Lifting the Suspension On Section 10 Of IBC- Need Of The Hour?

By Chirali Jain and Chahak Agarwal, fifth-year students at NLU, Jodhpur

In a recent development, a PIL has been filed by Mr. Rajeev Suri in the Delhi High Court, challenging the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (‘the Ordinance’) by way of which applicability of section 10 has been suspended for a period of 6 months owing to the current pandemic. The petition challenges the Ordinance as it suspends the operation of sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016 (‘the Code’), depriving the corporate applicant of the ability to initiate the Corporate Insolvency Resolution Process (‘CIRP’). Following submissions have been made through the petition to challenge the suspension of the aforementioned provisions:

a. Such suspension in these extraordinary times is “irrational, arbitrary, unjust and mala fide” as it stops a corporate applicant from exercising its statutory rights.

b. It will push the companies towards liquidation, discourage entrepreneurship and defeat the objectives of the Code.

c. Suspension is ultra vires Articles 14 and19(1)(g) of the Constitution of India.

d. It would result in further deterioration of the affairs of the corporate debtor and result in making the restructuring/ revival of the corporate debtor unviable.

The Delhi High Court has issued a notice to the Union Ministry of Law and Justice and Insolvency and Bankruptcy Board of India on July 28, 2020 and sought a reply till August 31 in the matter. 

Background

The current pandemic has impacted small and large businesses in various sectors across the economy. The Government, in an attempt to provide some relief to the distress caused by the pandemic, introduced a slew of changes to the insolvency framework of the country. 

On June 5, 2020, the President promulgated the Ordinance with immediate effect. The Ordinance introduced section 10A to the Code, thereby effectively suspending the operation of sections 7, 9 & 10 and consequently section 14 of the Code with respect to defaults arising on or after March 25, 2020 for a period of six months, extendable up to a maximum period of one year from such date as may be notified. The proviso to section 10A also bars any insolvency application from ever being filed, for any default occurring during the Suspension Period. 

Sections 7 and 9 of the Code, allow filing of an insolvency application against the corporate debtor, by a financial creditor and an operational creditor, respectively, when a default occurs above the threshold limit. Section 10, on the other hand, allows corporate entities to voluntarily file an insolvency application against themselves, where a default has occurred. By giving the corporate debtor the right to approach the adjudicating authority for initiation of CIRP, this provision affords the defaulting entity a chance to revive themselves through the resolution of debt. However, by suspending the applicability of this section, the Ordinance, despite having the aim of protecting corporate entities from creditors, does considerable harm to the corporate debtor.  It takes away the much needed resort, available to the corporate debtor, to subject itself to an insolvency proceeding for resolution of debt or revival of the entity. Moreover, the inability of creditors to file insolvency applications against intentional defaults or for debts that are not linked to Covid – 19, may further impede the flow of financial resources to the commercial sector in India. That said, the Ordinance does not render the corporate debtors and creditors remediless as there are other remedies available to them which are discussed later in the post. By way of insertion of section 66(3), the Ordinance also seems to exempt liability of directors or partners of corporate debtors in case of potential losses to creditors during the exemption period, due to lack of due diligence. However, this may provision may be misused and lead to further deterioration of realisable value for creditors.

It may be observed that the Ordinance protects companies and promoters from liability arising due to no fault of their own. However, the position regarding the liability of promoters is still not clear, owing to the fact that proceedings can still be initiated against personal guarantors.  

Implications Of Suspension Of Section 10

The rationale behind suspending the applicability of section 10 is not clear. Suspending the applicability of section 7 and Section 9 may be seen as a necessary or a justifiable move in order to revive economic activity and provide temporary relief to companies under severe distress caused on account of the Covid-19 pandemic and the national lockdown. However, suspending section 10 has sparked massive debate as move may cause more harm than the intended benefit. This provision has been used as a tool for companies to opt out of the market in times of extraordinary financial distress. This refusal of freedom to companies during this uncertain period acts as an impediment to the fulfilment of the spirit of the Code.

