What The Government's Got Wrong In Addressing Insolvency

Last week, the government issued an ordinance to amend the Insolvency and Bankruptcy Code, 2016 (the Insolvency Code). This follows on from the Finance Minister's press conference of May 17 where it seemed the government proposed to amend the definition of "default" under the Code. The government must then have decided that it was too difficult to attempt to define a Covid-19 related default as that may well lead to interpretation issues on whether such a default needed to be "directly related to", "in consequence of", "in relation to" and other terminology that lawyers tend to use or, worse, require a futuristic determination of causation - whether such a default would have occurred had the pandemic not unleashed its fury.

The ordinance doesn't venture into this murky territory and is deceptively simple - no application for the initiation of insolvency by a financial creditor (under Section 7), an operational creditor (under Section 8) or the corporate debtor itself (under Section 10) can be filed in respect of a corporate debtor for any default arising after March 25, 2020 for a period of six months or such further period that may be specified.

After the perfunctory language on the financial stress caused by the pandemic in its recitals, the ordinance states that because "it is difficult to find adequate number of resolution applicants to rescue the corporate person who may default", "it is considered expedient to suspend" the Code "to prevent corporate persons which are experiencing distress on account of unprecedented situation" from "being pushed into insolvency proceedings".

The reasoning isn't terribly helpful as it does not explain how companies that have defaulted (or would have defaulted, but for the existing moratorium on interest payments, which does not include a suspension on the accrual of interest) should conduct their affairs. They are expected to retain their employees, abstain from any pay cuts despite defaulting on their financial obligations to their creditors without the ability to even voluntarily seek refuge under the Insolvency Code, which at least would impose a moratorium on claims and proceedings against the corporate debtor, and provide protection from the takeover by the lenders of assets provided as collateral for the loans. Unless they are MSMEs which may have access to the financial package proposed by the government, such corporates face a very uncertain future with directors worrying not just about business operations, but also their fiduciary duties at a time like this.

In the absence of a moratorium on claims under the Code, the ordinance leaves open the possibility of banks and other secured financial creditors seeking to attach assets provided as collateral by the borrower companies. Borrowers will now be left to their own devices to restructure their debt and seek interim financing and this may provide certain opportunities for distressed funds. A vast majority of these borrowers may not be able to restructure their debt unless their economic prospects and the economy recover quickly, thereby leading to a worsening financial condition for these companies. Indian banks will also not be able to initiate insolvency proceedings to salvage what they can before matters get worse.

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The Ordinance may not, therefore, prove as helpful for the Indian borrower corporates that it seeks to assist, and certainly doesn't appear to be favourable for the financial institutions and operational creditors to whom monies are owed.

The government needs to do more. The suspension of a process that is designed primarily to resolve the financial condition of a borrower and to provide a recovery mechanism for public banks seems to me to be counterproductive. It is hard to see why public banks (with you and I as their depositors) should have to restrict themselves in the recovery of their debt, particularly where certain companies had defaulted on their debt obligations even prior to the incidence of the pandemic. Indian companies do not have the greatest track record of being fiscally prudent with their borrowings - the government is well aware of that - but sadly, the ordinance will give them additional cover.

(Uday Walia is a partner at Platinum Partners, a law firm.)

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