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Introduction

The outbreak of Covid-19 and the restrictive measures imposed by the governments to control it are causing significant stress on the businesses around the globe. The International Monetary Fund has warned that the world could face the worst recession since the Great Depression of the 1930s. Various entities across numerous industries are facing, or may soon face, an immediate liquidity shortfall. Policymakers all over the world fear that this could push large number of companies towards liquidation leaving thousands of workers unemployed and the insolvency courts over-burdened. Therefore, economies around the globe are taking temporary measures to mitigate this crisis and keep the entities afloat. Part I of this article discusses the various amendments made in the respective insolvency laws of some countries to fight this economic crisis, Part II deals with the relief measures announced by the Indian authorities and Part III concludes by analyzing the future challenges and proposing certain policy recommendations for the Indian insolvency law.

Measures Taken By Different Countries to Mitigate the Risk 

The common trend of measures taken by different countries indicates a shift towards debtor friendly laws. These measures serve twofold purposes; Firstly, allowing the debtors to survive this pandemic and secondly, to ease down the otherwise expected burden on the insolvency courts. 

Suspension of new fillings is one such measure which is being used by the economies to give some ‘breathing space’ to the effected companies. Countries like Russia and Turkey have decided to not allow the filing of new bankruptcy petitions against the debtor while the special provisions are in place due to the pandemic. Along similar lines, Germany has not only suspended compulsory obligation for a company to file for insolvency within three weeks of onset of their illiquidity or over-indebtedness but has also limited the creditors’ powers to initiate proceedings against the debtor. Such relaxations are however qualified by the condition that the problems in cashflow or over-indebtedness must have occurred because reasons related to Covid-19. UK may also introduce a three-month moratorium against creditors’ actions where the company is facing temporary challenges. For similar purposes, Australia has increased the maximum time period to reply to statutory demand from twenty-one days to six months. To avoid insolvency of medium and small scale industries, insolvency laws, all over the world, are being temporarily changed to increase the threshold of defaulted debt at which a company is presumed to be insolvent. 

At this point of time, it is also important for the governments to boost the confidence of the management and allow them to take strong decisions to keep their businesses afloat without the fear of any liability. In various jurisdictions, personal liability is imposed upon the directors for indulging in insolvent trading. These insolvent trading provisions aim to prevent companies from continuing trade while insolvent, and in trading, incurring debts to creditors who are unlikely to receive full payment. These laws are to deter the management from delaying the insolvency and forcing them to initiate the process to restructure their debts. Australia recently passed an appropriate legislation to suspend any liability on the directors for the credit taken in the specified period of time in ‘the ordinary course of business’. The term ‘in the ordinary course of business’ has been widely defined so as to allow directors to take trade credit during the specific period of the pandemic and to also enable them to take loans for ventures like taking their businesses online or paying salaries to the employees. UK and Germany have also suspended provisions imposing liability on the management for wrongful trading or insolvent trading.

Governments are also realizing the need to stimulate financial institutions and other creditors to extend loans to companies facing financial troubles during the crisis. Many countries have provisions voiding transactions entered into with the existing creditors in the specified period (lookback period) leading up to the insolvency of the company. Such provisions prevent undue advantage to any of the creditors during the equitable distribution of the estate. But, these rules tend to discourage creditors to deal with troubled entities. Germany has suspended any avoidance claim for any repayment of a new loan granted and for any collateral granted to secure such loan. 

Czech Republic has taken a step further and allowed for the companies to announce ‘extraordinary moratorium’ for a period of three months.  The move is aimed at protecting companies from insolvency declaration and debt enforcement. Importantly, any credit extended during this period would enjoy super-priority during the repayment. 

United States, which is already a debtor friendly regime, is simplifying the process further for companies facing the crisis. One of the major hurdles in US bankruptcy laws is the absolute priority rule which envisages that unless a class of creditors is paid in full, no lower class of creditors or shareholders could recover anything. For a small enterprise, ownership is an essential element for its continuous operation. The Small Business Reorganization Act relaxes this rule and further provides for an easy and cost-effective path to reorganization of the business enterprise. The CARES Act further tends to provide these benefits to an amplified number of companies by temporarily increasing the threshold value from $2,725,625 of debt to $7,500,000.  

