Suspension of IBC: Is it reasonable? What are the alternatives for MSMES to recover their dues?
SUSPENSION OF IBC: IS IT REASONABLE? WHAT ARE THE ALTERNATIVES FOR MSMES TO RECOVER THEIR DUES?
The COVID- 19 outbreak caused an unprecedented economic slowdown around the world, and India is no exception. The profits of MSMEs have plummeted, and some have even ceased operations. To ease the burden on the MSMEs, the government of India has decided to suspend certain sections of the Insolvency and Bankruptcy Code of 2016 (IBC), for the next six months extendable to a year[i].
Pre IBC era
India implemented the Insolvency and Bankruptcy Code in 2016, and it was the successor to the SICA or the Sick Industrial Companies Act, 1985. SICA was introduced to battle the widespread industrial sickness plaguing the economy in the 1980s. The act defined sick companies as those, which had been in existence for at least five years, and by the end of a financial year, accumulated losses are equal to or more than its net worth. Such companies were unable to pay their debts and, thus, insolvent. SICA laid down provisions to identify such companies and revive them. It was later replaced by the Sick Industrial Companies (Special Provisions) Act of 2003, which aimed at filling the lacuna left by the previous act.
Prior to the Insolvency and Bankruptcy Code, there existed a tedious legal framework which dealt with issues of insolvency and bankruptcy. This included Acts such as SICA, Securitisation, and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFESI Act), Companies Act, etc[ii]. These Acts dealt with insolvency procedures for different types of companies. However, these legislations often conflicted with each other and, thus, made the entire process cumbersome. A better insolvency mechanism was required to promote entrepreneurship and improve the ease of doing business. This led to the establishment of the IBC, which subsumed insolvency related provisions of all the previous Acts and created a single consolidated code.
The IBC has a much wider scope as compared to its predecessors. It makes the process of insolvency and bankruptcy smoother and simpler. It also introduced quicker mechanisms for the completion of the insolvency and bankruptcy procedures. The code prioritizes the interest of the company's employees and balances the interests of all stakeholders. Furthermore, it has created three bodies to improve the functioning of the code, which are the Insolvency and Bankruptcy Board of India (IBBI), the Insolvency Professionals Agency (IPA) and Information Utilities (IU). Therefore, it has created a robust structure to deal with the issues of Insolvency and Bankruptcy in India.
Is the suspension of IBC reasonable?
The outbreak of Covid-19 and the subsequent lockdown has slowed down the economy and is a threat to industries, especially to Micro, Small and Medium Enterprises ( MSMEs). The government of India recognized their peril and thus decided to suspend Section 7, 9, and 10 of the IBC. These sections deal with the initiation of insolvency proceedings by a financial creditor, operational creditor, and the company itself, respectively. The objective of this move is to save companies from insolvency or bankruptcy and giving them respite from immediate repayment of their dues.
Due to the economic slowdown caused by Covid-19, companies are likely to default on their payments. Under normal circumstances, this would lead to the initiation of insolvency proceedings against them. A resolution professional would then, take over the company and its assets and would lay down the criteria by which other companies could take over or support the sick company.
Since this process requires a third party to show interest in taking over a sick company, it will not prove to be successful in the present circumstances. The pandemic has caused a financial crisis due to which companies will not have the resources to finance distressed companies. The lack of investors in a company will force it to go into liquidation. This will mean that all its assets will be sold off to pay back the creditors and other stakeholders.
However, the resale value of assets has also plummeted in the present economy due to which the creditors will not be able to recover the amount due. On the contrary, if the company is allowed to continue, it will be able to exploit its potential and payback its dues. This will prove to be a more lucrative step for the future.
Therefore, the government's move to suspend provisions above of IBC will provide succour, especially to MSMEs. It is also unlikely to cause long term harm to creditors. Providing short term respite to companies will allow them to redeem their losses and repay creditors[iii]. It will also increase the value of their assets which will also profit creditors in the long run. This relief will also give the companies a morale boost to work better to improve their situation.