Suspension of section 10 is further detrimental to companies under huge financial distress, whose value of assets is deteriorating rapidly and their only viable option is to file for insolvency. Instead of enabling quick sale of assets so as to realise some value, suspension of this provision will only lead to more problems. A huge influx of insolvency applications could further impede the capital flow of the economy and can bring unexpected economic disruptions during COVID-19 when  ideally the target should be to get the capital flow moving. This move can also affect India’s position in the context of Ease of Doing Business which has been the guiding light for a lot of changes introduced by the government recently.

The suspension also deprives the corporate debtor from exercising the fundamental rights guaranteed under the Constitution. Article 19(1)(g) of the Indian Constitution guarantees every citizen the right to practise any profession, or to carry on any occupation, trade or business. Rights to carry on a business also include rights to start a business, right to continue a business and right to close a business.

In Excel Wear V. Union of India, the Supreme Court held that the right to carry on any business also provides an inherent right to close the business as no person can be compelled to carry on the business in case of losses or other circumstances. The act of the government to close the exit route for the corporate debtor by striking off section 10 of the Code is infringing the fundamental right provided to the corporate debtor under Article 19(1)(g) of the Constitution of India. Moreover, this would only result in keeping the industry alive forcibly to suffer the pain until it collapses.

However, the right to close the business comes along with reasonable restrictions as per Article 19(6) of the Constitution. The Court while considering this right has to take into account the background of the facts and circumstances under which the order was made, the nature of the evil that was sought to be remedied by such law, the ratio of the harm caused to individual citizens by the proposed remedy and to the beneficial effect reasonably expected to result to the general public. It will also be necessary to consider in that connection whether the restraint caused by the law is none than was necessary in the interests of the general public. Here, it is important to note that keeping Section 10 operational would not harm the creditors or any other stakeholders in any manner, thereby not violating public interest.

The Way Forward

The Ordinance has taken the corporate debtor to the pre-IBC era and uses alternative remedies which would defeat the whole purpose of the enactment of the Code. Some of these remedies are application under Section 230 of the Companies Act, 2013, application for recovery of money under Civil Procedure Code, applications under SARFAESI before DRT, bank negotiated restructuring, etc. 

However, even after resorting to these alternative remedies, they would still be less efficacious as the insolvency proceedings under the IBC because (i) the corporate debtor would still be liable to pay through the restructuring of debt despite being in a dubious position; (ii) the benefits of moratorium on legal proceedings would not be available; and (iii) it would have a low binding effect.

An alternative option could be the introduction of pre-packaged insolvency schemes, which are already prevalent in the UK and the US, as an aid to the current insolvency framework. An exception may also be created under the Code with respect to section 29A of the Code, in order to allow promoters to participate in pre – packaged schemes who have defaulted due to economic reasons stemming from the pandemic.  

It will also be beneficial to take a look at the approaches being followed in various countries such as the UK, Australia and Singapore. These countries have managed to keep the doors open for voluntary insolvencies while suspending any action by creditors against the companies in case of default. In UK, wrongful trading provisions of the Insolvency Act have been suspended,  effective from 1 March until 1 June 2020. This change seeks to remove the threat of directors incurring personal liability for ‘trading while insolvent’ during the pandemic. In Australia, due to the provision of voluntary insolvency proceedings, Air Mauritius, second largest airline of the country filed for insolvency. In Spain, companies can file voluntary bankruptcy applications, and in case of pending declarations on voluntary bankruptcy applications, judges might declare insolvency if waiting for too long might cause irreparable damage. Further, Singapore has provided relief by introduction of moratorium against commencement of insolvency of only an affected debtor.

Therefore, it is the opinion of the authors that while suspending section 7 and section 9 is justified, suspending section 10 is an extreme step and is not in accordance with the inherent spirit of the Code. 

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