Insolvency Laws and the Covid-19 effects
Owing to the coronavirus pandemic, the suspension of new insolvency cases, as well as the NCLT and the appellate tribunal transitioning to virtual trials, seem to have slowed the speed of resolution for distressed assets and realization for creditors. The article deals with the impact of the pandemic on the framework of IBC and how the distressed assets have reacted to the same. In pursuance of the burden put on NCLT and other authorities due to the large volume of cases of insolvency, the author proposes an alternative that was recently accepted and promulgated by the President in the name of Pre-packaged Insolvency Resolution Process under IBC Code (Amendment) Ordinance, 2021.
- What are Insolvency and Insolvency Frameworks?
It refers to a situation where the debts of a company or an individual exceed its assets. It often leads to filing for bankruptcy. However, several countries have provided for Insolvency Framework to help companies or individuals who end up in such a situation. Insolvency frameworks are the rules that determine how to resolve distressed assets so that business activity can continue or assets can be redeployed to more productive uses.
The average time for insolvency proceedings in India was 4.3 years which was much higher than other developed countries – 1 year in the United Kingdom and 1.5 years of the USA. This necessitated the need for the Insolvency and Bankruptcy Code, 2016 (“IBC”). It provides for a time-bound process to resolve insolvency. When a default in repayment occurs, creditors gain control over the debtor’s assets and must make decisions to resolve insolvency within a 180-day period. To ensure an uninterrupted resolution process, the Code also provides immunity to debtors from resolution claims of creditors during this period. The Code also consolidates provisions of the current legislative framework to form a common forum for debtors and creditors of all classes to resolve insolvency.
As per the Insolvency and Bankruptcy Board of India (“IBBI”), there was an increase of 123% in the number of cases under the IBC. The introduction of the code was a huge success as it enabled firms to deal better with their stressed assets. The banks were also able to recover bad loans at a greater pace. The net result was the generation of more liquidity with the banks and allowing certain companies who were on the brink of extinction to stay in business. The non-performing resources in the economy were also restructured or liquidated under the IBC and put to best use.
- Impact of COVID-19:
In the wake of the pandemic of COVID-19, there was increased stress on companies, especially small and medium enterprises. The impact of the lockdown was felt by almost all industries with the NIFTY 50 Index falling below 8100 in India for the first time since 2017. The impact on the global economy too was significant with large-scale shutdowns of industries all over the world and a drastic reduction in demand for numerous commodities.
If the IBC was allowed to operate it would have led to the institution of a huge number of default cases. Moreover, there was a fear of a situation where companies with greater assets and resources would take advantage of the situation to wrongly liquidate certain enterprises while also allow others to be kept alive artificially.
Hence, the government decided to suspend fresh proceedings under the IBC by the government for a period of 6 months beginning from March 25, 2020. It was later extended to 24 March 2021. The limit to initiate insolvency proceedings was also raised to INR 1 Crore from INR 1 Lakh. The intention of doing this was to prevent the companies from being forced to shut down. It also eased the burden on the National Company Law Tribunal (NCLT) and the National Company Law Appellate Tribunal (NCLAT) which were struggling to function optimally with reduced capacity.
However, despite the suspension, the time taken on average to resolve an insolvency proceeding increased to 433 days, 160% over the statutory mandate which is a mere 270 days. This created trouble for the companies resorting to insolvency proceedings and necessitates the need to find alternative solutions.
- The way forward:
It is 2021 and there has been the creation of numerous vaccines to tackle the menace of COVID-19. However, despite such developments, the end of the crisis does not look to be coming anytime soon. The full economic impact of such a major event has not fully unfolded. There is going to be a definitive rise in the number of corporate delinquencies globally. The Judicial Authorities and other supporting institutions can analyze and find which firms are to be liquidated and which of them are to be restructured.