The fallouts of Suspension of IBC
While the move of the government is welcomed by many, on the flip side, it has also faced criticism. The step aims at preventing a large number of companies from going into liquidation due to non-payment of dues. However, this is deemed to be unnecessary because the government has already increased the minimum amount of default to trigger insolvency proceedings, from the earlier Rs 1 Lakh to Rs 1 crore. By increasing the threshold limit, the government has ensured that a large number of companies don’t go into liquidation, in the absence of assistance from financers. Therefore, both the policies have the same net effect but suspending the IBC invites a barrage of other issues with it.[iv]
Another criticism of this policy was that it does not provide any protection from other recovery laws. For instance, a creditor mostly holds a mortgage over the immovable property of the debtor. Thus, even if a creditor cannot start insolvency proceedings, it can decide to sell the property with minimum intervention from the courts. The SARFESI Act also allows the creditor to take over the management of the debtor's company[v]. Furthermore, Under Part III of the IBC, if promoters and directors have provided a personal guarantee, they may be taken to the insolvency court. Thus, the step taken by the government may prove to be counterproductive if such provisions are not amended.
Furthermore, the suspension of Section 10 of the IBC may hurt the companies more than aiding them. Since now, the company has no way to exit from the market, even if it can no longer carry out its operations successfully. The freedom to exit from the market ensures that resources that are not exploited efficiently can be relocated to more successful endeavours. Therefore, the government has been condemned for its lack of foresight and half-baked planning to help distressed companies.
Alternatives ways for MSMEs to recover their dues
Micro, Small, and Medium Enterprises ( MSMEs) are different from other enterprises. They are entrepreneurial ventures with the local market as their focus. They have emerged rapidly in recent years and are essential to the Indian economy. However, MSMEs are more susceptible to irregularities in the market. The outbreak of the Coronavirus pandemic has especially affected these small and medium-sized enterprises. Unlike big enterprises, MSMEs do not possess the capital and resources to deal with a delay in recovering their dues. Therefore, this sector can go into distress and may collapse. The government has acknowledged its growing concerns regarding the same via press statements[vi]. The statements which released in March and May, have highlighted the importance of MSMEs.
Since the provisions of the IBC have been suspended at present, registered MSMEs can take advantage of the Micro, Small and Medium Enterprises Development Act (MSMED), 2006. This act was formulated to support the development of MSMEs. This act provides an alternative by which MSMEs, including startups, can recover their dues. Under the IBC, MSMEs often had to restructure, which had a major impact on them and their working. However, MSMED Act provides a simpler way for MSMEs to recover their dues and also provides the necessary safeguard to ensure timely payment is made. The speedy process also ensures that there is no loss of operations.
This MSMED act makes a buyer liable to pay the amount due on or before a pre-decided date. If there isn't any agreement between the parties, the deadline to receive payment is within 45 days from the date of acceptance of goods or services. The act provides a safeguard in case the buyer does not pay within the stipulated time. The buyer is made liable to pay compound interest on the due amount, at three times the bank lending rate for any goods or services provided. For example, if the current bank rate is 5% the MSME would be entitled to receive 15% of interest on the due amount. If such amount isn't paid then the enterprise can refer the case to the Micro and Small Enterprise Facilitation Council (MSEFC). The act mandates each dispute to be decided within 90 days from the date on which the case was referred. Thus, creating a stringent framework by which MSMEs can recover their dues.
The MSMED has also updated with time to assist MSMEs. For instance, the act recently developed an online portal for the filing of the applications by the micro and small enterprises that further relieves them from the litigation costs.
