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This post has been authored by Kartikey Sanjeev Bhalotia and Arshit Kapoor, B.B.A. LL.B (Hons.) candidates at the National Law University, Odisha.
Introduction
The Government of India (‘the Government’) enacted the Insolvency and Bankruptcy Code (‘the Code’) on 26 May 2016, with the primary objectives of insolvency resolution of corporate persons; maximization of the value of assets and balancing the interests of all the stakeholders.[i] Since its inception, the Code has witnessed numerous revisions by way of amendments and notifications, making the Code in its present form very dynamic in nature.[ii] Following the same trend, the Government on 24 March 2020 released a notification (‘the Notification’) by virtue of proviso to Section 4 of the Code,[iii] and increased the default threshold multi-fold from INR 1,00,000 to INR 1,00,00,000. [iv]
This notification came as an immediate attempt of relief for the chilling effect on the Indian economy caused due to the COVID-19 outbreak.[v] The Finance Minister of India in her press release stated that this move was taken in order to prevent the initiation of insolvency proceedings against companies especially the Medium, Small and Micro Enterprises (‘MSMEs’) considering the financial distress faced by them these force majeure times.[vi]
In this article, the authors analyse this notification on the grounds of first, its nature in terms of perpetuity, i.e., whether the notification brings in a permanent or a transient change in the Code; secondly, its applicability, i.e., prospective or retrospective; and lastly, its effect on the Operational Creditors. In doing so, the authors would conclude by classifying the notification as either ‘effective’ or ‘affective’ and suggest certain necessary steps that need to be taken in order to truly alleviate the stakeholders from the wrath of gruelling economic conditions caused by COVID-19.
Increased threshold : Really transient?
The Notification was released citing the reason as alleviating MSMEs of the economic crunch caused due to COVID-19 outbreak.[vii] However, the Notification as published in the Official Gazette of India had no mention of such objective whatsoever.[viii] It must be noted that the Report of the 3rd Insolvency Law Committee (‘the Committee’) published in February 2020, in para 2.4 had made a suggestion on the similar lines of increasing the default threshold to INR 50,00,000.[ix] The Notification when considered in the backdrop of the above fact, necessarily raises important questions vis-à-vis the perpetuity of this decision, i.e., whether the decision is merely a transient move and would be retracted once the economic conditions normalize, or is it aimed to give effect to the recommendation of the Committee.
The INR 1,00,000 threshold under Section 4 of the Code has been under severe scrutiny in the near past, for its effect of overburdening the judicial machinery which adjudicates the disputes under the Code.[x] This is apparent from the Committee’s Report which in recommending an increase of the said threshold reasoned that such revision would ‘significantly ease the burden on the Adjudicating Authorities while ensuring that cases that require recourse to the Code continue to have access to it.’.[xi] A perusal of the above background leads one to an inference that the Notification might be an attempt of bringing in a permanent change in order to give effect to the Committee’s recommendation. If it is the case, the Government has only tried to achieve two targets by adopting a single means, which might be ‘affective’ but not ‘effective’.
The permanency of this revision is likely to give rise to several important issues that are addressed in the subsequent parts of this article. However, without prejudice to the above, if it is assumed that this move is strictly transient in nature, it might change the whole perspective around it. Therefore, a clarification in this regard would become indispensable.
Applicability : Prospective or Retrospective
It is a well-settled law that before a legislative action clothes itself with retrospectivity, two prerequisites have to be satisfied, in the first place, the authority should have the power to make retrospective rules under a statute; and secondly, the notification issued should in the exercise of such power, should in unequivocal terms provide for such retrospective application.[xii]
In the case of the Code, the very first condition fails to be fulfilled. Neither Section 4 nor Section 239 (provisions that authorize the Government to notify rules in order to carry out the provisions of the Code) gives the Government a power to apply the rules made under these provisions retrospectively. As a necessary corollary, the Notification cannot have retrospective effect on the cases which have already come under the realm the Code on a date prior to releasing of the Notification.
While this might seem to be a ‘no question’, however, it becomes an important question when it is analysed as to when does a case actually come under the realm of the Code? The answer to this question lies within the Code itself, which provides that the code gets triggered only on acceptance of an application by the Adjudicating Authority.[xiii] In light of the Notification which is completely silent with respect to its applicability on pending applications which technically have not come under the realm of the Code, such applicants would be left in an erratic situation (for, in a literal sense, applying the Notification on pending applications can be termed to be prospective in nature). Therefore, it is essential to be clarified whether, by implication, the Notification applies to all cases which are pending consideration for ‘admission’, or to only such cases under which the application has been admitted.
Increased threshold : Ensuing into a class legislation singling out Operational Creditors
Scholars across the world have defined ‘Class Legislation’ as a State action that has an effect of singling out certain persons or group of persons for special benefit or burden.[xiv] The Notification increases the default threshold hundred-fold singling out the cases having default value below INR 1,00,00,000 which hitherto could have come within the ambit of the Code.
