876 crore. Recoveries through Debt Recovery Tribunals and Lok Adalats were Rs 10,575 crore and Rs 2,816 crore, respectively[15]. The stipulated timeframe for resolution of stressed assets under IBC is significantly lesser than for other mechanisms. The entire process has also inculcated fear in the minds of promoters over defaults and delays in resolutions as whatever kingdoms they’ve established might be taken away. The overall credit culture is improving as the paybacks are more efficient because the promoters are wary of being dragged into insolvency over defaults.

No doubt, that the threshold limit of Rs. 1 Lakh was definitely on a much lower side, which gave the creditors an upper-hand. In some cases, gave the creditors the liberty to misuse the process of the Code, which is contrary to the main objective and the purpose of the Code, i.e. revival and restructuring of the company. However, increasing the threshold to Rs 1 Crore has caused grievance to a larger section of the Creditors. Furthermore, the proposal to suspend IBC Sections 7,9 and 10 for a period of six months up to one year, would strike another damaging blow to the eligible creditors and shall in fact, be a step backwards from what the Code has achieved till now. In fact, it leaves even the ailing Company remediless, as it simply means that such a Company shall be deprived of its right to file an insolvency itself. The increase in the threshold has taken many players out of the equation including start-ups and MSME’s, who are most hard hit by the COVID-19 Pandemic, and were already on the lookout for a recourse to recover the debts or restructuring of their debtors, who are wilfully avoiding payment of admitted debts. It is however, important to note that the IBC is not a tool to recover money from the Debtors by escaping the ordeals of trial. The legislature in its wisdom has clearly defined the term ‘dispute’ vide Section 5(6) of the Code, which provides that the dispute should be pre-existing before the initiation of the insolvency proceedings under the Code and hence, avoids its misuse. However, one cannot lose sight of the fact that the threat of initiation of insolvency proceedings under section 7, 9 and 10 of the IBC have aided multitude of creditors in recovering most of their dues.

Suspension of Sections 7, 9 and 10 of the Code, would also, in effect, lead to a situation where Section 14 of the Code is rendered redundant. In such a scenario, the aggrieved party would have no other option but to avail other remedies and file appropriate proceedings before the civil/ commercial court or seek recourse to arbitration, as the case may be. Thus, defeating the very objective and purpose of the Code.

In these trying times, it would be sufficing to say that, undoubtedly, the global pandemic has played a pivotal role in disrupting the economy and the borrower needs adequate time to come out of this regression. However, at the same time such blanket suspension of the provisions of the Code, would hit the creditors hard, and especially those, who thrive on limited financial resources and are already struggling in these turbulent times to adhere to the directives of the Central Government including payment of full wages to their employees, without having any source of income during this period. Such measures, though seem to be in the interest of the some, however, appears to be at the expense of others and could defeat the very purpose of the Code. This is a significant departure from what we have achieved after the enactment of the Code.

DISCLAIMER: The opinions expressed herein are entirely those of the authors.  The Authors have made every effort to use reliable and comprehensive information, but they do not represent that the contents of the reports are accurate or complete. Nothing herein shall be deemed or construed to constitute legal advice.

 

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