1. India’s Insolvency Ordinance: Protections and Rationale
On 25 March 2020, the Central Government of India brought into force India’s first nationwide ‘lockdown’: an order to close all ‘non-essential’ businesses and restrict physical movement of peoples, for a minimum of three weeks, so as to control the spread of COVID-19. The impact of the lockdown on companies’ ability to repay their debt raised concerns amongst Indian businesses that previously healthy companies would be forced to undergo corporate insolvency under India’s Insolvency and Bankruptcy Code (‘Code’). Thus, on 5 June 2020, by the Insolvency and Bankruptcy Code (Amendment Ordinance), 2020 (‘Ordinance’), the President of India sought to redress these concerns, by permanently barring the filing of insolvency applications against corporate debtors by its creditors, and by the debtors themselves, in respect of ‘defaults’ (i.e. the non-payment of debts due and payable to creditors by these debtors) which occurred within six months (and up to one year if so notified) from 25 March 2020 (‘Protected Default’).
What is unique about the Ordinance, however, is the disparity between the category of corporations for whom the reprieve from insolvency was ostensibly meant, and to whom such reprieve was actually extended. Evidenced by its preliminary recitals, the Ordinance was promulgated to protect corporations which were ‘experiencing distress’ on account of the ‘unprecedented situation’ of COVID-19, and its economic consequences. However, the Ordinance does not limit its protection to only those corporations, but to any corporation committing a Protected Default, with no requirement to demonstrate that the default was a result of—or even related to—COVID-19. The possibility that numerous corporations would have committed Protected Defaults even if COVID-19 had not occurred is high, with the Reserve Bank of India predicting in December 2019 — well before the onset of the pandemic — that a minimum of 9.9% of the advances given by scheduled commercial banks would have been classified as ‘non-performing assets’ in 2020.
India’s reasons for this blanket protection are not explicit in the Ordinance. That said, the Chairman of the Insolvency and Bankruptcy Board of India—the Regulator responsible for administering the Code—has stated that the Executive specifically sought to avoid protracted litigation before courts to determine whether a Protected Default was a result of COVID-19.
2. The limited adverse impact of protracted litigation
Admittedly, requiring courts (formally the ‘Adjudicating Authority’ under the Code) to determine the causes of default would increase the litigation period prior to the commencement of insolvency proceedings against a corporate debtor. However, the adverse effects of this litigation period on the corporate debtor are mitigated by the Code itself, irrespective of the decision finally taken by the Authority.
During the period of litigation, and where the Authority (and subsequent appellate forums) refuses to commence insolvency proceedings against the corporate debtor, the corporate debtor, though incurring legal costs and the indirect costs associated with publicity of proceedings, remains under the control of its existing management. While there are good reasons for avoiding the imposition of these costs on struggling businesses, this could be achieved by making it harder to commence insolvency proceedings (by mandating that a creditor make its own assessment of the impact of COVID-19 on the debtor’s business prior to instituting proceedings, for example), rather than precluding them altogether. Pertinently also, these temporarily defaulting debtors, which were financially sound prior to COVID-19, can offset these legal costs through the resumption of their business once economic lockdowns are gradually lifted.
Were the Authority to institute insolvency proceedings against the Corporate Debtor, the impact of the litigation period would be mitigated by features of the insolvency process contemplated under the Code. Immediately upon commencement, a statutory ‘moratorium’ is imposed upon the corporate debtor, which bars the institution or continuation of any legal proceedings against it until the conclusion of the insolvency process, thereby preserving the value of its assets. Simultaneously, the management of the corporate debtor is transferred to a ‘Resolution Professional’ who is responsible for managing it as a going concern until the conclusion of the insolvency process. Therefore, even if the erstwhile (ousted) management chooses to challenge the decision of the Authority before appellate forums, thereby extending the litigation period, the asset-value of the corporate debtor remains preserved by moratorium, and its operation as a going concern continues until final resolution under the Code.
3. Criticism of the Ordinance, and a suggested amendment
Having been promulgated to protect against the Executive’s wariness of litigation, however, the Ordinance’s blanket protection has undesirable outcomes. First, creditors are forbidden from using the Code to resolve the debts of a corporate debtor that was in a precarious financial condition prior to 25 March 2020, but which committed default only after such date. This prevents, in perpetuity, this corporate debtor—whether it was commercially unviable, or being mismanaged by its directors—from being subjected to mechanisms under the Code that would result in the reorganisation of its debts, replacement of its management or liquidation of its assets. Secondly, a corporate debtor that is cognisant of the unviability of its business for reasons unrelated to COVID-19 is also precluded from filing an application for insolvency to resolve its debts, or allowing its management to be taken over by third parties through proceedings under the Code, if it has committed a Protected Default. This concretises the financial fragility of such a company, by exposing it to attritional recovery proceedings by its creditors outside the Code, which suffer from chronic delays and structural disadvantages of their own. Such a company would also be without recourse to a statutory moratorium under the Code, which would have staved off recovery proceedings of its creditors while its debts were being reorganised, which increases the likelihood of diminishing the value of the company. Clearly, these outcomes run contrary to the object of the Code to maximise the value of corporate persons undergoing financial distress by their debt reorganisation and insolvency resolution.
Instead of this blanket protection, the appropriate course for the Executive should have been to also amend the definition of a ‘default’ under the Code to draw a proximate nexus—as in the United States of America and in the United Kingdom—between the occurrence of the default and the effects of COVID-19 on the corporate debtor. By this amendment, where no such proximate nexus is determined to exist, even a Protected Default would result in insolvency proceedings. This amendment would further the fundamental objectives of the Code (as also the stated intent of the Ordinance) to protect otherwise healthy companies from undergoing insolvency solely due to the impact of COVID-19 on their business, while simultaneously permitting companies that were commercially unviable prior to COVID-19 to undergo insolvency resolution under the Code. Access to the resolution process under the Code, which have delivered more efficient and higher-value recoveries than other debt-recovery mechanisms, should, therefore, have been retained for non-COVID-19 defaults.
Praharsh Johorey is a Law Clerk at the Chambers of Justice RF Nariman of the Supreme Court of India. Views are personal.