BANKRUPTCY PROCEEDINGS HALTED: ANY ALTERNATIVE DEBT RESTRUCTURING MECHANISMS?
This post is authored by Aastha Agarwalla, an L.L.B. Candidate at the Campus Law Centre,
Faculty of Law, University of Delhi.
In a bid to provide relief to financially stressed companies on account of the outbreak of the coronavirus pandemic, the Hon’ble President of India promulgated the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 (hereinafter "Ordinance”) on June 5, 2020.[i] Pursuant to the enforcement of the Ordinance, the insolvency regime has come to a halt as no fresh applications can be filed for the initiation of proceedings of the Corporate Insolvency Resolution Process for one year. Pertinently, the enactment of the Insolvency and Bankruptcy Code, 2016 (hereinafter “IBC”) operationalized a robust debt structuring mechanism in India, thereby the temporary suspension of the IBC necessitates the evolution of the alternative debt restructuring mechanisms by deploying extant legal recourses, by the regulatory authorities.
Companies, both internationally and domestically, will invariably seek to resort to other debt restructuring mechanisms in order to mitigate their financial stress and revive from the economic meltdown triggered by the novel coronavirus. In this article, the author discusses the alternative mechanisms available to companies to restructure their debt, whilst vouching for the need to adapt innovative measures such as pre-packaged insolvency to supplement and strengthen the existing framework in India.
Debt Restructuring Mechanisms
Corporate debt restructuring framework is premised on the objective to ensure a timely and transparent mechanism for restructuring of corporate debts of corporate entities experiencing financial distress. Prior to suspension of the IBC, a corporate entity sought to restructure their debt by resorting to any of the three methods: resolution mechanism envisaged in IBC; scheme of arrangement under section 230 of the Companies Act, 2013 (hereinafter “the Act 2013”) and Prudential Framework for Resolution of Stressed Asset by the Reserve Bank of India (hereinafter “RBI”). However, now companies can soften the financial setback and tide over the capital crunch, either by the schemes of arrangement or the Prudential Framework, as discussed herein.
A. Prudential Framework for Resolution of Stressed Assets by the RBI
The RBI on 7 June 2019 rolled out a prudential framework for expeditious resolution of stressed assets (commonly known as Non-Performing Assets) in the banking system (hereinafter ‘the Prudential Framework”).[ii] Essentially, the mechanism is based on the ‘London Approach’ which is founded upon the principles of collective and coordinated efforts to rescue a defaulting firm that has multiple creditors.[iii] The Prudential Framework postulates regulatory timelines for lenders (Scheduled Banks, All India Term Financial Institutions, Small Finance Banks; and Non-Banking Financial Companies) to implement the resolution plan before initiating court driven proceedings under IBC. Once a borrower is reported to be in default by any of the lenders aforementioned, the lender shall undertake a prima facie review of the borrower account within thirty days from such default (hereinafter “Review Period”) in order to decide the resolution strategy. In this continuum, the lenders implement the resolution plan in respect of entities in default within 180 days from the end of the Review Period.
It is also worth noting that to ease the impact of the novel pandemic, the RBI on 17 April 2020 issued a regulatory package revising the prescribed resolution timelines in the Prudential Framework.[iv] The RBI directed that accounts which are within the Review Period as on 1 March 2020, the period from 1 March 2020 to 31 May 2020 (Exclusion Period) shall be excluded for the calculation of the review period of 30 days
Earlier this year, Sulzon Energy Ltd., chose to restructure the debt of their company and the identified subsidiaries under the said Prudential Framework, and consequently, the resolution plan to convert loan into equity was unanimously approved by the consortium lenders.[v] Thus, the Prudential Framework will potentially act as a breather in such unprecedented times, for financially troubled companies for immediate reinforcements and less formal corrective action, without any recourse to the courts. Moreover, it’s a transient opportunity for the Lenders as they have the power to control the negotiations of resolution process in contrast to framework of IBC (i.e. a court-driven mechanism), and without the fear of enforcement actions by one or more creditors.
B. Scheme of Arrangement under the Act 2013
The scheme of arrangement as a tool of debt restructuring has been available for over a century in India, right from the provisions of section 153 of the Companies Act, 1913; more importantly, it is used sparingly because it is a collective action. Presently, it is contained in section 230 of the Act 2013. Succinctly, the modus operandi to restructure debt begins with the passing of a board resolution by the board of directors proposing a scheme between itself and its creditors or shareholders. Further, to operationalise the scheme, the company makes an application to the National Company Law Tribunal (hereinafter “NCLT”) to convene meetings of the respective classes of creditors. Thereafter, the NCLT, keeping in mind the interest of all the stakeholders, sanctions the scheme.
