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The Constitution of India, 1950 vests law-making powers to the President of India, under Article 123, wherein the President may promulgate ordinances when the Houses of Parliament are not in session. The ultimate motive for conferring the Executive with the authority to issue ordinances is to deal with circumstances where an emergency or like situations dictates urgent action in a nation, as seen in the case of an unprecedented crisis caused by the global pandemic, i.e. COVID-19. The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 was promulgated by the Hon’ble President of India by virtue of the above provision of the Constitution, to assist the survival of several corporate debtors who are affected ascribable to the pandemic, causing extensive commotion of business operations to them varying across the nation.
The said Ordinance as promulgated on 5th June, 2020, effectively suspended the operation of Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 (IBC) apropos to defaults arising on or post 25th March 2020 for an initial time period of six months, extendable to a maximum time phase of a year as notified. This was done by inserting new clauses [Section 10A and Section 66(3)] in the IBC, 2016. The Ordinance undoubtedly voices that the added provisions would not be applicable to any defaults in payments which arose before 25th March 2020. Consequently, creditors are free to file applications under the suspended provisions if the corporate debtor committed defaults pre-25th March.
Background of the issue
The nation-wide lockdown had significantly affected business operations across the country. The global outbreak of the Corona Virus created uncertainty and stress for businesses, which were beyond the control of the owners. Additionally, it was difficult to find adequate number of resolution applicants for a defaulting business, who would come forward to rescue the defaulting Corporate person in the discharge of their debt obligation during the difficult times. In such scenario, to offer respite to corporates caught in the present crisis, the Ordinance was promulgated pursuant to the announcement made by Ms. Nirmala Sitharaman, Minister of Finance, GOI on 17.05.2020 which highlighted the Central Government’s intent to suspend these provisions as a part of the economic relief measures formulated by the Government in these hardship times.
Significance of the development
The Primary objective behind putting forth the Ordinance was to safeguard the interest of debtors who have had experienced severe economic agony amidst the unprecedented event from being pushed into insolvency proceedings under the Principal Act. It attempts to exclude defaults arising on account of such circumstances. Even after the said time period (six months, extendable to a year), an application can be maintained only if the debt amount is higher than the brink of one crore rupees. The intent behind these is to simply lower the value realisation of assets. The intention behind adding Section 66(3) in the Amendment Ordinance is to create a Covid-19 exception to Section 66 (2) of the same Code which creates liability on the partner or Director of the Corporate Debtor for failure to exercise due diligence, to avoid initiation of Corporate Insolvency Resolution Process. The added clause seems to provide for an exception to this due diligence obligation.
Legal provisions involved in the amendment
Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 permits for insolvency filings by financial creditors, operational creditors (supplier, employee, and workman) and the corporate debtors themselves. The Ordinance shuts down all insolvency filings against any company that defaults on a debt, by insertion of Section 10A. The six-month suspension will almost run parallel to a six-month loan moratorium that financial institutions and non-banking financial companies (NBFC) may extend to insolvents. Thus, the probability of financial defaults during this time period is extremely low and banks & NBFCs would have had to invoke the Code. However, the RBI moratorium does not apply to other financial creditors like debenture holders, to whom the receivables are sold. In case of default, they would no longer invoke the IBC. The suspension would also hinder operational creditors from filing insolvency against corporate debtors; and will also restrict corporate debtors from self-filing.
Furthermore, the Ordinance has amended section 66 of the Code, with an aim to provide relaxation from wrongful trading provisions, i.e. resolution specialists shall be barred from introducing wrongful trading applications against directors of companies where the Code is suspended.
There are certain uncertainties dominant in the Ordinance. The expression used in the first proviso to Section 10A is “no application shall ever be filed”, which cannot be interpreted as relaxation of clauses is available even after the scheduled time phase. It would defeat the purpose of the Ordinance if counter interpreted. Companies might use this flexibility during this period and escape insolvency repeatedly. It is indistinct as to how a default in the six-month suspension period which remains a default (provided the debt is unpaid in the period) after the exempted period should escape insolvency.
The moratorium provided by the RBI for six months had already factored the Corporate debtors and the present Ordinance would have an adverse impact on the operational creditors, who are mostly Micro, Small, Medium Enterprises (MSMEs), for whom it would be a double edged sword with the threshold limit of default too having been enhanced to 1 crore.
The fate of the Operational Creditors, who had issued demand notices prior to the amendment of the minimum threshold is in a limbo, though the other point of controversy with regard to operation of the notification and consequential threshold limit date had been brought to quietus by the Kolkata and Chennai benches of NCLT vide their Orders dated 20.05.2020 (M/s. Foseco India Limited v M/s. Om Boseco Rail Products Limited) and 02.06.2020 (M/s. Arrowline Organic Products (P) Ltd v. M/.s Rockwell Industries Limited) respectively thereby holding the operation of the Notification dated 24.03.2020 as prospective in nature and allowing the pending cases without those being challenged on the ground of maintainability of minimum threshold of default pursuant to the notification.
The Ordinance which provides relief to the distressed companies during the COVID lockdown period, primarily covers two aspects i.e. ‘default’ and ‘wrongful trading. As regards default, the Ordinance seeks to exclude default arising out of ‘unprecedented situation’, but the iinsertion of Sec 66(3) provides relaxation from wrongful trading provision. The scope of the Ordinance is not extendable for ongoing matters, where creditors had proceeded against the corporate debtors for default which occurred prior to 25.03.2020.
Though apparently the Ordinance seems to have also benefitted fraudulent or wrongful person or Directors acting on behalf of the defaulting Corporate Debtor, during the pandemic, but all concerned stakeholders need to keep a watchful eye and await for clarifications from the Government/ Insolvency and Bankruptcy Board of India for addressing such ambiguities, else it would lead to plethora of issues being raised by the creditors before the adjudicating authorities (NCLT, NCLAT).
Author: Debargha Mukherjee from ILS Law College, Pune.
Editor: Silky Mittal, Junior Editor, Lexlife India.