IBC suspension and its consequences
Corporate borrowers were once again saved by the bell. On Thursday, the government extended the suspension of bankruptcy proceedings by three more months till December 24, just hours before the relaxation was about to lapse. It had first suspended the corporate insolvency resolution process under the Insolvency and Bankruptcy Code (IBC) in June. Via an Ordinance, Section 10A was inserted, staying operations of Sections 7, 9 and 10 and in effect barring insolvency proceedings for debt defaults arising on or after 25 March 2020 for six months, extendable up to a maximum of one year.
With Thursday’s relief, all corporate defaults between March 25 and December 24 are knocked permanently out of the IBC radar. Predictably, it didn’t enthuse creditors and critics, who believe that such a blanket prohibition incentivises wilful defaults favouring permanent protection. Besides, they argue, the move eliminates IBC’s inherent rationale of creditor-in-the-saddle approach in lieu of debtor-in-control regime. That’s because Sections 7 and 9 allow financial and operational creditors respectively to initiate the resolution process, while Section 10 facilitates voluntary insolvency by corporates. With all three now suspended, concerns were raised regarding unintended consequences and whether it deprives users of the very benefits of IBC.
Clearly, the suspension prevents two things—garage sale of companies driven by pandemic-led low valuations and NCLTs from getting choked with cases. Globally too, bankruptcies are bound to rise, perhaps compelling the government towards an all-hands-to-the-pump approach. In any case, creditors can initiate action against defaulters via debt recovery tribunals, civil courts and even the Sarfaesi Act.
Moreover, insolvency proceedings against personal guarantors aren’t suspended, so banks can invoke securities in cases they deem fit to avoid accumulation of living-dead borrowers, once dominant on bank balance sheets leading to the recent NPA crisis. Importantly, banks must continue risk-based supervisory processes to ensure timely recognition of risks. The IBC’s objective is to avoid problems in extreme downturns of a business cycle, but in its attempt to salvage value in loan assets, the government should avoid exacerbating systemic trouble.