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The suspension of the Insolvency and Bankruptcy Code proceedings is grounded in preventing many liquidations which could burden the National Company Law Tribunal process, putting further stress on the efficacy of its functioning. However, the move glosses over some structural issues inherent in the framework and preamble of the code.

Further, with IBC proceedings suspended and Covid-19 induced insolvencies on the rise, firms and banks will remain in want of channels to restructure their debt and effectively deal with debt exposure and non-performing assets, respectively. Thus, the time is opportune to revisit and implement reforms centred on strengthening debt restructuring and resolution outside the ambit of the IBC, formal mechanism for which is missing.

The Announcement

On May 17, Finance Minister Nirmala Sitharaman announced that insolvency proceedings be suspended for one year, in pursuance to cabinet decision a fortnight back. This is being done by suspending IBC Sections 7,9,10 which relate to the triggering of insolvency proceedings by a financial creditor, operational creditor, and debtor (voluntary insolvency), respectively. The minister also announced that a special insolvency resolution framework for micro small and medium enterprises will be notified under Section 240A of the IBC. In addition, Covid-19-related debt will be excluded from the definition of “default” under the IBC for the purpose of triggering insolvency proceedings. Earlier, in March, the Ministry of Corporate Affairs had increased the minimum default limit for accepting cases under the IBC from a meagre sum of Rs 1 lakh Rs 1 crore through a notification.

Why Suspend The IBC?

The suspension of IBC proceedings is founded on the principle that Covid-19 is an external variable that does not allow “business as usual”. Inevitably, several businesses will face distressed conditions, due to cash-flow issues and default on their debt obligations—leading to a higher number of liquidations. There is also the underlying understanding that many necessities of the corporate insolvency resolution process—such as interim financing for insolvent assets, time-bound resolution process, and a “creditor in control” model may not be easily met under the present Covid-19-induced conditions. Another concern is an overburdened NCLT which hears all cases related to the IBC, besides other corporate cases.

A Cookie Cutter Solution

The suspension does not necessarily solve many problems as much as it merely puts them on a back-burner and buys time for inevitable decisions. Even though a large number of cases will avoid the NCLT for now; one can anticipate greater volumes of IBC cases once the suspension is lifted unless there are material monetary policy move and/or another dosage of liquidity-inducing stimulus measures. Similarly, suspending the IBC to prevent liquidations may prove counter-intuitive as firms that could have restructured under the IBC will now be pushed into liquidation. For firms that may not immediately meet the fate of liquidation, there will be deterioration in value as the longer a firm continues to remain distressed, the harder it is to make it viable.
The high number of liquidations and an overburdened NCLT pre-date the onset of Covid-19.

Per the December 2019 Insolvency and Bankruptcy Board of India quarterly [pre-Covid-19 data], 22 percent of the cases admitted for the CIRP were recommended for liquidation against only five percent cases being closed through a resolution. Further, the average timeline for case resolution was over 350 days for all cases resolved. Considering that the case resolution delays related to the IBC and NCLT are persistent, the need for reforms creating robust outside restructuring processes to handle insolvencies has been underscored before, including in our India Reforms Scorecard 2019-24. With IBC suspended, this is an opportune time to implement these reforms.

Strengthening Outside Restructuring

Until now, NCLT-led resolution within the ambit of the IBC has been the predominant method of debt restructuring and resolution.

Bank-led resolution was introduced through the Reserve Bank of India’s Prudential Framework for Stressed Assets (June 7 circular). As per the circular, the primary lending bank can attempt resolution before filing for formal insolvency proceedings. This mechanism becomes important now as it allows resolution at the bank-level. However, the bank-led resolution only covers RBI- regulated creditors, thwarting resolution in many cases—as creditors can come from different classes and may not always be banks and non-banking financial companies. Thus, there is a need to institute a framework that ensures time-bound resolution amongst all classes of creditors at the bank or pre-insolvency proceeding level. Banks should also embrace a leadership role and not be averse to bank -led resolutions owing to fear of later investigations.

“Other channels also need development and strengthening.

Recognising this need even in pre-Covid-19 times, the Sunil Mehta committee in 2018 presented a five-pronged plan for NPA resolution called Project Sashakt. Importantly, it advocated for other resolution processes which can be particularly helpful today:

SME-Led Resolution: The plan suggested that loans up to Rs 50 crore or $7 million will be handled using a template approach supported by an SME steering committee. The government is yet to notify the announced special insolvency resolution framework for MSMEs. It will be interesting to see if any inspiration is taken from earlier proposed ideas of quick and timely resolution, which remain untested

AMC-Led Resolution: The idea here is to turn around delinquent firms through mergers and acquisitions facilitated by a fund. The government did set up a Sashakt India AMC, however, it was never operationalised. In present circumstances, the government can back and fund this asset management company while also roping in money from foreign funds who have an appetite for large deals in the distressed asset class. This could dovetail with the Finance Minister’s announcements last week wherein a sum of Rs 20,000 crore has been allocated for the subordinate debt of 2 lakh SME’s which fall in the banking systems as NPA class or stressed situations. Minister Sitharaman specifically highlighted that it was also to deal with stressed situations. If this works well, allocations can increase and this alone shall help insolvencies in the MSME sector.

Asset Trading Platform: An asset trading platform creates an exchange for trading distressed or delinquent companies. The Indian Banking Association was rather enthused about this idea at one point and the move can help banks offload large exposures. It will also help develop a secondary market for such assets and enable mobility and price discovery of the said assets. It is worth noting that most developed markets have similar asset trading platforms.

“ Instituting robust outside restructuring processes was a pre-Covid-19 requirement. However, with Covid-19 induced insolvencies, distress on the rise, and the IBC suspended – it becomes even more time-critical.

The time is now to create and strengthen outside restructuring processes for salvaging maximum value. This will ensure timely resolution under normal times and prevent mounting insolvencies and bankruptcies during these abnormal times.

As India shares economic duress with the world, regulatory changes must be thoughtful, somewhat-flexible, and reasonable. Putting a full-stop to a resolution system is a slapdash answer to a deeper problem. It is a delaying tactic that offers little obvious long-term benefit. Instead, the government should assess the deeper structural changes to its insolvency framework which have already been vetted and debated. Most of the pre-Covid good ideas make even more sense during, and post-Covid.

Mukesh Butani is Managing Partner at BMR Legal and a Senior Associate at the CSIS Wadhwani Chair in U.S.-India Policy Studies. Kriti Upadhyaya is a Research Associate with the CSIS Wadhwani Chair in U.S.-India Policy Studies at Washington D.C. Views are personal.

The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.

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