It has already been observed that the Code was enacted with a set of predetermined objectives, and ‘balancing the interests of all the stakeholders’ was an essential part of the same. Generally, a CIRP would have stakeholders inter alia in the form of a Corporate Debtor,[xv] Financial Creditors[xvi] and Operational Creditors.[xvii] The Financial and the Operational Creditors being the ones who in the first place invoke the Code against the Corporate Debtor for its default in payment of dues, this increased threshold has a direct bearing on their interests.
The difference between a ‘financial debt’ and an ‘operational debt’ is very instrumental for our analysis of the Notification and its effect of ensuing class legislation. A ‘financial debt’ is usually defined as a ‘debt taken in consideration of time value of money’,[xviii] or simply a loan is taken from a financial organisation against payment of interest.[xix] On the other hand, ‘operational debt’ are usually debts pertaining to goods and services, or wages and salaries.[xx] A bare perusal of these definitions points out towards the nature of these debts in terms of its quantum in value, i.e., it would not be farfetched to infer that financial debts of a Corporate Debtor would be higher in value than its operational debts.[xxi]
The effect this differentiation unequivocally raises several alarms for the Operational Creditors, i.e., persons supply goods and services to the Corporate Debtors on credit on the anticipation of payment in future. The Notification which increases the threshold to an amount as high as INR 1,00,00,000 inevitably significantly reduces the scope for Operational Creditors to bring their claims under the Code. Therefore, the Notification can be taken to single out Operational Creditors and create a Class Legislation to their disadvantage.
The disadvantage here is that the Operational Creditors for the reason of the low value of their claims would not be able to take benefit of the summary nature of the proceedings under the Code and therefore, would be deprived of the speedy avenue for ventilating their grievances against a Corporate Debtor.[xxii] It has to be noted that Operational Creditors majorly consist of vendors that sell goods and services on credit, and therefore, are likely to involve the business of smaller magnitude.[xxiii] It is therefore argued that while the Notification was aimed to ameliorate the conditions of MSMEs by preventing initiation of CIRP against them, has a very high probability of proving rather counter-productive in warding them off from seeking recourse under the Code for settlement of their claims.
Conclusion
There is no denying the fact that the whole world is going through red alert like circumstances on account of the COVID-19 outbreak. With the over 1.77 million confirmed cases and around 108,000 death across the world (increasing every minute), the overall day to day life has significantly suffered the pandemic’s blow.[xxiv] This has resulted in a worldwide economic slowdown, to which India is no exception.[xxv] The Notification was released in the light of these facts in order to prevent the situation of the weaker sects of the economic ecosystem of India (the MSMEs) from worsening. However, the authors on the basis of the prospective issues that flow from this action believe that the Notification might prove to be significantly counter-productive for the stakeholders in the long run.
It is, therefore, an immediate requirement that the Government issues a clarification on the perpetuity of the Notification, i.e., whether it is meant to be in operation only till the current economic situation normalizes or is it meant to stay for times to come. In doing so, the Government can offer some ease to the stakeholders, especially the Operational Creditors who have pending claims of an amount lower than the mammoth threshold of INR 1,00,00,000. The Government should also make a clarification regarding the Notifications applicability on a pending application, where the Code is yet to kick in.
The authors believe that a better alternative to this move could be opting for a strategic increase in the threshold for Financial Creditors exclusively, instead of raising the default threshold for all the creditors. The Supreme Court has already found that there exists an intelligible differentia between the two classes of creditors, i.e., Financial and Operational Creditors, therefore, a differential increase of the threshold for these two different classes of creditors would prove to be fairer and more practical.[xxvi]
Furthermore, another differential category that can be taken into consideration is on the basis of the size of a Corporate Debtor. The Government can ‘effectively’ achieve its purpose of safeguarding the interests of MSMEs by raising the default threshold exclusively for initiation of CIRP against them. In doing so, the Government can prevent the situation of MSMEs from worsening on two fronts, first, by preventing initiation of CIRP against them for defaults of small amounts; and secondly, by not pulling the plug of their access to the speedy recovery of their claims under the Code. This does not amount to class legislation but only amount to reasonable classification for the purposes of legislation, which is not barred.[xxvii] Therefore, such differential threshold limits would stand the test of constitutionality and at the same time would not be self-destructive. This, in the opinion of the authors, can be both ‘effective’ and ‘affective’ in achieving the ultimate objective of the Government.
