Not the Best Solution for Insolvencies

Context – Govt of India passed a resolution to amend the Insolvency and Bankruptcy Code (IBC) to suspend some section of the provisions that trigger corporate insolvency proceedings.

Amended Sections of IBC

• Section 10: provides for a defaulting debtor to itself initiate the insolvency process. 
• Sections 7 and 9: provide for initiation of the insolvency resolution against a corporate debtor by financial creditors and operational creditors, respectively.

Purpose of the Move

• Prevent cash-strapped companies from being forced into insolvency. 
• Despite good intentions, the move is both over- and underinclusive, and requires a rethink.

Impact of COVID on Insolvency

• COVID-19 crisis has realised many companies and its stakeholders the unviability of continuation of operation. 
• Data released by the Insolvency and Bankruptcy Board of India (IBBI) reveals that about 10% of all admitted corporate insolvencies were initiated under Section 10.

Impact of the Amendment

• Domino Effect of defaults: if creditor is unable to exercise remedies against defaulting corporate debtor. 
• Lack of incentive for companies: to clear dues, disrupting the flow of capital in the economy 

• A creditor that does not receive dues from its corporate debtors would be very likely to default on its own debts, and the entire ecosystem would be destabilised.

• Creditor still has the legal right to enforce recovery under other laws, against which there is no reprieve proposed.
• Creditors unable to initiate insolvency against corporate debtors but would be able to drag promoters who have given personal guarantees through the bankruptcy process.

Suggested measures

• Raising the default threshold: to initiate insolvency proceedings to Rs 1 crore to precluded insolvencies against corporate debtors, especially MSMEs.
• Encourage Lending: to allow businesses to meet their dues. 
• Extend the 3-month financial moratorium both in time period and scope: This would allow banks and NBFCs to shift repayment dates as per their discretion and be favourable to further lending activity.