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COVID-19, IBC suspension and operational creditors

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (ordinance), provides that no application to start a corporate insolvency resolution process (CIRP) in respect of a corporate debtor may be made for any default arising on or after 25 March 2020 for a period of six months, which may be extended to one year, and that no application shall be filed at all for any default occurring in that period of six months. It is therefore important that operational creditors reassess their recovery strategies. These measures are beneficial and intended effectively to divert the cash flow of debtors from financial creditors to operational ones in a bid to address the present lack of liquidity.

To comprehend this, it is necessary to understand how operational creditors would have fared without the suspension of the Insolvency and Bankruptcy Code, 2016 (IBC), especially as the Supreme Court in Committee of Creditors of Essar Steel India Limited v Satish Kumar Gupta has held that most operational creditors are unsecured. Operational creditors are thus ranked just above shareholders under the IBC waterfall mechanism.

The IBC suspension has to be understood in the context of key measures introduced by the government and the Reserve Bank of India (RBI). These include the freezing of asset classification downgrades; the extension by the RBI of the one-time settlement scheme for micro, small and medium enterprises (MSME) to 31 December 2020; the proposed resolution framework for MSMEs under section 240A of the IBC; the boost by the RBI to small industries through a special refinance facility for the Small Industries Development Bank of India, and the RBI’s COVID-19 Regulatory Package. This last measure provides for the rescheduling of payments of term loans and working capital facilities, the extension of the moratorium by financial creditors, and allowing lenders to defer the recovery of interest in respect of cash credit, overdraft and related facilities until 31 August 2020. These measures are all aimed at increasing liquidity and putting back the preference of payments to financial creditors.

The government has not, however, completely reversed the effects of the IBC. Section 10A as inserted by the ordinance provides that the IBC suspension is not a blanket one. Defaults prior to 25 March 2020 can be taken before the National Company Law Tribunal (NCLT) under the IBC.

Many non-performing asset accounts in respect of which the 180-day resolution period in the RBI’s prudential framework expired before 1 March 2020 have yet to be taken to the NCLT. The RBI issued notifications dated 17 April and 23 May 2020 clearly stating that in respect of all other accounts the provisions of the prudential framework shall be in force without any modifications.

For operational creditors, it is necessary to distinguish the defaults in respect of which operational creditors may proceed against the corporate debtor, and those which are now suspended by the ordinance, especially where accounts are maintained and delayed interest is calculated on a running basis.

Despite no express clarification, it is implied that the IBC may be invoked for the resolution of corporate debtors for running defaults up to 24 March, but not for amounts that will accrue for six months from 25 March 2020. Any amount that becomes due from the initiation of the CIRP is excluded from the claim, as held by the NCLAT in Export Import Bank of India v Resolution Professional JEKPL Private Limited. It is therefore crucial that operational creditors ensure that they accurately compute amounts due and in default before 25 March 2020 to avoid unnecessary delay.

A major concern is that some corporate debtors may deliberately default after 25 March 2020 despite not having suffered from the COVID-19 economic onslaught. The option for operational creditors to initiate legal action against the corporate debtor for recovery has, however, not been suspended and this has to be understood against the background that the IBC provides a resolution process not a recovery option.

These measures effectively create an environment in which operational creditors can modify their recovery strategies. They may even resort to appropriate legal measures in the event of non-payment, whether through dispute resolution clauses, conciliation processes, mediation, recovery suits and so on, depending on the circumstances of the case. Most importantly, these measures will not be affected by moratoriums under the IBC and will enable effective recovery, possibly by out-of-court settlements through the rescheduling of payments of the outstanding amounts.

With the correct recovery strategies, operational creditors can strengthen their financial positions during the current crisis because of the environment that has been created by the government and the RBI.

This article originally published at India Business Law Journal: -

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