Suspension of IBC okay, but there’s scope for further fine-tuning

ECONOMY/ GOVERNANCE

Topic: General Studies 2,3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. 

Suspension of IBC okay, but there’s scope for further fine-tuning

Context: On 5th June 2020, an Ordinance was promulgated dealing with Insolvency & Bankruptcy Code (IBC)

About Insolvency & Bankruptcy

• Insolvency is the situation where the debtor is not in a position to pay back the creditor. 
• For a corporate firm, the signs of this could be a slow-down in sales, missing of payment deadlines etc. 
• Bankruptcy is the legal declaration of Insolvency. 

Need of Insolvency & Bankruptcy Code (IBC)

• Earlier the issue of insolvency was handled under at least 13 different laws and hence a unified code was essential.
• Earlier, if a company defaults, there were at least four different legal routes available to the debtors and creditors – the high courts, the Company Law Board, the Board for Industrial and Financial Reconstruction (BIFR), and the Debt Recovery Tribunals (DRTs)
• This could lead to multiple negotiations, multiple penalties etc. for the debtor, compounding his plight.
• This situation was compared to the Chakravyuh – where companies can easily enter but difficult to exit
• In the background of rising NPAs, the easing of liquidation process can help the banks recover a lot of bad debts

Salient features of the Insolvency and Bankruptcy Code:

• IBC was thus enacted in 2016 for reorganization and insolvency resolution of corporate persons, partnership firms and individuals in a time bound manner for maximization of the value of assets of such persons
• IBC Code 2016 covers all individuals, companies, Limited Liability Partnerships (LLPs) and partnership firms.
• The adjudicating authority is 
  • National Company Law Tribunal (NCLT) for companies and LLPs 
  • Debt Recovery Tribunal (DRT) for individuals and partnership firms.

• Insolvency Professionals: A specialised cadre of licensed professionals is created. These professionals will administer the resolution process, manage the assets of the debtor, and provide information for creditors to assist them in decision making.

• Insolvency and Bankruptcy Board: The Board will regulate insolvency professionals, insolvency professional agencies and information utilities set up under the Code.  The Board will consist of representatives of Reserve Bank of India, and the Ministries of Finance, Corporate Affairs and Law.

Working of IBC

• It has led to resolution of 221 cases with a 44% recovery rate
• As compared to other options, banks are recovering much better through IBC
• The credible threat of the IBC process, that a company may change hands, has changed the behaviour of debtors. 
• Thousands of debtors are settling defaults at the early stages of the life cycle of a distressed asset.

Why do we need changes in IBC now?

• The nearly two-month lockdown imposed to contain COVID-19 brought much of the economic activity to standstill
• This impacted the business operation of firms which negatively affected their revenues and hence their debt repaying capacity
• The financial stress faced by debtors may lead to defaults. This situation called for dilution/suspension of IBC so that insolvency proceedings are not initiated for such unexpected defaults

What were the provisions of June 5th Ordinance?

• It barred initiation of the corporate insolvency resolution process for defaults committed within six months (extendable up to one year) from 25th March 2020.
• The Ordinance also clarifies that no application can ever be filed in respect of such defaults, thereby, giving a permanent immunity to such defaulting companies under the Insolvency Code.

Critical analysis of suspension of operation of the Insolvency code

• Blanket time-specific embargo: Instead of identifying a criterion based on which relaxations could have been granted, the government has completely suspended the system.

• No option of restructuring: The absence of criteria and its linkage to the suspension of the insolvency resolution process may actually cause more harm to the businesses, as the Insolvency Code will no longer remain available for restructuring of stressed assets of firms

• Misuse: If an entity was already under stress and started making defaults in ordinary course after March 25, they will be able to take shelter under the newly instituted Ordinance even when the root cause of the default may not relate to the global pandemic.

• Against Freedom of Business: The SC, in its judgments, has categorically stated that the ability to start and end business is a constitutional right, and, therefore, it cannot be taken away. Still, the Ordinance takes away the right of a company to initiate insolvency proceedings against itself.

• Other options still available: Creditors can still take recourse to other methods and means to recover dues or prosecute the defaulting companies, like enforcement of a SARFAESI or initiation of arbitration or other legal proceedings.

Conclusion

• The government could have considered providing an effect- or impact-based immunity.
• The government should also consider enacting special pandemic legislation through which an immunity akin to the moratorium granted under IBC, is afforded to businesses that can prove pandemic-related stress

Connecting the dots:

• Bad Bank – Critical Analysis
• Twin sheet problem