When IBC is Suspended – What Happens Next


India, like the whole world, is suffering from an unprecedented economic downturn, as it owes its genesis to a virus. The spread of the novel coronavirus has led to a complete lockdown of all business establishments which has struck at the heart of our economy. Industries have had to deal with a disruption in supply as well as a slowdown in demand. Sectors such as hospitality and aviation are and will be severely affected due to people’s reluctance to engage in such activities and will likely experience stress. The unfortunate byproduct of this slowdown will be increased stress and failures for Indian businesses.

The government has decided to suspend for six months the provisions of the Insolvency and Bankruptcy Code 2016 (IBC) which trigger this process of corporate insolvency resolution against insolvent corporate debtors. After examining the situation, the six-month period can be extended to twelve months. This means that for a period of six to twelve months, creditors will be prohibited from initiating insolvency proceedings against debtor companies. The intention of this relaxation is to provide relief to corporate debtors, already struggling with routine circumstances, from the specter of the IBC.

Hanging the IBC – His movement?

Although the decision to suspend IBC has already been made, it must be said that suspending IBC may not be the best decision in these circumstances. IBC is not a draconian law. This is holistic legislation aimed at recovery and does not penalize or oust promoters unless they have been running a company that is a non-performing asset for a significantly long period or have failed to their warranty obligations. During this turbulent time, BAC would have provided a valuable opportunity for corporate debtors and their promoters to resolve their defaults in a way that met the interests of all categories of their stakeholders and did so within a specified time frame.

Alternatives to IBC

Despite the government’s decision, in the coming times stress in the Indian economy is expected to increase along with defaults. Creditors who will not benefit from the IBC would turn to other available mechanisms to remedy defaults. The most common route used in this scenario would probably be the Prudential Framework for Resolution of Stressed Assets released by the Reserve Bank of India on June 7, 2019 or the June 7 framework. This framework applies to commercial banks, large non-bank financial corporations, all term financial institutions of India, small financial banks and, in a key aspect, asset reconstruction companies. This includes a wide range of creditors who are likely to be the source of business credit.

Creditors who do not benefit from the June 7 framework can turn to other recovery mechanisms in the event of default. Recovery would generally depend on whether or not the creditor has security in connection with the loan granted. The Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest Act 2002 (also known as the SARFAESI Act) is the most preferred means of enforcing collateral, but access to it is limited to a restricted group of creditors. Foreign portfolio investors may benefit from the security enforcement provisions of the SARFAESI Act if they have lent under secured debentures.

Creditors who do not benefit from the SARFAESI law or who are unsecured and operational creditors with an unpaid operational debt have the possibility of taking legal action or arbitrating to obtain the recovery of their debt according to the disputes provided for in their contract. Needless to say, with these two options, the payback period is long while the capital remains tied up.

June 7 frame

In the event of default, the preferred option of the debtors’ promoters would be to reach a settlement under the aegis of the June 7 framework agreement. Despite the availability of other options, creditors may prefer this option in order to reach consensus with the promoter and avoid litigation.

The June 7 framework requires lenders to carry out a prima facie examination of the debtor in the event of default and decide on the future course of action which may be the formulation of a resolution plan or even the initiation of legal proceedings. insolvency or recovery. If the lenders decide that formulating a resolution plan is the best strategy, then they must enter into an inter-creditor agreement which governs their inter-creditor relations on how to agree and approve a resolution plan and provides for a related status quo provisions until the plan is implemented, etc. Asset recovery companies are not covered by the June 7 framework but are required to enter into the intercreditor agreement. Lenders not covered by the June 7 framework are not required to enter into the intercreditor agreement and should do so voluntarily. Their entry into the inter-creditor agreement may be affected if they are governed by different sector regulators and have different considerations compared to the remaining pool of creditors. More importantly, commercial creditors or government authorities cannot be a party to the intercreditor and participate in the debtor company’s resolution plan even if the debtor company owes them money. This would mean that any resolution reached as part of June 7 would provide only partial relief to the debtor and could be impacted by collection actions taken by the company’s other creditors who are not bound by the terms of the recovery plan. resolution.

A popular means of resolution within the June 7 frame may involve selling banks’ exposure to asset reconstruction companies (ARCs), followed by rebuilding that exposure outside the June 7 frame. Adopting such a structure would also allow private equity investors to participate in the restructuring of distressed debt by investing in securities issued by the ARC. Subsequently, these investors and the CRA of their choice can enter into an agreement with the distressed debtor’s existing promoters to resolve the problem. This would give sponsors greater flexibility over the IBC process in resolving their businesses’ stressed debt. However, a key question is whether this route would be as time efficient as the IBC process is in resolving the debtor crisis situation. Furthermore, as with the June 7 framework mentioned above, this would not lead to a full resolution that meets the requirements of all classes of creditors. The needs of operational creditors would not be met, and these creditors would then have the option of waiting for the IBC provisions to come back into force or trying their luck in litigation or arbitration.

SARFAESI and litigation

Lenders benefiting from a guarantee may seek to collect their outstanding debts by imposing a guarantee under the SARFAESI law. Unsecured lenders and operational creditors would seek to recover their claims through arbitration or litigation. In both of these cases, the chances of the debtor company and its promoters challenging the creditors’ action are high, which can lead to protracted litigation rendering these avenues highly ineffective as collection mechanisms. It remains to be seen whether creditors will choose to initiate these recovery actions or wait until the end of the IBC suspension period to benefit from the IBC process.

What does the future hold?

The suspension of the IBC was intended to be a relief measure, but the fact remains that the IBC process not only provides for the relaunch of the debtor company, but also all the stakeholders of the debtor company within a specified period. The suspension of the IBC will not prevent creditors from attempting to recover their capital, but the alternative means that creditors would have recourse to could lack the protean nature of the IBC process. Additionally, these mechanisms may not lead to effective stress resolution that is the need of the hour during this economic downturn. Another factor to consider is that the deterrent effect typically achieved by lenders by threatening IBC action would no longer remain leading to at least some bad faith play of the system.

In order to ensure a quick resolution of troubled cases, it is imperative that creditors turn to consensual resolutions within a limited period of time rather than collection actions involving protracted legal proceedings.

BAC has proven to be effective legislation and the referral mechanism for creditors to achieve results. We are entering an interesting period where defaults will multiply without the use of IBC. It remains to be seen whether the alternative mechanisms can and will be sufficient to strengthen investor sentiment.

The contents of this document do not necessarily reflect the views/positions of Khaitan & Co but remain solely those of the authors. For any other questions or follow-up, please contact Khaitan & Co at [email protected].

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