In view of the outbreak of the pandemic Covid-19 affecting businesses and economies globally, and in light of the nationwide lock down in India due to the same, the Finance Ministry of India on 24.03.2020 had announced certain specific reliefs packages for companies under the Companies Act 2013 as well as the Insolvency and Bankruptcy Code, 2016. The same was followed by a notification[1]. This change will have a major impact on several stakeholders and the same is assessed herein.
The existing threshold limit provided for under Section 4 of the Insolvency and Bankruptcy Code, 2016 of Rupees One lakh to trigger insolvency proceedings has been raised to Rupees One Crore by way of a notification by the Central Government. The Central Government is of the opinion that raising of the threshold limit will prevent triggering of insolvency proceedings against small and medium enterprises that are facing currently the heat of coronavirus pandemic, thereby effectively safeguarding the interests of Micro, Small and Medium Enterprises (MSME’s) in these times of strife. Also, there have been views stating that this revised threshold limit being put in place may not just be temporary, but in fact may be permanent. This of course only time can answer.
It ought to be noted that in the recent past, as early as February 2020[2], the Insolvency Law Committee in its 3rd Report had recommended an increase in the threshold limit for initiating proceedings under the Code. Thus the same had been envisaged and had been in the pipelines for some time now. A relevant extract from the Preface of the aforesaid report reads thus:
“Threshold for calculating default-due to the low threshold of default of INR 1 lakh that is currently required under the Code for initiation of CIRP, a large number of applications were being filed for initiation of CIRP. This has led to an increased burden on the Adjudicating Authority. Therefore, a need to review the minimum default threshold for admitting a case under Section 4 the Code was felt, and in this respect, it is recommended that it would be appropriate to notify a higher default threshold of INR 50 lakhs. However, it was considered necessary to provide certain exemptions to the MSME sector and accordingly, modified threshold limits have been specifically recommended for MSMEs.”
The Ministry of Finance has also via its memorandum (No. F 18/4/2020-PPD) dated 19.02.2020 has clarified that the pandemic Covid-19 would come under an extraordinary event or circumstance beyond human control and stated that the Force Majeure Clause maybe invoked for Covid-19 wherever considered appropriate.[3]
This decision being taken by the Ministry of Finance is most likely being made in the long term vision considering the fact that parties who have entered into contractual obligations in their respective businesses shall be unable to fulfil the same, particularly since time is of essence in most contracts. In the background of the economic slump across multiple sectors in the country and with the pandemic COVID 19 wreaking havoc in India in such a big manner leading to more or less of a lockdown of officially for 21 days w.e.f. 25.03.2020. However, it is to be noted that even before the notification dated 24.03.2020 of the country-wide lockdown was announced several states had gone into a lockdown mode of sorts and closed its borders. It is also pertinent to note that businesses across multiple spectrums had also begun slowing down almost a week prior to the main lockdown. This has and will continue to have a contagion effect across various sectors in the economy considering the fact that most of them are interdependent on each other.
The most benefitted sector would obviously be the MSME’s, who are facing insolvency situations in case of defaults of payments of amounts lesser than Rs. 1 crore to operational creditors wherein technically they were not in insolvent situation but under liquidity crunch & crisis which obviously gets aggravated once there is a spate of insolvency petitions filed against them by operational creditors who are primarily unsecured trade creditors.
The introduction of Insolvency and Bankruptcy Code, 2016, certainly did bring in a depression amongst MSME’s. However, there were constant representations to the government as a result of which certain relaxations for promoters of these companies even in the background of there being able to come in as Resolution Applicants to propose restructuring plan/revival plan for their own companies were brought in. It is to be noted that this option was not available for other promoters who were not in the category of MSME.
Having said that, the statistics of IBBI[4] show that the Resolution : Liquidation ratio under the IBC had been about 1:4, hence a lot of companies in the MSME sector were being hit. It is to be noted that once insolvency proceedings commence; a lot of aspects tend to go out of control, i.e., the promoter loses his position; uncertainty looms over employees in the business; lenders are reluctant to take haircuts; Insolvency Professionals not being domain experts face challenges apart from other issues such as non-cooperation on part of the erstwhile management etc.
