Economic Updates: Amendments to Insolvency & Bankruptcy Code gets Parliament nod

Insolvency and Bankruptcy Code (Second Amendment) Bill, 2020

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Insolvency and Bankruptcy Code (Second Amendment) Bill, 2020

In News:

  • The Parliament has passed the Insolvency and Bankruptcy Code (Second Amendment) Bill, 2020.
  • It replaces the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020 promulgated in June this year.
  • The ordinance came in response to the Covid-19 pandemic, which had created uncertainty and stress for businesses.
  • The bill amends the Insolvency and Bankruptcy Code (IBC), 2016 which provides a time bound process for resolving insolvency in companies and also among individuals.
  • Insolvency is a situation where individuals or companies are unable to repay their outstanding debt. 

Insolvency and Bankruptcy Code (Second Amendment) Bill, 2020:

Prohibition on the initiation of insolvency resolution process:

  • When a default occurs, the IBC allows the creditors of the company or the company itself to initiate an insolvency resolution process by filing an application before the National Company Law Tribunal (NCLT). 
  • As per the bill, for defaults arising during the six months from March 25, 2020, insolvency proceedings can never be initiated by either the company or its creditors. 
  • The central government may extend this period to one year through notification. 
  • The Bill clarifies that during this period, insolvency proceedings can still be initiated for any defaults arising before March 25, 2020.

Liabilities for wrongful trading:

  • Under the IBC, a director or a partner of the corporate debtor (company) may be held liable to make personal contributions to the assets of the company in certain situations
  • This liability can occur if despite knowing that the insolvency proceedings cannot be avoided, the person did not try to minimize the potential loss to the creditors. 
  • The Resolution Professional may apply to the National Company Law Tribunal (NCLT) to hold such persons liable. The Resolution Professional is appointed to manage the resolution process.
  • The Bill prohibits the Resolution Professional from filing such an application in relation to the defaults for which insolvency proceedings have been prohibited during the above mentioned period.

Issues with the Amendments:

  • A complete suspension of insolvency proceedings may prevent an already stressed company’s opportunity to initiate insolvency proceedings under the IBC framework.  
  • Thus, for certain companies, postponing the insolvency proceedings may increase their financial stress and loss in value.  
  • There may be certain defaults, which may not be due to Covid-19 related disruptions, but due to the stress in the company before the pandemic. Thus, there is no need to treat all the defaults in the specified period, in the same manner.

Prohibition of corporate debtor from initiating insolvency proceedings:

  • The current amendments prohibit the corporate debtor (the company) from initiating the insolvency proceedings.
  • However, a corporate debtor may have a better idea on the need for initiating insolvency proceedings.
  • A voluntary and timely initiation of insolvency proceedings could maximize the benefits for the debtor as well as creditors.

Prohibition of insolvency proceedings forever:

  • The Bill states that no insolvency proceedings can ever be initiated against defaults occurring during the specified period.  
  • This could result in a scenario where creditors are unable to hold the company responsible for these defaults even after the company’s ability to repay has been restored.

Insolvency proceedings against the personal guarantor:

  • Under the IBC, insolvency proceedings can be initiated against the personal guarantor of a corporate debtor.  The personal guarantor provides a guarantee for the debt of a corporate debtor.  
  • While the Bill prohibits insolvency proceedings against the corporate debtor for the defaults occurring during the specified period, it does not disallow such action against the personal guarantor.  
  • It does not sound logical that the personal guarantor should be held liable for defaults, when the original debtor’s liability has been relaxed.

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