From UPSC perspective, the following things are important :
Prelims level : IBC, difference between operational and financial creditor, threshold limit to file insolvency case etc.
Mains level : Paper 3- Purpose and issues with IBC, its various provisions and changes that needs to be made in the wake of Covid-19.
This article argues the suspension of IBC for six months. The issues arising out of suspension like damage to the creditors are also dealt with here. Reading of this article will help us understand the finer details of IBC that are relevant from the UPSC point of view. We have also covered one article from livemint dealing with the same issue, but that article covered the issue in a broader sense.
Who are operational and financial creditors?
- After the lockdown is over, several companies are likely to default on their dues to both operational and financial creditors.
- Who is a financial creditor? The financial creditors include banks and others who have given financial assistance to a company in the form of loans and debentures.
- According to a 2018 amendment to the Insolvency and Bankruptcy Code (IBC) 2017, flat purchasers are also deemed as financial creditors.
- An operational creditor is just about anyone who has to receive money from a company.
- The IBC provides a fast-track mechanism to deal with companies which are unable to repay their creditors and have become financially unviable.
- Section 22 of the Code mandates the appointment of a Resolution Professional (RP) who is expected to miraculously turn around the company in 330 days.
- If this attempt fails, the company goes into liquidation.
The two types of creditors were in the news, so pay attention to these terms.
Increase in threshold limit to file an insolvency petition
- The IBC’s provisions have been extensively used by various creditors whose dues were not paid.
- What was the threshold limit? Initially, the threshold limit was just Rs 1 lakh and the IBC became an effective recovery mechanism for all operational creditors.
- What is the limit now? Just before the lockdown, the finance minister raised the threshold for invoking the insolvency provisions to Rs 1 crore.
- This limit was raised to prevent proceedings being initiated against small and medium enterprises.
Possibility of the domino effect after the lockdown is over
- After the lockdown, several enterprises, large, medium and small, might not be able to pay their dues, at least in the short-term.
- The easiest way for a creditor to recover money is to initiate insolvency proceedings against the debtor company and threaten it with liquidation.
- The shutdown of business after the lockdown could have a domino effect.
- How would the domino effect come into play? If an auto-manufacturer has shut down its operations, the ancillary units will not get their dues.
- This would then lead to non-payment to downstream vendors and service providers as well.
- It might take at least three to four months for the situation to stabilise.
Steps that should be taken to avoid the domino effect
- Moratorium on the IBC: The most important, and immediate, step that needs to be taken is to have a six-month moratorium on the IBC.
- It may be necessary to promulgate an ordinance suspending the prospective operation of Sections 7 and 9 of the IBC so that no fresh petition is filed against a company.
- Impact on creditors: While this could hurt some of the creditors, the damage that could be done to the corporate sector by invoking the IBC is likely to be far greater.
- A distressed creditor is not without a remedy as he can always approach the civil courts for relief, which will not be so severe on a defaulting company.
- If an insolvency petition is filed and the RP appointed, it is difficult to stop the insolvency process.
- The IBC requires a financially-stressed company to be taken over by a financially-sound
- For example, Essar Steel was taken over by ArcelorMittal and Bhushan Steel was taken over by Tata Steel.
- In the current scenario, it will be difficult, if not impossible, for an RP to find a suitable buyer and the only option would be to liquidate the company.
- Using the insolvency process to recover dues is contrary to the IBC’s objectives.
The objective of the IBC is not just insolvency but the reorganisation of companies, maximisation of value of assets and the need to balance the interests of all stakeholders. Pay attention to this point.
How the suspension of the IBC will be beneficial?
- Suspending the IBC for a short period would enable several companies to return to normalcy.
- It will help them function without the constant threat of an insolvency application and its Board of Directors and management being taken over by the RP.
- Moreover, the National Company Law Tribunal benches will simply be unable to take any additional workload.
Suspending the IBC for six months would be a much-needed step to prevent further damage to the economy. It would be in the larger public interest. Indeed, at this critical stage, permitting the legal remedy of insolvency could be the last nail in the coffin of many companies.
Back2Basics: What is the Insolvency and Bankruptcy Code?
- IBC provides for a time-bound process to resolve insolvency.
- When a default in repayment occurs, creditors gain control over debtor’s assets and must take decisions to resolve insolvency.
- Under IBC debtor and creditor both can start ‘recovery’ proceedings against each other.
- Insolvency and Bankruptcy Code 2016 was implemented through an act of Parliament.
- It got Presidential assent in May 2016.
- The law was necessitated due to huge pile-up of non-performing loans of banks and delay in debt resolution.
- Insolvency resolution in India took 4.3 years on an average against other countries such as United Kingdom (1 year) and United States of America (1.5 years), which is sought to be reduced besides facilitating the resolution of big-ticket loan accounts.