Another way in which MSMEs can benefit is if the government decides to introduce a pre-pack restructuring or resolution mechanism for them. While the government announced its decision to suspend sections of the IBC, the insolvency resolution framework for MSMEs is yet to be announced. Therefore, the government may take steps to propose the Pre-packaged insolvency as an alternate solution. Pre-package insolvency is a mix of out of court settlements and formal insolvency proceedings. The process involves both parties, i.e. the creditor and debtor, agreeing on restructuring or investment by the third party, before commencing the insolvency process. This allows for pre-agreed terms, which have the approval of both parties, to be implemented through IBC mechanisms. It is done under the supervision of the insolvency court and is binding on all the stakeholders.[vii]
The IBC disallows promoters of an insolvent company from acquiring it but pre-pack incentivizes the existing management to revive a company. This ensures continuity in business and avoids delays caused by a change in management. Pre-packaged insolvency also reduces the money and time spent on the litigation process. In the case of the US Company, Sungard Availability Services, a pre-packaged insolvency was confirmed within 19 hours, making it the fastest bankruptcy case.
However, in India, Pre-packs may face certain challenges because it puts the debtor in charge of the management of the company. This conflicts with the prevailing model of having the creditors in charge under the IBC. Thus, the structural framework of the insolvency laws will need amendment. Nevertheless, in the wake of the Covid-19 pandemic, pre-package insolvency will strike a balance between the concerns of both debtors and creditors. Therefore, providing the MSMEs with an alternate approach to recover their dues helps them tackle the economic havoc wreaked by the Coronavirus pandemic.
In Conclusion, the government’s plan to suspend the IBC is an affirmative measure. However, unless the policy makers introduce other changes to supplement the move, it may not prove to be successful. Furthermore, suspending the IBC delays the financial trouble that companies are facing but it does not remedy it. The government needs to introduce economic policies which incentivise companies to perform better and thus, boost the economy.
ABOUT THE AUTHOR
Tuhina Sahai is a 5th Year Student at Symbiosis Law School, Pune. She is an aimable person who enjoys meeting new people and making friends. She finds as much comfort in going on outdoor adventures as she does in sitting in her room with a book, sipping tea. She is an avid reader and enjoys the works of authors like John Grisham, Khaled Hosseini, Paulo Coelho, Arundhati Roy, etc. She is passionate about Music and creating Art. She is a highly organised person and enjoys creating schedules and lists for all her daily activates. She has an inquisitive nature and enjoys learning about varied topics. She is an expressive and creative person.
[i] Govt decides to suspend up to 1 year IBC provisions that trigger fresh insolvency proceedings: Report, The Economic Times, 23rd April 2020 available at
[ii] Vidushi Trehan, IBC (Insolvency And Bankruptcy Code, 2016) – The Bankruptcy Law Of India, 26th July 2019 available at https://www.mondaq.com/india/insolvencybankruptcy/829988/ibc-insolvency-and-bankruptcy-code-2016-the-bankruptcy-law-of-india
[iii] Sriram Venkatavaradan, Ramya Subramaniam, Does IBC provisions’ suspension provide intended succour?, The New Indian Express , 11th May 2020 available at https://www.newindianexpress.com/opinions/2020/may/11/does-ibc-provisions-suspension-provide-intended-succour-2141717.html
[iv] Hemant Kothari, The Insolvency and Bankruptcy Code is needed now more than ever, 22nd Arpil 2020 available at https://www.moneycontrol.com/news/economy/policy/policy-the-insolvency-and-bankruptcy-code-is-needed-now-more-than-ever-5176221.html
[v] Hemant Kothari The Insolvency and Bankruptcy Code is needed now more than ever, 22nd Arpil 2020 available at https://www.moneycontrol.com/news/economy/policy/policy-the-insolvency-and-bankruptcy-code-is-needed-now-more-than-ever-5176221.html
[vi] Ministry of Finance, Press Statement , 24th March 2020, available at https://pib.gov.in/PressReleasePage.aspx?PRID=1607942
[vii] With IBC suspended, now pave the way for pre-packaged insolvency, Finance Express, 12 May 2020 available at https://www.financialexpress.com/opinion/with-ibc-suspended-now-pave-the-way-for-pre-packaged-insolvency/1955662/
About the author: Tuhina Sahai is a 5th Year Student at Symbiosis Law School, Pune. She is an amiable person who enjoys meeting people and making friends.An adventure-loving person but also enjoys her time indoors with books. She is also quite keen on planning tasks which she accomplishes by making her daily to-do list.