While this move of increasing the minimum threshold is being certainly appreciated by MSME’s it would be unfair to completely ignore or turn a blind eye to the concerns of lenders – Banks/NBFC’s and other financial and operational creditors. The raising of the threshold limit is a big decision and while more or less a lot of people were of the view that Rs 1 Lakh in today’s times was too less a value; Rs 1 Cr is now being seen as too high an amount by certain sections of stakeholders and their general tenor and pulse is that it could have been a possible midway amount like Rs 25 lakhs or Rs 50 lakhs. The reason for the same is that in all the prior regimes, while money recovery suits were extremely time-consuming and not effective; even cases of winding up had a threshold of ₹ 1 lakh. Hence now operational creditors whose dues are below ₹ 1 crore are left remediless as the winding up provisions have been scrapped and the only option for them is to go for money recovery suits if the amount is below Rupees 1 crore.
The general tendency of businesses to default in making payments to trade creditors was slowly coming down and there was certain sense of financial discipline that was coming in to the business models which will again be affected now in light of the recent developments. The use & misuse of the provisions of the IBC has been a much debated and controversial subject with different school of thoughts sticking to their respective strict points – one taking the view that this brought in a sense of seriousness and business discipline while the other stating that this had become a tool of threat and recoveries of money and ultimately led to a lot of good companies going into insolvency when actually they were in a solvent position and suffering nothing beyond the mere liquidity crisis which they could have come over had they been given time.
The other sector which will have serious concerns is that of the NBFC’s and other unsecured financial lenders whose loan amounts are less than the new threshold. Such lenders will also be constrained to only move to the civil courts given that most of them cannot approach the DRT’s (not that the process is any faster there); but this handicaps them as it narrows down the recourses available and puts them in a financial strain and as far as NBFCs are concerned, they will have to figure out as to how will they manage their NPA’s as companies will become relaxed once again in terms of repayments.
The Finance and Corporate Affairs Minister of India, Mrs. Nirmala Sitharaman also stated that the Government may also consider suspending the trigger provisions under the Insolvency and Bankruptcy Code, 2016 in case the current situation following the outbreak of the COVID-19 continues to remain beyond 30.04.2020. Sections 7, 9 and 10 of the Code might be suspended for a period of six months in case the current situation shows no improvement.
Again, if the suspension cited supra materializes, it largely appears to be good news for corporate entities, including MSME’s as this will give them a breathing period to revive and focus on the business without the worry of being pushed into insolvency either by an operational or a financial creditor. But one will have to also take into account the perspective of the bankers and their concerns and challenges. It might be really difficult to once again implement the financial discipline that were just starting to be seen amongst several companies which were in the default category; but as they say extraordinary circumstances call for extraordinary measures; this could be seen as one of them and hence at this moment commenting against the same might be premature. It would be advisable to discuss this matter once the government officially takes a call on this post 15.04.2020.
The anti-thought of the above is that when the same banker had been patient enough to allow the company to go to a level where it became a bad account and ultimately a Non-Performing Asset, they can wait for another six months and not make it appear as though the heavens will fall if the trigger of insolvency is withheld to allow the companies to revive which on a larger scale may assist the resuscitation of the economy. However these relaxations should not be seen as a precursor to withdrawal of the Code itself; as this is one piece of legislation which has been most effective and has led to recoveries of more than Rs 4 lakhs Crores; as per earlier statements of the very same finance minister. If withdrawal is going to be the case, then we are headed for some serious concerns and problems in the coming years.
By Anant Merathia, Poornima Devi & Priyanka Verma – Anant Merathia and Associates.
[1] https://www.ibbi.gov.in/uploads/legalframwork/48bf32150f5d6b30477b74f652964edc.pdf
[2] http://www.mca.gov.in/Ministry/pdf/ICLReport_05032020.pdf
[3] https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf