By: Meghna Punjabi
Government of India has announced a slew of measures to ease regulatory and statutory compliance obligations in the wake of the Corona pandemic. One of these is a notification dated 24th March, 2020 (Notification) increasing the minimum threshold limit for invoking insolvency under the Insolvency and Bankruptcy Code, 2016 (Code).
This Notification has elicited mixed reactions and we have tried to examine why.
Instituting Insolvency Proceedings – Before and After the Notification
The Code requires a monetary default threshold to be met in order to initiate the corporate insolvency process against a company (corporate debtor). Previously, the threshold of default stood at INR 100,000 (Rupees One hundred thousand). In other words, in the event the corporate debtor fails to repay a debt of this amount or more, an application could be filed by an operational creditor to initiate the insolvency resolution process. The Notification has now enhanced this threshold to INR 10 Million.
The Code has been immensely helpful to creditors seeking quick recovery of their dues. The low threshold enabled creditors to use the Code as a recovery tool. On the flip side, the National Company Law Tribunals (NCLTs) where these applications are filed were getting overwhelmed and many solvent companies were threatened with liquidation even when they were battling temporary liquidity issues. For instance, e-commerce giant Flipkart was recently dragged to the NCLT by one of its operational creditors for a payment default.
What are the implications?
The immediate impact of the change is that it impairs a major class of operational creditors from resorting to the Code for relief as their claim may fall below the minimum threshold.
Under the Code, the operational creditor stands on a different footing from a financial creditor. A financial creditor may file an application by itself or jointly with other financial creditors enabling it to trigger the Code along with defaults of other financial creditors. An operational creditor, on the other hand, must meet the default threshold individually as there is no provision for operational creditors to file a joint application for combined debts against the corporate debtor. This prevents an entire class of operational creditors from bringing a claim against the corporate debtor under the Code.
On the other hand, the Notification comes as a major relief for MSME debtors facing severe business losses in this time of uncertainty. The Notification will enable corporate debtors to focus on business operations without the looming danger of insolvency proceedings.
Applicability of the amendment?
The effective date of the Notification is not clear. There is also no clarity on its impact on pending applications filed but not admitted and matters where the demand notice has been issued but the Section 9 application could not be filed due to the lockdown.
What remedies are now available to the operational creditors?
With the Code no longer an option for operational creditors with claims less than INR 10 million, they may have no choice but to resort to the following remedies:
Arbitration, if the agreement provides for an arbitration clause. Although a costly option, arbitration is substantially quicker than litigation.
Civil suits, which will take several years to conclude.
Invoke the provisions of Section 18 of the Micro, Small and Medium Enterprises Development Act, 2006, (MSMED Act) provided the creditor is a registered enterprise under the MSMED Act.
An operational creditor, who is registered as a micro, small or medium enterprise can approach the facilitation council set up in the relevant state seeking orders for payments that are pending for more than 45 days. The MSMED Act provides for compound interest of three times the RBI rate of interest on the delayed payments. On receipt of such a complaint from an MSME unit, the MSMED Facilitation Council may issue notice to the opposite party and work out conciliation. If the conciliation does not succeed, the dispute is referred to arbitration. The facilitation council is required to dispose of the matter within 90 days from the date of reference. The short timelines and the high interest rate are great incentives to pursue relief under the MSMED Act. However, in practice, the timelines are hardly met for want of adequate number of facilitation councils in the states and the infrequency of its meetings.
The Notification comes at a time when businesses across sectors are staring at prolonged uncertainty. The revised threshold will no doubt prevent triggering of insolvency proceedings against small and medium enterprises that are major contributors to India’s GDP and employment. The Notification will also curb frivolous applications and ease the burden on NCLTs across the country. On the flip side, the Notification deprives legitimate creditors grappling with cash flow constraints an efficient remedy and is not aligned with the objective of the Code, i.e., to balance the interest of the operational creditors and the corporate debtors.