COVID's impact on Insolvency and Bankruptcy Proceedings

Now with the increasing number of cases of Covid-19 in India, the economy is facing a major turmoil thereby resulting in a slowdown.

April 09, 2020 8:24 IST | India Infoline News Service
coronavirus bull and bear
Government initiatives to ease insolvency in the times of Corona virus

An office memorandum dated February 19, 2020 was issued by the Ministry of Finance, (Department of Expenditure, Procurement Policy Division) which stated that disruption of supply chains due to coronavirus in China, or any other country was to be treated as a natural calamity and force majeure clause may be invoked as a consequence, wherever considered appropriate after following the due procedure as mentioned in the memorandum. This was one of the initial steps taken by the Government.

Now with the increasing number of cases of Covid-19 in India, the economy is facing a major turmoil thereby resulting in a slowdown. The Government of India with a view to majorly protect the Micro, Small & Medium Enterprises ('MSMEs') from being pushed into insolvency during these tedious times has amongst its other economic measures now by its notification dated March 24, 2020 specified that with immediate effect the default threshold amount in order to trigger the insolvency process under sections 7, 9 and 10 under the Insolvency and Bankruptcy Code, 2016 ("Code") be increased from 1,00,000 to 1,00,00,000. The notification could be a relief to the MSMEs in this time of crisis.

The Government has also indicated that in the event the Covid-19 pandemic is not curbed, until April 30, 2020 then in that event, the Government may also consider suspending filing of new proceedings under sections 7 (application by a financial creditor), 9 (application by an operational creditor) and 10 (application by a corporate debtor) of the Code for a period of six months.

The Government, having ordered a temporary lockdown across India to control the spread of the pandemic and the economy virtually coming to a partial shutdown, the aforesaid moves by the Government is indeed laudable considering the present situation.

Understanding the impact on the operational creditors with the increase in basic threshold for IBC

Preceding to the aforesaid notification dated March 24, 2020, the Insolvency Law Committee’s recent report in February, 2020 ("Report") had already recommended that it would be appropriate to notify a higher default threshold of 50,00,000 to trigger the insolvency proceedings under sections 7 and 10 the Code. The Report had also suggested that for invoking insolvency, by the operational creditors under section 9 of the Code the minimum threshold should be increased to 5,00,000.

The Report noted that due to the low threshold of default, a large number of applications were being filed for initiation of CIRP. This large number of applications is adding pressure on judicial infrastructure, which is causing delays both at the stage of admission and during the CIRP. Operational creditors have been dragging companies into insolvency only with a view to recover its claims due to the low threshold.

Due to the low threshold for default, there is a chance that solvent debtor companies were also being pushed into the CIRP.

The primary reason for the success of the Code for operational creditors is due to its speedy nature of the proceedings which provides a faster mechanism as to non-payment of dues as compared to other remedies available in law.

In the event, after the pandemic situation continues to be at its increased threshold of Rs 1,00,00,000 it may to a large extent drastically effect the interest of smaller creditors. The way forward could be that the operational creditors could invoke insolvency with a threshold for 5,00,000 as suggested, or have an effective mechanism under the Code, which will provide for easy and cost-effective mechanism for small scale creditors.

Pros and cons for increasing the threshold and if this could lead in a reduction of the filings done for IBC:


Small operational creditors with a debt for Rs 1,00,000 would file applications before the Adjudicating Authority seeking insolvency of a debtor solely with a view to pressurise debtors to repay their dues would now be curbed;

By virtue of less filings, the Adjudicating Authorities will be de-clogged to some extent across India; and will be able to expedite the matters currently on hand, including but not limited to hearing of the resolution plans, disposing off matters etc and All of the above will consequently also reduce the burden on NCLAT and Hon’ble Supreme Court of India.

Qua the other remedies available in law, the Code has been a blessing in disguise so far as the operational creditors are concerned. The Code is shown to be an expediated remedy tool in the hands of the operational creditors and also a cost effective one.

Owing to the quick disposal of cases under the Code, it not only reduces the legal costs, but also increases the likelihood of settlement of claims, unlike the other mechanisms available under law.

If the increase in the threshold under the Code is made perpetual, it would be causing a lot of unrest among small operational creditors, MSMEs etc, since they would not be in position to drag the corporate debtors into insolvency due to the higher threshold of more than 1,00,00,000.

The debts owed to small operational creditors, MSMEs etc are relatively smaller amounts and in many cases may not be 1,00,00,000 or more.

The small creditors would then be constrained to invoke certain other remedies available to them under law like arbitration, summary suits, and possibly also seek redressal under the Micro, Small & Medium Enterprises Development Act, 2006 which was introduced to solve the problem of delayed payments to MSMEs.

How will COVID-19 impact ongoing and future proceedings?

From the prospective of on-going insolvency matters before the respective Adjudicating Authorities the same may be expedited, since new filings will be curtailed, owing to increase in threshold limit.

For future proceedings under insolvency, only time will tell the impact of Covid-19 on such matters. Especially as the Government will be deciding the further course of action; including the possibility suspending future filings to be done under sections 7, 9 and 10 of the Code.

Matters which are currently at the stage of issuance of the demand notice and where obviously the increased threshold criteria are met, the debtors in all likelihood will respond to such demand notices citing the force majeure event for non- payment. Will such a plea for force majeure be construed as a “dispute” within the contours of the Code? This will be an interesting debate.

How can debtors use this period to restructure their debt and reorganise their affairs?

Reserve Bank of India vide its circular dated March 27, 2020 titled, Covid-19 – Regulatory Package granted a moratorium of three months on payments of all instalments falling due between March 1, 2020 and May 31, 2020. This was indeed a major amnesty given to the common man.

Payments instalments including home loans, auto loans, agricultural term loans, etc to their names. It will also be applicable on credit card dues. The only caveat being that that interest will continue to accrue on the outstanding portion of the loans during the moratorium period.

In addition, the RBI has also clarified that the rescheduling of payments will not qualify as a default.

There will be no risk of the account being classified as a non-performing asset.

Non-payment of EMIs for the next three months will also not impact the credit history of the beneficiaries.

In our view, the debtors during this pandemic may consider handling their financial affairs;
focus on their employees to avoid lay-offs, salary cuts etc.

Debtors should consider commencing reviewing their commercial agreements with parties in order to review the rights of such parties, including termination, force majeure etc.

The review would enable the defaulting parties to take swift action; and adequate notice can also be given to the non-defaulting party.

Whether or not, Covid-19 is likely to be considered as a force majeure defence under every contract? Well that will depend on the wordings of such a clause in a contract which may vary on a case to case basis.

Authored by Devesh Juvekar, Partner and Dikshat Mehra, Principal Associate, Rajani Associates.

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