Indian Efforts

India has seen some of the harshest lockdowns in its fight against Covid-19. Different authorities are continuously working together to give much required relief to companies/business enterprises during the crisis. The Central Bank has allowed banks and other financial entities to grant a three-month moratorium on payment of all term loans, outstanding as of 1st March 2020. Further, it also allowed for a moratorium on ‘interest on working capital facilities’ availed in the form of cash credit or overdraft falling, due between 1st March 2020 and 31st May 2020 and permits such interest to be paid immediately after the completion of the moratorium period. The government also increased the threshold of default amount from existing one lakh rupees to one crore rupees. The regulatory authority further amended the regulations to exclude the period of lockdown while calculating the period within which a company is required to be resolved under the code. As per reports, the cabinet has also approved the suspension of Sections 7, 9 and 10 for a period of six months extendable to the time the government deems fit.

Challenges and Recommendations

The Indian economy was already suffering from the problem of bad loans, before this lockdown further made many to suffer from an abrupt cut-off in cash flows, further hurting their ability to service loans. The country still awaits a comprehensive bail-out plan for industries, specially the MSME sector, which have been majorly affected by the crisis. 

One of the measures expected to be a part of the plan is the suspension of Sections 7, 9 and 10 of the Code. At the same time, it must be noted that a blanket ban on any fresh insolvency petition could be detrimental to the economy. Suspending even voluntary insolvency process under Section 10 for a period of six months could actually delay a possible relief for businesses which cannot be revived otherwise and force them towards liquidation with little or no recovery.  Further, taking a cue from German law, it is proposed that all reliefs available to creditors under Sections 7 and 9 of the Code should be suspended except if; (i) the company is facing a crunch in cash flow due to reasons not related to Covid-19 or (ii) the company has ‘no prospect of eliminating the insolvency’. The law should contain a refutable presumption for the blame of insolvency on reasons related to Covid-19. A further safeguard for otherwise financially viable firms could be added by temporarily lowering the voting majority required to withdraw the process to 75% from the current 90%.

Another challenge likely to be faced by corporate borrowers is the lack of new debt. Following the global trend, the government should consider temporary relaxations in the provisions allowing for avoidance of preferential and undervalue transactions.  Section 66 of the Code, which deals with fraudulent transactions would ensure that the relaxations are not used with bad intent. Further, to incentivize the creditors to extend monies during the time of crisis, repayment of such loans should be given ‘super priority’ during the distribution of estate after liquidation. 

Moreover, experts also envisage a lack of potential bidders to revive the companies. In India, this would be aggravated because of the disqualification of a large number of promoters under section 29A of the Code. In that light, it is suggested that temporary relaxations should be allowed under section 29A. It would be unfair to promoters who have lost or will lose their companies because of this pandemic (which in all terms, is a force majeure event) not to be given a second chance to get control of their respective companies.

Further, reports suggest that because of the ongoing uncertainties, potential buyers who have submitted their final bids or whose plans have been approved may pull out of the same. The current economic fallout could also impact their ability to fulfill obligations in the time lines mentioned under the resolution plans of the entities resolved before the pandemic. Special provision should be incorporated to allow such resolution applicants to apply for the revised bids and timelines to the adjudicating authority.

Lastly, it must also be mentioned that the functional disruption caused by the current crisis would also overburden the adjudicating authorities. This could cause a failure to resolve effected companies in a time bound and cost-effective manner. Therefore, the government should push towards restructuring the debts outside the formal insolvency process. Inter-creditor agreements and provisions for pre-pack insolvency along with the moratorium period would be some appropriate steps in the direction.

(Harshit Agrawal is a part of the Editorial team and a third year BA LLB(Hons) student at Dr. Ram Manohar Lohiya National Law University, Lucknow)


Cite as: Harshit Agrawal, ‘Covid-19 and Insolvency Laws: Steps Taken and Way Forward’ (The Contemporary Law Forum, 03 May 2020) , <http://tclf.in/2020/05/03/covid-19-and-insolvency-laws-steps-taken-and-way-forward>, date of access.

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