End-Notes
[i] The Insolvency and Bankruptcy Code 2016 (India) <https://www.mca.gov.in/Ministry/pdf/TheInsolvencyandBankruptcyofIndia.pdf> accessed 5 April 2020. [ii] Since 26 May 2016, the Code has witnessed around four Legislative Amendments and over ten Notifications implementing varied changes in the Code in a period of merely 3 years from its enactment. Insolvency and Bankruptcy Board of India <https://www.ibbi.gov.in/> accessed 5 April 2020. [iii] Section 4 of the Code reads as follows – ‘This Part shall apply to matters relating to the insolvency and liquidation of corporate debtors where the minimum amount of the default is one lakh rupees: Provided that the Central Government may, by notification, specify the minimum amount of default of higher value which shall not be more than one crore rupees.’. [iv] The Notification Dated 24 March 2020 <https://www.ibbi.gov.in/uploads/legalframwork/48bf32150f5d6b30477b74f652964edc.pdf> accessed 6 April 2020. [v] ‘India's GDP May Grow at 4.8% in FY21, COVID-19 to Have Adverse Economic Impact Globally: UN Report’ The Economic Times (09 April 2020) <https://economictimes.indiatimes.com/news/economy/indicators/indias-gdp-for-fy21-projected-at-4-8-covid-19-to-have-adverse-economic-impact-globally-un-report/articleshow/75060555.cms> accessed 9 April 2020. [vi] ‘Finance Minister Announces Several Relief Measures Relating to Statutory and Regulatory Compliance Matters Across Sectors in View of COVID-19 Outbreak’ Press Information Bureau Government of India Ministry of Finance (24 March 2020) <https://pib.gov.in/newsite/PrintRelease.aspx?relid=200639> accessed 9 April 2020. [vii] ibid. [viii] The Notification (n 4). [ix] Insolvency Law Committee, Report of the Insolvency Law Committee (Insolvency Law Com No 3, 2020) <http://www.mca.gov.in/Ministry/pdf/ICLReport_05032020.pdf> accessed 10 April 2020. [x] ‘Government mulls raising Rs 1 lakh default threshold for invoking IBC: Srinivas’ The Economic Times (14 October 2019) <https://economictimes.indiatimes.com/news/economy/policy/government-mulls-raising-rs-1-lakh-default-threshold-for-invoking-ibc-srinivas/articleshow/71583287.cms> accessed 10 April 2020. [xi] Report of the Insolvency Law Committee (n 9). [xii] Director General of Foreign Trade and Anr v Kanak Exports and Anr Civil Appeal No 554 of 2006 <https://main.sci.gov.in/jonew/judis/43099.pdf> accessed 10 April 2020; cf General Clauses Act 1897, s 6 <http://legislative.gov.in/sites/default/files/A1897-10.pdf> accessed 10 April 2020. [xiii] Insolvency and Bankruptcy Code 2016 (n 1), ss 7(5), 7(6), 9(5), 9(6), 10(4), 10(5); Swiss Ribbons Pvt Ltd and Anr v Union of India and Ors Writ Petition (Civil) No 99 of 2018 <https://main.sci.gov.in/supremecourt/2018/4653/4653_2018_Judgement_25-Jan-2019.pdf> accessed 11 April 2020. [xiv] Melissa L Saunders, ‘Equal Protection, Class Legislation, and Colorblindness’ (1997) 96 (2) Mich L Rev 245 <https://www.jstor.org/stable/pdf/1290069.pdf?refreqid=excelsior%3A74f1adde968bdec0afbf21e3efa57a74> accessed 12 April 2020. [xv] Insolvency and Bankruptcy Code (n 1) s 3(8). [xvi] Insolvency and Bankruptcy Code (n 1) s 5(7). [xvii] Insolvency and Bankruptcy Code (n 1) s 5(20). [xviii] Swiss Ribbons (n 14) [23]. [xix] Insolvency and Bankruptcy Code (n 1) s 5(8). [xx] Insolvency and Bankruptcy Code (n 1) s 5(21). [xxi] Swiss Ribbons (n 14) [25]. [xxii] M/S Innoventive Industries Ltd v ICICI Bank and Anr Civil Appeal No 8337-8338 of 2017 [13] <https://main.sci.gov.in/supremecourt/2017/17291/17291_2017_Judgement_31-Aug-2017.pdf> accessed 12 April 2020. [xxiii] Swiss Ribbons (n 14) [27]. [xxiv] ‘Coronavirus India Updates: Total Cases Rise To 8,447; Death Toll At 273’ Bloomberg Quint (12 April 2020) <https://www.bloombergquint.com/coronavirus-outbreak/coronavirus-india-updates-total-cases-rise-to-8356-death-toll-at-273> accessed 12 April 2020. [xxv] Andrea Shalal and David Lawder, ‘IMF sees pandemic causing global recession in 2020, recovery in 2021’ Reuters (23 March 2020) https://in.reuters.com/article/us-health-coronavirus-imf/imf-sees-pandemic-causing-global-recession-in-2020-recovery-in-2021-idINKBN21A33O accessed 12 April 2020. [xxvi] Swiss Ribbons (n 14) [84]; Committee of Creditors of Essar Steel India Ltd Through Authorised Signatory v Satish Kumar Gupta and Ors Civil Appeal No 8766-8767 of 2019 [55] <https://main.sci.gov.in/supremecourt/2019/24417/24417_2019_4_1501_18158_Judgement_15-Nov-2019.pdf> accessed 12 April 2020. [xxvii] Navtej Singh Johar and Anr v Union of India Writ Petition (Criminal) No 76 of 2016 [236] <https://main.sci.gov.in/supremecourt/2016/14961/14961_2016_Judgement_06-Sep-2018.pdf> accessed 1 June 2020.