Relief and Respite: a look at changes to the insolvency regimes in India and the UK resulting from the Covid-19 crisis
CYK Senior Associate Arish Bharucha and Associate Shamilee Arora consider the Covid-19 pandemic, the resulting restrictions that have been imposed by the UK and Indian governments and how these have caused severe difficulties to a vast number of businesses.
The Covid-19 pandemic and the resulting restrictions that have been imposed by governments across the globe have caused severe difficulties to a vast number of businesses. Public apprehension, uncertainty, lockdowns, quarantine and distancing rules, restrictions on travel etc. have led to a sudden and drastic shock to the global economy, affected demand in a number of sectors and battered the cashflows, supply chains and logistics of countless companies.
It is unsurprising that governments have taken far-reaching steps to shore up businesses – by providing both financial assistance and legal and regulatory support. In taking such steps, they hope to prevent mass unemployment and stave off a depression by ensuring that companies are able to survive and to help deliver rapid economic growth and recovery. An important component in the strategy of governments has therefore been to reform insolvency laws to help companies to continue trading. In this article, we look at some of the changes that have been made to the insolvency regimes in India and the UK to help companies survive.
The UK Corporate Insolvency and Governance Act 2020 (the “UK Act”)
The UK Act was fast-tracked through Parliament and came into force on 26 June 2020. It contains a number of permanent and temporary measures and, whilst the former will continue to apply and assist companies after the present crisis has passed, they are all intended to assist companies that are struggling due to the pandemic. In fact, the explanatory notes to the Bill (which became the UK Act) stated, “the overarching objective of this Bill is to provide businesses with the flexibility and breathing space they need to continue trading during this difficult time.”
Here, we briefly outline a couple of changes brought about by the UK Act (although it is worth noting that there are others as well).
The Moratorium (permanent measure)
The relevant provisions, in essence, allow the directors of a company to remain in control whilst they try to ensure that the company can remain a going concern. Accordingly, the directors can apply to enter a moratorium for an initial (extendable) period of 20 days, during which time they will continue to be in charge and try to rescue the company. An independent ‘monitor’ is appointed during the moratorium period to perform certain important supervisory functions and can request information from the directors for this purpose.
During the moratorium period, the company receives a ‘payment holiday’. This essentially restricts the ability of creditors to recover pre-moratorium debts (subject to certain limited exceptions) whilst the moratorium is in effect. Accordingly, the company is given respite by being substantially protected from its creditors for a limited period, whilst it tries to turn things around.
We see this measure as the possible first step to other stages in insolvency proceedings, such as voluntary administration or liquidation. For example, if a company is unable to operate as a going concern following the extension of the moratorium, directors may then wish to proceed with formal insolvency proceedings. However, for some companies who are able to rescue the business in the short period of relief offered by the moratorium, this provision provides a viable alternative to insolvency.
Temporary suspension of statutory demands and winding up petitions.
Statutory demands and winding up petitions can be used by creditors to put pressure on a company with the aim of recovering monies owed. The provision, in essence, protects a company from being wound up during the relevant period (27 April to 31 December 2020) on the ground that it is unable to pay its debts unless the court is satisfied that coronavirus has not had a financial effect on the company. As such, it provides some breathing space for companies during this difficult time.
Whilst the provision may give some companies the needed respite from enforcement of debts and the requisite time to recoup losses, it is likely that companies whose revenues and cash-flows have not been able to recover, either owing to the social distancing measures or general dip in demand, will find themselves at the receiving end of statutory demands and winding up petitions following the lifting of such measures.
Changes to the Indian regime
By way of the IBC (Amendment) Ordinance 2020 dated 5 June 2020 (the “Ordinance”), issued by the Finance Ministry of the Government of India, key provisions of the Insolvency and Bankruptcy Code, 2016 (“IBC”) have been temporarily suspended in order to protect businesses from the disruption caused by the Covid-19 pandemic and the stringent lockdown measures imposed by both the union and relevant state governments of India.
Suspension of sections 7 and 9: enforcing debts
The Ordinance suspends the initiation of insolvency proceedings against entities pursuant to sections 7 (proceedings initiated by financial creditors) and 9 (proceedings initiated by operational creditors) for defaults arising on or after 25 March 2020. The relevant suspension is in place for a year (from 25 March 2020). The sweeping measures allow companies and businesses to operate without the fear of being subject to insolvency proceedings for defaults that are likely to arise because of the economic impact of the pandemic. Coupled with the raised financial threshold for commencing insolvency proceedings, the measures are aimed at protecting businesses that may otherwise find themselves being subject to insolvency proceedings because of cash-flow issues and falling demand in the current economic climate.
The interesting point to note is that, given the suspension on enforcement of debts is temporally fixed for all defaults arising after 25 March 2020, companies whose cash-flow difficulties and inability to pay debts are not necessarily linked to the pandemic, will now be able to take protection from enforcement as a result. That said, whilst the government could have put in place provisions for preventing the enforcement of debts or defaults resulting from the effect of the pandemic, demonstrating direct causation and defining rules to cover a myriad of potentially complex scenarios would have been tricky and likely to result in uncertainty. Therefore, it seems to us that the collateral effect of protecting weak companies that would have defaulted, notwithstanding the pandemic, is, on balance, preferable to more complicated rules specifically targeting defaults directly linked to the pandemic.
Suspension of section 10: insolvency resolution proceedings
The purpose of section 10 of the IBC is to permit companies who are struggling with existing debts to institute insolvency resolution proceedings with a view to restructuring and reorganising debts. The insolvency resolution proceedings are a powerful tool for corporate entities to seek to avoid hostile insolvency proceedings and retain control of a company and its assets whilst the restructuring process is ongoing. In the face of considerable cash-flow difficulties resulting from diminishing demand, companies may want to begin resolution processes in order to manage debts and reorganise themselves for the post-pandemic economic landscape. However, it seems that this provision has been suspended with a view to allow companies to use this time to focus on running their businesses as opposed to considering potential insolvency/restructuring.
We note that this provision has been the subject of much criticism from commentators on the basis that it deprives companies of the means to take control of and restructure their debts at a time when a considerable number of companies are seeing falling revenues and diminished cash flows. It seems to us that it is likely, upon the reinstatement of this provision, that we will see numerous applications pursuant to section 10 from companies that have been unable to stabilise revenues and manage debts in the interim.
The similar measures taken by the UK and Indian governments are not without risk. Both the governments’ approaches have been criticised in some quarters on the basis that such measures simply delay the economic impact of the pandemic induced recession and are likely to be detrimental to creditors’ interests, possibly precipitating a financial crisis. However, given the scale and urgency of the problem, we consider that that these steps were necessary. Whilst the prospect of large-scale insolvencies remains (as and when the temporary measures lapse), the respite provided should give sustainable companies, whose financial difficulties arise as a result of the pandemic, a reasonable chance to survive and thrive in the future.