Many struggling firms may be unable to tide over the crisis arisen out of the coronavirus pandemic and could face corporate failure due to cash constraints, recessionary conditions and other external factors. It is precisely in such a situation that a firm should be able to rely on a sound bankruptcy law framework that can assist in reorganising its debts to preserve itself as a going concern, or efficiently wind down the business and return capital to the stakeholders.
The Insolvency and Bankruptcy Code (IBC) provides a creditor-in-possession regime in which a resolution professional appointed by the creditors takes over the management of the corporate borrower, creditors assess the viability of the business and adopt a resolution plan with 66% majority which will be binding on the corporate debtor and all its creditors.
However, despite a regime that gives lenders an upper hand over debtors, the former have often struggled to resolve insolvency cases within the timelines defined under the IBC due to extensive litigation, difficulty in accessing information, and indecisiveness due to the competing interests of different classes of creditors.
For corporate borrowers reeling under the pressures of Coronavirus, it will be critical to be able to seek early intervention and avert insolvency. However, India's insolvency law provides limited ability to corporate debtors to pre-empt insolvency and initiate early resolution.
Under section 10 of the IBC, a corporate debtor can seek restructuring under an insolvency proceeding only upon the occurrence of a default. Even in debtor-initiated insolvency proceedings, the resolution process is controlled by the creditor committee. The founders/promoters are considered to have contributed to the default of the firm and are barred from proposing a turnaround plan to maintain or regain control of the insolvent firm under section 29A.
As a relief to businesses, the government recently announced suspension IBC for a one-year period, and coronavirus-related debt will be excluded from the definition of default under the code. Suspension of the IBC may provide temporary relief against forced lender actions but does not resolve the financial stress on the books of the debtor or lenders.
The coronavirus crisis highlights the need to introduce pre-packaged restructuring within the IBC to have a binding effect on out-of-court negotiated plans. Pre-packs could enable debtors to pre-empt financial stress and negotiate bespoke rescue plans with buyers and lenders while preserving the trading value of the business better.
As the purpose is to encourage the debtor to prepare the business for a sale or pre-arrange a viable restructuring plan for the creditor's approval, all procedures and restrictions under the IBC (that apply to a CIRP process) need not be followed.
The global response to the COVID-19 pandemic is similar -- to temporarily suspend insolvency filings or increase the thresholds to prevent multiple filings. But many other countries also have insolvency regimes that permit corporate debtors to set off restructuring and propose revival options.
It is also important to allow unviable businesses to swiftly wind down their operations and enable stakeholders to recirculate their funds to other ventures. In the current volatile environment, we must destigmatise business failure and accept it as an integral part of a dynamic economy.
The IBC does not permit an insolvent company to file directly for liquidation. As solvency is a necessary condition to file voluntary liquidation under the IBC, companies in which the liquidation value of assets has depleted and is insufficient to pay the debts of the business are not eligible.
The Companies Act provides for voluntary winding up of companies by the NCLT with the approval of shareholders and creditors, but the court process takes a considerable amount of time and cost. Summary liquidation rules were recently introduced under the Companies Act for companies with assets below Rs 1 crore and loans below Rs 50 lakh, or turnover below Rs 50 crore. These companies can apply directly to the Regional Director of Companies and avoid a court filing; however, the process is otherwise similar to a long-form voluntary winding up before the NCLT and does not help in quick dissolution.
There is a need for a more efficient winding up framework to facilitate business closure where it is the only equitable solution to deal with the coronavirus situation. The government has announced that a special insolvency resolution framework for MSMEs will be notified under the IBC soon.
This is a welcome step as a softer approach is desirable for small businesses, which do not have the ability to cope with the crisis. Perhaps the 'fresh start' concept which gives a debt write-off for individuals who are below certain thresholds of income can be extended for a temporary period to micro and small businesses. This can be based on appropriate eligibility criteria like low investment, turnover and debt levels, no instance of fraud or malfeasance, and financial distress attributable to Coronavirus pandemic.
The coronavirus situation calls for a quick and agile turnaround action, and even if for a temporary period, business owners and managements do need more liberty to promptly dive into crisis management and rescue planning in the collective interests of the business and its stakeholders.
(The author is a partner at the law firm Trilegal. Views expressed are personal.)