Despite considerable delays because of onerous procedural requirements, it has certain advantages. Firstly, Section 230 encompasses various types of transactions to restructure debt that might involve the sale of assets or business of the debtor company or its amalgamation with another company. Hence, it provides sufficient leeway to the financially distressed company and its creditors to negotiate using innovative types of restructuring options. Secondly, a temporary halt of IBC will witness a shift from the ‘creditor in control’ model in IBC to the ‘debtor-in-possession’ regime envisaged in the Act 2013 because it will not affect the management control of the company. However, in case of companies in distress due to mismanagement or self-serving behavior on the part of the management or promoters, the debtor-in-possession regime may exacerbate the situation further, exposing the creditors to further peril.[vi] Last and the most important advantage, once the scheme is sanctioned by the NCLT, it has a binding effect on all stakeholders (even the dissenting minority shareholders), which is a colossal drawback of the Prudential Framework. The Prudential Framework’s narrow coverage discriminates against nonparticipating creditors who remain outside the framework, and hence a complete and meaningful resolution becomes impossible.[vii]
Historically, section 230 has been invoked in complex debt restructuring cases such as BPL Limited and Essar Oil Limited among others. Therefore, schemes of arrangement can be employed as a feasible tool to accomplish debt restructuring in different ways in large and complex transactions.
Way Forward and Conclusion
From a legal and institutional perspective, India still has inadequate avenues for financially distressed companies to manage their stressed assets and thus, significant reforms ought to be introduced in the realm of debt restructuring. To obviate the compulsion to resort to the overburdened court system, mechanisms such as ‘pre-packaged insolvency’, similar to the practice used extensively in the United States and the UK, can be adopted in the near future. The pre-packaged insolvency is a novel hybrid model wherein a restructure plan is agreed in advance of a company declaring its insolvency. In 2019, the Ministry of Corporate Affairs solicited public comments on ‘pre-pack insolvency’ as a viable resolution mechanism in India in order to avoid lengthy negotiations in the court.[viii] Additionally, pre-pack insolvency will be a win-win for both entities as the company avoids bankruptcy and the lenders typically receive more than what they would through a bankruptcy proceeding because of less value destruction of assets.
In the author’s opinion, a blanket suspension of the IBC without introducing alternatives to debt restructuring will invariably aggravate the financial crisis and economic fallout in the Indian economy. The legislature and policymakers in India must focus on the mechanisms adopted by the matured jurisdiction like USA, UK, and Australia, and take a cue to supplement the disgruntled creditors/lenders with an effective and efficient debt resolution framework in such times.
[i] Ministry of Law and Justice, The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, No. 9 of 2020, June 5 2020 available at http://www.mca.gov.in/Ministry/pdf/IBCAmedBill_05062020.pdf [ii] Reserve Bank of India, Prudential Framework for Resolution of Stressed Assets, Notification RBI/2018-19/203, (June 7 2019), available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0 [iii] Rajeswari Sengupta, Anjali Sharma, Susan Thomas, Evolution of the insolvency framework for non-financial firms in India, June 2016, available at http://www.igidr.ac.in/pdf/publication/WP-2016-018.pdf [iv] Reserve Bank of India, COVID19 Regulatory Package – Review of Resolution Timelines under the Prudential Framework on Resolution of Stressed Assets, Notification RBI/2019-20/219, (Apr. 17 2020), available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11871&Mode=0 [v] Suzlon Energy receives lenders approval for debt resolution plan, Business Standard, available at https://www.business-standard.com/article/news-cm/suzlon-energy-receives-lenders-approval-for-debt-resolution-plan-120033000969_1.html [vi] Umakanth Varotill, The Scheme of Arrangement as a Debt Restructuring Tool in India: Problems and Prospects, (Mar.. 2017), available at https://law.nus.edu.sg/wps/pdfs/005_2017_Umakanth.pdf [vii] Sunil Kumar Gupta, Corporate rescue in India: trends and prospects (2014) Int’l Company Com. L. Rev. 244 [viii] Ministry of Corporate Affairs, (Apr. 16 2020), available at https://ibbi.gov.in/webfront/Notice%20for%20inviting%20public%20comments%20on%20Code.pdf