However, post-COVID-19, the cases are bound to increase drastically. This is not the first time such a situation has occurred globally. There have been economic crises throughout history that necessitated reform to facilitate the rehabilitation of corporates and prevent liquidations. International Organisations like the IMF, World Bank and think tanks like the BIS have mentioned through various publications the need to continue to provide liquidity support to illiquid but solvent firms and facilitating the restructuring of insolvent firms to ensure swift resource reallocation. The enhancement in the number of out-of-court settlements has been suggested by them. However, due care must be taken to ensure that the support that is being given to the corporate sector does not lead to the creation of zombie firms.
- Possible Reforms to facilitate moving forward:
Presently, the world looks underprepared to tackle the tide of insolvency cases that will be presented before it once the complete economic impact of COVID-19 is unleashed. This fear is further strengthened by the G30 Report which states that most countries do not have suitable insolvency laws to deal with the situation of insolvency that will arise post the pandemic.
However, the lessons from the past and some new suggestions can aid in developing measures to tackle this issue. An amendment to the laws relating to Bankruptcy and Insolvency can be done in order to meet the demands of the new world that have been created post-COVID-19. There can be provisions to include special bankruptcy courts for a limited period of time to deal with the huge number of cases that are to come. This method was used by several East Asian Countries during the East Asian financial crisis of 1997.
There is also a possibility to introduce new mechanisms which promote out-of-court settlements that are quicker and more efficient. Even these can be done under the guidance of judicial bodies and be monitored. However, they would be much more efficient and reduce the burden on the Courts. Such methods were used by countries like France, Italy, Poland, Estonia, and the Philippines to tide over the 2008 economic crisis caused by the drastic fall of sub-prime bonds in the USA. Professionals can be hired specifically for these purposes that are able to facilitate such transactions. The countries which report a lack of such professionals can hire some from countries that have an excess of them.
There is also huge support for the idea of pre-pack resolutions. These are already operational in some jurisdictions around the world. However, it is a good time to introduce a framework that will allow pre-packaged resolutions in developing countries like India. It is one of the fastest methods for the resolution of stressed assets. It is cost-effective as “some tasks of an insolvency proceeding are completed before the formal process begins, and some elements of the formal process are avoided, pre-pack saves both on costs and time. This will reduce the role of the NCLT to a supervisory body while companies and creditors would work together in order to negotiate an acceptable restructuring package.
It would expedite the process while still remaining under the watchful eyes of NCLT. The continuity of business would be maintained and the obligations of the company would be restated to an acceptable level. The government has already made an effort to introduce pre-pack in the Indian IBC ecosystem. It is a special framework made for MSMEs that will allow them an expedited and more convenient resolution. The chief of the Insolvency and Bankruptcy Board of India, Mr. Sahoo has also publicly spoken in favor of pre-packs agreements and explained their benefits. Hence, the current view is in favor of pre-pack agreements as one of the ways out of the post-pandemic crisis regarding insolvency.
Moreover, it also needs to be realized that the delay in such proceedings also adversely affects the banks who are the creditors for many of these companies. In order to help these financial institutions, the Indian government has allowed for a creation of a Bad Bank. The motive behind its creation is to resolve the stressed debts worth INR 2.25 Lakh Crore that adversely affects the Indian Banks. It is proposed that there will be a creation of an Asset Reconstruction Company and Asset Management Company. It will allow the banks with a ton of stressed assets to reduce their overall losses. It will also positively impact the IBC process. Resolution of stress would be given special focus. It would be easier to differentiate between economic and financial stress as there would be a greater business acumen that will be created. This would make it easier to focus on the right strategy to resolve the stress.
There is a genuine need to review and amend the insolvency laws post-COVID-19. It is not the first time the global financial ecosystem has been hit with such a crisis and it has found solutions to resolve it in the past. Looking towards the future it is essential that every State carefully analyses and reviews its economic situation in order to ensure that the best measures are taken to implement the insolvency laws. There has been a huge amount of research on potential alternatives by world organizations, global think tanks, and the best financial analysts around the world. It is up to the States to implement these suggestions effectively to find a way out of this crisis.
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