These measures effectively create an enabling environment for the Operational Creditors to rethink and redesign their recovery strategies by even resorting to appropriate legal measures against their debtors in the event of non-payment...
With the notification of Insolvency and Bankruptcy Code (Amendment) Ordinance,
2020 confirming that no applications 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 6 months (extendable up to 1 year)and that no
application shall ever be filed for the said period of 6 months, it is paramount for
Operational Creditors to optimally realign their recovery strategies by developing a
much-needed insight into the impact of the suspension of IBC. Contrary to the
seemingly popular and pre-mature beliefs of such and other related measures – as
have been proactively introduced by the Government as well as the Reserve Bank of
India in the wake of Covid-19 – defeating the Operational Creditors from realizing
their dues – that have been defaulted on or after 25th March 2020 – it is essential to
identify the silver-lining that these measures intend to provide – if not actively
outright, but certainly a gradually calculated – diversion of cash flow of debtors from
servicing the EMIs of Financial Creditors, to the incoming ledger entries of
Operational Creditors.
In a nutshell, the much needed Covid-19 Relief Packages and the suspension of IBC
have been introduced in a bid to address and phase-out the prevalent illiquidity in the
economy; and to demonstrate the same, it is essential to firstly identify how exactly is
it that the Operational Creditors would have fared under the IBC had it been allowed
to be invoked for debts arising out of the economic mayhem caused by Covid-19.
The Hon’ble Supreme Court of India had very accurately observed in Committee of
Creditors of Essar Steel India Limited v. Satish Kumar Gupta & Ors. 2019 SCC
OnLine SC 1478 that “most financial creditors are secured creditors and most
operational creditors are unsecured creditors”, in view whereof the waterfall method
of distribution engrained under Section 53 of the IBC placed Operational Creditors
much below the Secured Creditors; and effectively relegated Operational Creditors to
the slab just above share-holders of the Corporate Debtor, and thereby seeking to
revive and rescue the Corporate Debtor at – to put it simply – the cost of Operational
Creditors. Interestingly, as per the Insolvency and Bankruptcy Board of India (IBBI),
by March 2020 only 14% of the total 1604 closed IBC cases had found a resolution,
while 57% has ended in liquidation of the Corporate Debtors, and it is anybody’s
guess that had the IBC continued in the times of Covid-19, the number of companies
ending up in liquidation would have significantly increased, thereby equally
significantly lowering the share of recoveries by Operational Creditors. Moreover,
the pari passu principle which is central to the distribution of the liquidation estate of
the Corporate Debtor would have prevented the Operational Creditors from
superseding the creditor hierarchy.
A major exception to the pari passu principle is that of public interest, which
propounds that on grounds of equitable and fair treatment, the claim of an unsecured
creditor may be treated on an equal footing with that of secured creditors or given a
preference in view of the social and political fabric of the concerned nation, which is
peculiarly crucial for any economic legislation, such as the IBC.
Importantly, the measure to suspend IBC needs to be understood in the context of
the following key-measures introduced by the Government and the RBI:
The RBI has prevented asset classification downgrade thereby effectively freezing a Special Mention Account as it stood on 1st March 2020 from qualifying as a Non-Performing Asset, which would have in its absence entitled the Financial Creditors to initiate debt recovery proceedings against the Corporate Debtors, thereby draining out the assets of the Corporate Debtor and leaving little room for Operational Creditors;
The RBI has extended the one-time settlement scheme (first introduced on 1st January 2019) for MSMEs till 31st December 2020, thereby giving the MSMEs an opportunity to restructure their debts;
The Government of India has widened the definition of MSMEs by basing the same on their turnover in addition to their net profits to ensure that a larger number of corporates are protected under the provisions of the Micro, Small and Medium Enterprises Development. Act, 2006 which enables them to speedily recover their outstanding receivables thereby furthering their payments to their creditors in turn, including Operational Creditors,
The Government is in the process of introducing an alternative insolvency resolution framework for MSMEs vide the Section 240A route under IBC to ensure timely resolution of the MSMEs to further create liquidity in the market, thereby again in turn enabling payments to Operational Creditors;
Small Industries have been provided an added booster by the RBI through a special refinancefacility of Rs. 15,000 Crore to the Small Industries Development Bank of India, with the flexibility to roll over the facility at the end of the mandated 90 days by another period of 90 days;
The RBI vide the Covid-19 Regulatory Package has introduced schemes to (i) rescheduling payments towards term loans and working capital facilities, (ii) permitting a wide base of Financial Creditors to extend the moratorium to their debtors by another three months from 1st June 2020 to 31st August 2020, and (iii) allowing lending institutions to introduce deferment of three months till 31st August 2020 on recovery of interest in respect of cash credit/overdraft and such other facilities;
Vide notification dated 22nd May 20, the RBI has announced certain developmental and regulatory policy measures to improve the functioning of markets and market participants and measures to support exports and imports in efforts to further ease financial stress caused by COVID-19 disruptions by providing relief on debt servicing and improving access to working capital;
Government has introduced various measures to ease out numerous statutory payments; and
Importantly, even allowing relaxations to the State Government in making withdrawals from their Consolidated Sinking Funds. The above facilities are specifically aimed at improving the liquidity in the economy, thereby effectively putting the payments to Financial Creditors on the back-burner for the time-being and enabling the debtors to make the payments to their Operational Creditors.
