IBC: Increase In Threshold To Trigger Insolvency May Not Be A Temporary Measure, Experts Say

Blanket suspension of sections that allow for initiation of insolvency may not be a prudent move, experts say.

(Photographer: Udit Kulshrestha/Bloomberg)  
(Photographer: Udit Kulshrestha/Bloomberg)  

To avoid large-scale insolvencies as a result of financial stress caused by Covid-19 disruption, the government raised the threshold for default under the bankruptcy law.

So far, an insolvency resolution process could be initiated for a default of more than Rs 1 lakh. This has been increased to Rs 1 crore.

Industry had sought a higher threshold even before the Covid-19 outbreak since it was leading to way too many insolvency applications, Pooja Mahajan, managing partner of Chandhiok & Mahajan, said. “This may not be a temporary amendment since it has been announced as an MSME (medium, small and micro enterprises) measure. The finance minister didn’t spell out any expiry date for this change like it was done for many other announcements.”

As for the delays caused due to Covid-19, the National Company Law Tribunal should grant extensions to ongoing cases.

More changes to the Insolvency and Bankruptcy Code, 2016 may be in the offing, Finance Minister Nirmala Sitharaman said in a press conference on Tuesday.

If the current situation continues beyond April, IBC provisions that allow for initiation of insolvency resolution may be suspended for six months, she said. These are Sections 7 and 9, which allow financial and operational creditors to initiate insolvency resolution; and section 10 that provides for voluntary insolvency filing.

If Section 7 is suspended, it will be a huge blow for creditors of legacy cases where the default is above Rs 2,000 crore and are impacted by RBI’s June 7 circular, Suharsh Sinha, partner at AZB & Partners, told BloombergQuint.

My fear is that there are a lot of companies who were in distress even before Coivid-19, and banks are incurring provisioning cost as a result of them. If section 7 is suspended starting April, banks will have to do a 35 percent provisioning for these cases.
Suharsh Sinha, Partner, AZB & Partners

According to the RBI’s June 7 circular, banks get 210 days from the day of default to come up with a resolution plan for borrowers with outstanding dues of over Rs 2,000 crore. They are expected to make additional provisioning of 20 percent, over and above the provisions they hold, if the plan is not implemented within 180 days. If the plan is not implemented within 365 days, provisioning goes up to 35 percent.

If the government goes ahead with the decision to suspend Section 7, the Reserve Bank of India should also consider suspension of ageing and provisioning norms so that banks don’t end up absorbing a disproportionate part of the blow, Sinha said.

Similarly, suspending section 10 might not be a prudent move either. If the company itself wants to file for insolvency due to economic stress, why should it not be allowed to, Sinha asked.

The decision to suspend the three sections may be considered after April 2020.