The government of India has effectively suspended fresh bankruptcy proceedings against persons impacted because of COVID-19 for at least six months, up to a maximum of one year. The amendments to IBC were promulgated by President Ramnath Kovind through the Insolvency and Bankruptcy Code Ordinance, 2020. The new rules come into effect immediately, as of June 5.

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These changes have been made by inserting Section 10A in the Code, which says, “Notwithstanding anything contained in Sections 7, 9 an 10, no application for initiation of corporate insolvency resolution process of a corporate debtor shall be filed, for any default arising on or after 25th March, 2020, for a period of six months or such further period, not exceeding one year from such date, as may be notified in this behalf.

Provided that no application shall ever be filed for initiation of corporate insolvency process of a corporate debtor for the said default occurring during the said period."

The changes to IBC to this effect were first announced by union finance minister Nirmala Sitharaman as part of the Atma Nirbhar Bharat Abhiyan reforms. The idea, as per the government, is to “prevent corporate persons which are experiencing distress on account of unprecedented situation, being pushed into insolvency proceedings under the said Code for some time”, the ordinance read.

While Section 7 of IBC enables financial creditors to file for insolvency against a corporate debtor, Section 9 provides for application of insolvency by an operational creditor. Similarly, Section 10 relates to initiation of insolvency proceedings by a corporate applicant.

These three sections have now been suspended temporarily for defaults arising on or after March 25, 2020 “for a period of six months or such further period, not exceeding one year from such date, as may be notified,” the ordinance said.

Now that more details about these IBC amendments have emerged, several things become clear.

First, creditors have at least one reason to cheer. Any defaults that occurred before March 25 can still be resolved via the bankruptcy code. When the government first announced the suspension of IBC proceedings for one year, the fear was that there would be a blanket ban on initiating proceedings for the entire period. Bankers need not worry about this any longer. Cases under RBI’s June 7 circular for instance, where the 180 day timeline ended in January, can still be taken to the bankruptcy court. Defaulters, for reasons not related to COVID-19, therefore have no escape.

Second, as per bankruptcy experts, the Section 10A provision that “no application shall ever be filed for initiation of corporate insolvency process of a corporate debtor for the said default occurring during the said period” spells trouble. This is because for defaults that have occurred between March 25, 2020 over the next six months to one year, banks can never initiate insolvency proceedings. “So promoters who somehow managed to keep their account standard would default now and hence be exempted from IBC for life,” remarked Abizer Diwanji, head of financial services at EY India.

With Section 10 off the table for a while, Diwanji said even pre-packaged deals would be impossible, as promoters who default now can be exempted from insolvency proceedings for life.

“The proviso to Section 10A is absurd. Its excessive and invalid in law, top corporate lawyer Shardul Shroff told CNBC-TV18, who is the executive chairman of Shardul Amarchand Mangaldas & Co.

Shroff said, "The suspension of the right to institute proceedings under Section 7,9 and 10 does not destroy the right of recovery or institute a proceeding after the lapse of Section 10 A. A person who has not cured his default by voluntary payment in the period covered under Section 10 A, remains liable."

He explained that once the clock restarts, the default would still be a default upon the lapse of Section 10A. “If a sum of Rs 1 crore or more is payable after such lapse then all rights arising from the non payment of debt due exceeding Rs 1 crore are available. The language of the proviso creates doubt and are contrary to the other provisions of IBC," he summed up.

Third, the very MSMEs that the government is trying to protect may be the worst affected due to this amendment. Section 9 of the IBC, which allows operational creditors to file for insolvency applications against a corporate debtor, has now been suspended for up to one year. An operational creditor is simply a person to whom an operational debt is owed. This person can be a supplier of goods or services to companies, and is most likely to fall into the MSME category. Therefore, if a corporate/entity fails to repay such operational creditors (OCs) during the period, they will have no legal recourse left under IBC. Filing a civil case against such corporate debtors would be the only option left.

Fourth, the legal protection a corporate debtor can get under Section 10 via voluntary bankruptcy is also suspended. So if a creditor decides to use the SARFAESI route in the absence of IBC, the debtor will get no protection from security enforcement etc which it would have otherwise been able to get.

To be sure, the amendments will ring-fence those genuinely facing stress from being dragged to bankruptcy courts for reasons that were beyond their control to begin with. IBC proceedings against past-defaulters (prior to March 25, 2020) can also continue unhindered. But protection from bankruptcy proceedings for default during this specified period ON A PERMANENT BASIS is bound to have some unintended consequences that must be considered.

First Published:Jun 5, 2020 8:02 PM IST