To think however that the Cabinet has thrown the baby out with the bathwater when it
comes to lending institutions will be erroneous. It is quite clear upon reading Section
10A inserted by the Ordinance that the suspension of IBC is not a blanket one and
denotes that defaults that may have occurred prior to 25th March 2020 can still be
dragged to the NCLT vide the IBC route. The key here will be to note that many NPA
accounts for whom the 180-day resolution period prescribed under the RBI’s
prudential framework has expired before 1st March 2020 are yet to be taken to the
NCLT, and the RBI has vide its notifications dated 17th April 2020 and 23rd May
2020 clearly spelled that:
In respect of all other accounts, the provisions of the Prudential Framework shall be in force without any modifications
thereby effectively leaving the option for lending institutions to initiate IBC proceedings against NPA accounts for which the 180-day resolution period had expired prior to 1st March
2020.
For Operational Creditors, however, it will be necessary to identify how to bifurcate
the defaults against which the Operational Creditors may proceed against the
Corporate Debtor, and which defaults are now suspended by the Ordinance,
especially in cases wherein running accounts are maintained and delay interest is
calculated on a running basis. Although, there is no express clarification in this
respect, it is implied that IBC may be invoked for insolvency resolution of Corporate
Debtors for the running defaults till 24th March 2020, but not for the amount that will
be accrued for six months on and from 25th March 2020. This is sacrosanct with the
exclusion from the claim amount of any amount that may become due from the date
of initiation of the insolvency resolution process in the usual process of submission of
claims to the (Interim) Resolution Professional, and as had been noted by the
Hon’ble NCLAT vide order dated 14thAugust 2018 in Export Import Bank of India v.
Resolution Professional JEKPL Pvt. Ltd. (Company Appeal (AT) (Insolvency) No. 304
of 2017). Ensuring accurate computation of amounts due and amounts that were
defaulted before 25th March 2020 is therefore crucial.
A major concern, however, remains with respect to willful defaults by certain
Corporate Debtors post 25th March 2020 despite the said Corporate Debtors not
having been impacted by the economic onslaught of Covid-19. In this regard it is
essential to note that the option with Operational Creditors to initiate appropriate
legal actions against the Corporate Debtor for recovery has however not been
suspended; and this has to be conjointly understood with the matter of fact that IBC
provides not a recovery option but a resolution process, which is difficult to obtain
given the circumstances and the erosion in overall valuation of the Corporate Debtor.
On the other hand, these measures effectively create an enabling environment for
the Operational Creditors to rethink and redesign their recovery strategies by even
resorting to appropriate legal measures against their debtors in the event of nonpayment,
be it through invocation of dispute resolution clauses, conciliatory
processes, mediation, recovery suits, etc., which can be best determined upon
assessing the case-by-case circumstances. Most importantly, the above measures of
the Operational Creditors will now not be hit by the blanket moratoriums under
Section 14 of the IBC and enable effective recoveries by even out of court
settlements through agreeing upon and entering into agreements with their debtors
for rescheduling payments of their outstanding recoverable amounts.
With the right recovery strategies, Operational Creditors can seek to strengthen their
financial positions during the current crises in the environment that has been enabled
by the Government and the RBI.
(This article was originally published in LegalEra-